Yoshihisa Morimoto: Economic activity and prices in Japan and
monetary policy
Summary of a speech by Mr Yoshihisa Morimoto, Member of the Policy Board of the Bank of
Japan, at a meeting with Business Leaders, Saitama, 9 December 2010.
* * *
I. The global economy
Economic activity in Japan is closely linked to global economic developments. Therefore,
before discussing the Japanese economy, I will first take a look at trends in the world
economy. From around 2005, the world economy grew at a rapid pace of around 5 percent
annually, with China and other emerging economies gaining in prominence. The failure of
Lehman Brothers in September 2008, however, brought this growth to a sudden halt, and the
world economy marked negative growth in 2009 due to the severe contraction in the first half
of the year. Causes of the sharp decline include the rapid deceleration in economic and
financial activity due to the financial crisis triggered by the Lehman shock, and the
corrections to the various excesses that had built up in the world economy since the
mid-2000s. By "excesses," I am referring to overborrowing by households, excess production
capacity in the corporate sector, and the large amount of nonperforming loans held by
financial institutions.
Measures to address the financial crisis implemented by governments and central banks
around the world started to show effects from the second half of 2009. With the contraction in
economic and financial activity having come to a halt, policy measures to stimulate demand
provided a further boost. It should be noted, however, that the pace of economic growth has
been slowing somewhat since summer 2010, as restocking of inventories that took place
during the recovery phase came to an end and the effects of demand-boosting measures in
the United States and other countries waned. The slowdown is also due in part to the
unwinding of accommodative policies in emerging countries in order to keep economies from
overheating.
A. Advanced economies
Let us look at advanced economies in more detail. The U.S. economy remains on a
moderate uptrend. Although the effects of fiscal stimulus measures have been waning,
exports to emerging and commodity-exporting economies have continued to increase and
private consumption and business fixed investment have been rising moderately. Housing
starts have remained at a depressed level after dropping sharply due to the expiry of tax
credits for homebuyers, but are unlikely to fall further.
As for the outlook, the U.S. economy is likely to continue recovering on the back of
increasing exports and accommodative monetary policy. It must be added, however, that in
the labor market employment conditions have not improved greatly, with unemployment, for
example, remaining at a high level. Consequently, balance-sheet adjustments in the
household sector - that is, the restoration of financial health, including the repayment of
household debt - are unlikely to gather pace, so that the pace of recovery is likely to remain
moderate.
Economic activity in the euro area as a whole has been recovering moderately, with some
differences in growth by country: Germany has performed strongly while other countries have
lagged behind. Although the pace has been slowing, exports and production have continued
to increase, while domestic demand components, such as private consumption, have been
rising from the previous quarter. For the present, the euro area is likely to continue
recovering moderately. However, attention needs to be paid to the effects of fiscal
consolidation, which from next year will start in earnest also in the major economies, and to
volatility in financial markets due to concerns over the public and private debt problems in
some of the peripheral countries.
B. Emerging and commodity-exporting economies
Although emerging and commodity-exporting economies are often grouped together, they
are a diverse group. Here, I will focus on the major East Asian economies, since they are
most relevant to Japan. First, the Chinese economy has continued to show high growth of
around 10 percent. Although the pace of increase in exports has been slowing due to a
deceleration in overseas economies such as the United States, domestic demand, as
indicated by retail sales and investment in fixed assets, has continued to show high growth.
Like China, South Korea, Taiwan, Thailand, and other NIEs and ASEAN countries also
experienced continued economic growth driven by domestic demand, although inventory
adjustments in IT-related goods are casting a shadow on the outlook for exports.
Overall, it is very likely that emerging and commodity-exporting economies will continue to
show relatively high growth due to robust domestic demand and capital inflows from
overseas. The pace of growth of the Chinese economy is likely to decelerate somewhat due,
among other things, to government measures to restrain the increase in real estate
transactions. However, given the continuing increase in private consumption, growth is
nevertheless likely to remain relatively high. Economic conditions in the NIEs and ASEAN
countries are expected to follow a recovery trend due to the inflow of overseas capital and
increases in private consumption and business fixed investment.
II. The Japanese economy
Based on the above assessment of the world economy, I will now talk about economic
activity and prices in Japan. Semiannually, in April and October, the Bank of Japan releases
the Outlook for Economic Activity and Prices, known as the Outlook Report, in which it
makes public its forecasts for economic activity and prices for the next two to three years, the
background for its forecasts, and the associated risk factors. My speech today will from time
to time refer to this report, in particular the October 2010 Outlook Report.
A. Economic activity
Real GDP growth for the July-September quarter of 2010 was relatively strong. Recent
developments in production, however, indicate that the economic recovery seems to be
pausing. The pause in the recovery can be attributed to various factors, including a decrease
in demand following the last-minute rise in demand ahead of the expiration of subsidies for
purchasers of environmentally friendly cars and the boost from the extremely hot weather,
the deceleration in overseas economies, and inventory adjustments in IT-related goods.
Looking at the situation for each demand component, real exports as a whole have recently
been more or less flat, reflecting the following factors: (1) the effects of inventory adjustments
in IT-related goods such as semiconductors in South Korea and Taiwan; (2) the deceleration
in the U.S. economy; (3) the unwinding of accommodative monetary policies in emerging
economies; and (4) the effects of the strong yen on exports of cars and other goods.
However, given the strong domestic demand in emerging economies, Japan's exports are
unlikely to fall precipitously and are likely to recover in the longer term, providing support to
the economy overall. Furthermore, production, which is likely to remain lackluster for a while
due to the reasons mentioned above, is expected to gradually return to a moderate upward
trend along with the recovery in exports.
The Bank maintained its assessment of business fixed investment as "showing signs of
picking up." This rather cautious assessment, despite the fact that business fixed investment
this fiscal year is likely to turn out to be higher than in the previous year, reflects the
following: (1) the fact that firms continue to feel that their capital stock is still excessive;
(2) the shift of production to overseas locations; (3) the deceleration in overseas economies;
and (4) the appreciation of the yen. Yet, I frequently hear that there is considerable pent-up
need for replacement investment and investment in environmentally friendly equipment,
given that firms have held back on such investment since the collapse of Lehman Brothers.
Barring any extreme external shocks, the pick-up in business fixed investment is therefore
expected to gradually become more pronounced as a result of the improvement in corporate
profits.
Turning to the household sector, private consumption in the July-September quarter of 2010
was supported by the last-minute rise in demand ahead of the expiration of subsidies for
purchases of environmentally friendly cars and the increase in the tobacco tax, in addition to
the boost from the extremely hot weather. There was a clear decrease in sales of cars, with
the exception of small cars with engine sizes of 660 cc or less, which in October and
November were sharply down, by approximately 30 percent, from the same period a year
earlier. I earlier mentioned some factors behind the current "pause" in the economic
recovery. Among them, I have been most concerned about the drop in car sales because of
the wide range of firms and industries encompassed by the automotive sector. With the drop
in car sales having become a reality, the question now is the depth and length of the decline.
Demand for cars has been brought forward for a year and half since the introduction of
subsidies in April 2009, so the decline in car sales is likely to continue. That being said,
though, one would expect the negative impact on the economy to be greatest immediately
after the expiration of subsidies and to subsequently ease gradually. Therefore, private
consumption is expected to gradually recover. Obviously, the timing of a full-fledged recovery
of private consumption is not clear, since the employment and income situation is expected
to remain severe. Developments in this area, together with housing investment, which has
been recovering gradually, warrant a close watch.
Against this background, if overseas economies, led by emerging and commodity-exporting
economies, were to register higher growth, this would increase the likelihood of Japan's
economy returning to a recovery path fueled by an increase in exports. The October 2010
Outlook Report paints such a scenario for fiscal 2011 onward. The report also said that in
"fiscal 2012, Japan's economy is expected to continue growing at a pace above its potential,
as the transmission mechanism by which the strength in exports and production feeds
through into income and spending will likely operate more effectively amid the continued
relatively high growth in overseas economies, especially emerging and commodity-exporting
economies." Although this is subject to a considerable margin of error, the Bank estimates
that Japan's potential growth rate during the projection period is around 0.5 percent.
B. Prices
Domestic corporate goods prices are expected to remain on a moderate uptrend for the time
being, mainly due to the uptick in international commodity prices. The decline in the
consumer price index (CPI; excluding fresh food) on a year-on-year basis is decelerating and
is expected to continue decelerating as a trend as the aggregate supply and demand
balance gradually improves.
As stated in the projection in the Outlook Report for the period ending in fiscal 2012, it will
take considerable time for the supply and demand balance to improve because the drop in
demand after the financial crisis was considerable and the pace of economic recovery has
been moderate. Therefore, the deceleration in the decline in the CPI on a year-on-year basis
is likely to remain moderate and it will likely take until sometime in fiscal 2011 for the
year-onyear rate of change in the CPI to enter positive territory. Thereafter, the rate of increase is
expected to start rising through fiscal 2012.
III. Risks to the outlook
The above outlook for economic activity and prices suggests that the Japanese economy will
be able to overcome deflation and return to a sustainable growth path with price stability,
although it will take time. However, there are various upside and downside risks to economic
activity and prices.
A. Risks to economic activity
In the October 2010 Outlook Report, the Bank listed the following as risk factors concerning
the outlook for economic activity: (1) developments in advanced economies; (2) developments
in emerging and commodity-exporting countries; (3) developments in business and household
sentiment; and (4) firms' medium- to long-term growth expectations.
Regarding the first risk, economies burdened with balance-sheet adjustments, such as the
United States, are unlikely to achieve strong growth and will remain prone to weakness until
the adjustments are completed. U.S. household debt relative to income remains high. In
Europe, financial markets remain volatile, as indicated by the recent surge in yields on Irish
government bonds. Furthermore, the amount outstanding of public debt has increased
considerably due to the implementation of vigorous fiscal policies. The implementation of
fiscal consolidation measures, which will proceed further, might exert greater-than-expected
downward pressure on individual economies and the global economy.
Emerging and commodity-exporting economies are likely to maintain relatively high growth
led by domestic demand, and in this situation the continued large-scale monetary easing in
advanced economies might accelerate capital inflows to emerging and commodity-exporting
economies. Stock and housing prices in these economies have been rising already. If
economic conditions in these economies are boosted further, Japan's economy could realize
stronger-than-expected growth through the increase in exports to these economies. On the
other hand, if economic and financial activity in these economies becomes excessive, there
is a risk that this could, in the longer term, lead to a sharp reversal. Therefore, whether
emerging and commodity-exporting economies will be able to achieve a soft landing and
return to a sustainable growth path is an issue that warrants careful attention.
A domestic issue that warrants attention is the possibility that fluctuations in business and
household sentiment might affect economic activity. For example, the appreciation of the
yen may on the one hand encourage mergers and acquisitions abroad - a positive
development - but on the other it is also likely to exert downward pressure on the profits of
exporters and might damage economic activity if this were to hurt business confidence and
lead firms to change their behavior.
A final point concerns firms' medium- to long-term growth expectations. If firms are able to
capture infrastructure and consumption demand in emerging and commodity-exporting
economies, this would increase the possibility that economic activity will be stronger than
projected. On the other hand, if firms' growth expectations continue to shift downward, there
is a risk that business fixed investment and private consumption could decrease more than
expected.
I believe that the risks to either side are equally important and that at present the upside and
downside risks are broadly balanced. However, I will continue to carefully monitor
developments concerning these risks.
B. Risks to prices
Risks to prices, in addition to the above four risk factors affecting economic activity, include a
possible decline in firms' and households' medium- to long-term inflation expectations. If the
pace of recovery in resource utilization of labor and production capacity remains moderate,
firms and households might expect prices to fall, which in turn could affect actual prices.
Other risks to prices that require careful observation include the high uncertainty in gauging
the aggregate supply and demand balance and its impact on prices, as well as price changes
due to fluctuations in international commodity prices and foreign exchange rates.
IV. Monetary policy
Let me now turn to the Bank's conduct of monetary policy. The Bank recognizes that Japan's
economy is faced with the extremely important challenge of emerging from deflation and
returning to a sustainable growth path with price stability. Based on this recognition, the Bank
has been doing its utmost as the central bank, using a three-pronged approach consisting of
(1) strong monetary easing, (2) ensuring stability in financial markets, and (3) providing
support to strengthen the foundations for economic growth. Today, I would like to explain the
Bank's pursuit of strong easing through comprehensive monetary easing and the support for
strengthening the foundations for economic growth to address the medium- to long-term
issues faced by the Japanese economy.
A. Pursuing strong monetary easing: the comprehensive monetary easing policy
With regard to its pursuit of strong monetary easing, the Bank has reduced its policy interest
rate twice since the Lehman shock and, by increasing longer-term funds provision to financial
institutions through new funds-supplying operations, the Bank has been influencing directly
longer-term interest rates such as 3-month and 6-month rates. As a result, market interest
rates have been stable at extremely low levels and firms' funding costs have been declining.
However, at the Monetary Policy Meeting held on October 4 and 5, 2010, it was judged that
the economic growth rate was likely to be somewhat lower than the projection presented in
the July 2010 interim assessment, reflecting the slowdown in the U.S. economy since
summer 2010 and the effect of the appreciation of the yen on business sentiment. It was also
agreed at the meeting that, in view of the downside risks to the economic outlook, it had
become more likely that the return of Japan's economy to a sustainable growth path would
be delayed compared to what had been projected earlier. In this context, what particularly
caught my attention was the results of the September 2010 Tankan (Short-Term Economic
Survey of Enterprises in Japan) released by the Bank. Although I had anticipated that firms'
view of future business conditions had deteriorated to some extent due partly to the decrease
in demand following the expiry of government measures to boost demand, the extent to
which it had deteriorated was larger than I had expected.
The Bank has repeatedly stated that it will continue to consistently make contributions as the
central bank so that Japan's economy will overcome deflation and return to a sustainable
growth path with price stability. Therefore, the members of the Policy Board, myself included,
thought that the time had come for the Bank to express this stance more clearly, examine
concrete measures, and take drastic measures. Moreover, it was important to announce
these measures as a package rather than piecemeal policies. The purpose of this package is
to further enhance monetary easing, and I personally felt that first of all it was important for
the Bank to announce a change in the guideline for money market operations and clarify the
Bank's commitment regarding the time horizon based on the "understanding of medium- to
long-term price stability" (hereafter the "understanding").
Regarding the change in the guideline for money market operations, the Bank lowered the
target for the uncollateralized overnight call rate - the shortest interbank rate - from "at
around 0.1 percent" to "at around 0 to 0.1 percent," thereby clearly indicating that it was
pursuing a virtually zero interest rate policy. As for the clarification of its commitment
regarding the time horizon based on the "understanding," Policy Board members agreed that
(1) the Bank would maintain the virtually zero interest rate policy until it judged that price
stability was in sight, and (2) the "understanding" would be appropriate as the basis for that
judgment. The "understanding" is the level of inflation that each of the nine Policy Board
members understands as being consistent with price stability over the medium to long term.
The "understanding" at present falls in a positive range of 2 percent or lower, and the
midpoints of most Policy Board members' understanding are around 1 percent.
In considering policy options the Bank could take, the Bank's options within the conventional
monetary policy framework were limited, given that short-term interest rates - ranging from
overnight to longer-term rates - were already at levels that left little room for a further
decline. In these circumstances, the Bank decided on the establishment of the Asset
Purchase Program (hereafter the Program) as the third measure in the comprehensive
monetary easing package. Like other Policy Board members, I felt that the Bank should
consider a variety of policy options without precluding measures that are temporary or
extraordinary for a central bank, such as directly influencing longer-term rates and expanding
the type of financial assets eligible for the Bank's purchases.
The details of the Program are as follows. The Bank established a program on its balance
sheet to conduct outright purchases of various financial assets, such as Japanese
government bonds (JGBs), CP, corporate bonds, exchange-traded funds (ETFs), and Japan
real estate investment trusts (J-REITs), and the fixed-rate funds-supplying operation against
pooled collateral. The total amount of the Program will be about 35 trillion yen, consisting of
about 5 trillion yen for purchases of financial assets and about 30 trillion yen for the fixed-rate
funds-supplying operation against pooled collateral. The Bank has already begun purchasing
JGBs and corporate bonds, and the first auction for the purchase of CP is scheduled for
tomorrow, December 10, 2010. The Bank also decided to start purchasing ETFs and
J-REITs in the near future. As the Bank has been explaining, this is a temporary and
extraordinary measure for a central bank. Moreover, the Bank did not adopt this measure
lightly, since it entails the critical issue of making sure that the risks involved in holding
various risk assets are properly managed in order to ensure the financial health of the central
bank of Japan.
B. The Bank's measure to support strengthening the foundations for economic
growth
Lastly, I will move on to talk about the fund-provisioning measure to support strengthening
the foundations for economic growth, which the Bank decided to introduce at the Monetary
Policy Meeting held on June 14 and 15, 2010. The measure supplies long-term funds at a
low interest rate against eligible collateral to financial institutions in accordance with their
efforts in terms of lending and investment toward strengthening the foundations for economic
growth.
Japan's economy faces the critical challenge of overcoming deflation and returning to a
sustainable growth path with price stability. To achieve this, the key, in my view, is to tap
potential demand, and both economic entities in the private sector and the authorities need
to continue to make steady efforts to this end. The main cause of the current deflation is the
negative output gap, which largely reflects a long-term downtrend in the economic growth
rate since the 1990s. However, looking again at major trends such as demographic
developments and globalization, can we really say that Japan has nothing to gain from these
trends? I do not think so. It all depends on one's perspective. For example, demographic
trends can be seen as a shrinking of the total and the working-age population, or they can be
seen as an increase in the importance of the elderly. Similarly, global warming is an issue
that requires an immediate response, but even more important is a medium- to long-term
strategy covering the next 10 or 20 years.
Regarding the fund-provisioning measure to support strengthening the foundations for
economic growth, Bank of Japan Governor Masaaki Shirakawa has commented that, in
addition to providing practical support through the provision of funds, he felt that it was more
important to raise awareness of the challenges the economy faces. Having worked in the
business world, I feel exactly the same. I believe what is needed is to identify the root cause
of the challenges Japan's economy faces and take the most appropriate action to address
them, no matter how long this may take.
On December 7, 2010, the Bank carried out the second new loan disbursement under the
fund-provisioning measure to support strengthening the foundations for economic growth, so
that the amount of loans disbursed now totals about 1.5 trillion yen. Individual investments
and loans under the measure cover a broad range of fields, with financial institutions making
a variety of efforts reflecting the particular customer base and/or region they serve. I feel
these are extremely encouraging signs and that such efforts are a vital step toward
overcoming the challenges the economy faces. The Bank, as the central bank, is determined
to offer support as broadly as possible for the efforts that private financial institutions are
making on their own initiative toward strengthening the foundations for economic growth.