Mr. Matsushita discusses recent monetary and economic conditions in Japan
and comments on the Bank of Japan's monetary policy management Speech by the
Governor of the Bank of Japan, Mr. Yasuo Matsushita, to the Research Institute of Japan in
Tokyo on 5/11/97.
I. Introduction
It is a great honor to be invited by the Research Institute of Japan to address this
distinguished audience.
It has been one year since I last attended this gathering in November 1996.
Looking back at the economic developments in Japan over the past year, economic growth
temporarily accelerated from the latter half of 1996 through the spring of 1997, helped to some
extent by increased demand ahead of the rise in the consumption tax rate in fiscal 1997. Since
April this year, however, economic growth has been decelerating partly reflecting the lingering
effects of the rise in the consumption tax rate. During this period, business sentiment seems to
have become more cautious. Today, I would like to give views of the Bank of Japan on the
present condition of and on the outlook for the Japanese economy. I will also discuss the Bank's
thinking behind its monetary policy management.
I would then like to use the remaining time to discuss the Bank's views on some
of the comments and questions the Bank has been receiving recently concerning the prolonged
easy money policy, by which the official discount rate has been maintained at 0.5 percent for
more than two years. Through my explanation, I hope to gain your better understanding on the
Bank's aims in its monetary policy management.
II. Recent Monetary and Economic Conditions and the Bank's Monetary Policy Management
A. The Present Condition of and the Outlook for the Domestic Economy
Let me first discuss the domestic economic condition. Japan's economic growth
has been decelerating since April 1997 partly reflecting the impact of the rise in the consumption
tax rate that took place that month. In addition to the continuing decrease in public investment
since autumn 1996, household spending such as personal consumption and housing investment
has also dropped significantly since April 1997. As regards personal consumption, outlays on
services such as those provided by the travel industry have been increasing moderately.
However, outlays on goods have remained sluggish, as indicated by the sales of automobiles and
household electric appliances as well as department store and chain store sales, although there
are signs of a slight recovery. In addition, housing investment in terms of housing starts has
declined more recently to 1.3 million from the 1.6 million per annum level that existed until
spring 1997.
Several factors are responsible for such declines in household spending. The first
is the strong and persistent reaction to the significantly increased demand ahead of the rise in the
consumption tax rate. The increase in sales in the consumer goods- and housing-related
industries from the latter half of 1996 had been taken as a strong indication of a sustainable
recovery. In hindsight, those sales in fact included a significant amount of demand for household
spending that would most likely have taken place later this year had the hike in the tax rate not
been scheduled. The second factor, which to some extent had been anticipated, is the slowdown
in the growth of real disposable income of households -- nominal income less tax payments and
income erosion due to inflation -- following the rise in the consumption tax rate and the
discontinuation of the special tax reduction. In addition, it seems undeniable that consumer
confidence has weakened somewhat.
This decline in household expenditure since spring 1997, which was greater than
had initially been anticipated, created excess inventories in certain sectors of consumer
goods- and housing-related industries. These sectors have been required to reduce excess
inventories since summer 1997 and, as a result, industrial production has leveled off. These
developments in household expenditure and industrial production have resulted in a more
cautious business sentiment.
The question is whether these developments in household expenditure and
industrial production will undermine the momentum of economic recovery, or in other words,
whether the declining personal consumption and housing investment will affect other demand
items such as business fixed investment, thereby placing further downside pressure on the
economy. The answer lies in the current strength of the self-sustained recovery in the private
sector, and this is precisely what the Bank has carefully attended to over the past two years. As
this is the most important factor when judging the outlook for the economy, I would like to give
the Bank's views in some detail.
I will start off by discussing what is meant by the momentum of a self-sustained
economic recovery, and then move on to the Bank's assessment of the present force of the
self-sustained recovery as compared to that in 1995, when the Bank lowered the official discount
rate to 0.5 percent. Lastly, I will use these points to examine the actual developments in demand
and production, and assess the outlook for the economy.
The strength of self-sustained recovery of the private sector can be considered as
the strength of the cyclical force inherent in the private sector. With this force, a build up of
economic activity should lead to improved business sentiment, which, in turn, should lead to
increased earnings and income. The rises in earnings and income should eventually encourage
sustained growth in business fixed investment and personal consumption, respectively. When the
strength of the self-sustained recovery, or the momentum of this cyclical force, is very weak,
there is a risk that private-sector activity might begin to decline, particularly if unable to absorb
the negative impact of such exogenous factors as external demand and fiscal policy. However,
when there is a reasonable measure of strength in the self-sustained recovery, the inherent force
can be expected to withstand the negative impact and put the economy back on the recovery
path, despite being temporarily decelerated. In this case, the negative impact is contained and the
private sector's economic outlook and investment attitude remain firm. As the pressures created
by those exogenous factors subsequently subside, economic recovery should gradually become
apparent.
I will now turn to my second point, that is, assessment of the strength of Japan's
self-sustained recovery. The Japanese economy began to recover in late 1993 from a recession
that followed the collapse of the "bubble" economy. In early 1995, however, the recovery
paused, and there were even concerns about the occurrence of a deflationary spiral. In view of
these circumstances, drastic monetary and fiscal policy measures were adopted. While the halt
was directly attributable to the negative effects of the rapid appreciation of the yen, it was also
due to the fact that the strength of the self-sustained recovery in the private sector was yet too
weak to overcome the downward pressures from outside the private sector. It is true that the
economy had been on a recovery trend since late 1993. However, we at the Bank judge that
because firms' profitability as well as capacity utilization had remained at a low level, the shock
of a sudden appreciation of the yen applied the brakes to the economic recovery.
The important issue now is how much strength there is in the recent economic
recovery in Japan. Balance-sheet adjustment and adjustment of industrial structure are still in
process. This being the case, we at the Bank do not believe that the self-sustained economic
recovery has gained sufficient strength. This is precisely why we have maintained the official
discount rate at a low level since September 1995. In the course of the gradual economic
recovery over the past two years, however, the level of economic activity has doubtlessly been
rising steadily, gradually adding to the strength of the self-sustained economic recovery.
Specifically, there has been some progress in balance-sheet adjustment and
industrial restructuring as corporate profits continued to increase. The manufacturing sector,
especially large manufacturers, have achieved a higher than average level of profitability,
although the profitability of the nonmanufacturing sector remains low. According to the results
of the "Tankan -- Short-Term Economic Survey of Enterprises in Japan", firms feel that there
have been declines in the excessiveness of production capacity and employment. This implies
that while business fixed investment increased over the past two years, excessive accumulation
of capital stock has been avoided. Judging from these points, the force of the self-sustained
economic recovery has clearly strengthened compared to 1995, at which time there were
concerns about a deflationary spiral.
Thirdly, I would like to discuss the outlook for demand, production, and income
based on the aforementioned assessment of the self-sustained economic recovery.
As for final demand, personal consumption and housing investment continue to
be sluggish in general and public investment is expected to follow a declining trend.
Employment, however, continues to be on a trend of gradual recovery. Firms plan to increase
the number of newly hired graduates in fiscal 1998 for the second consecutive year. Although
the growth of the household sector's real disposable income is expected to slow, any substantial
income erosion should be avoided owing to the increase in employment. Therefore, provided
that there is no serious deterioration of consumer confidence, personal consumption should
gradually move toward recovery as the initial impact of the rise in the consumption tax rate
diminishes.
Meanwhile, net exports and business fixed investment continue to increase.
Exports have increased significantly since the latter half of 1996, reflecting the depreciation of
the yen until spring 1997. Imports, after having increased rapidly until mid-1996 due partly to a
growth in imports from the overseas subsidiaries of Japanese manufacturers, have leveled off
recently reflecting the depreciation of the yen.
Under these circumstances, the key issue for the time being is how the recent
currency and financial instability in Southeast Asia will affect Japan's exports and imports and
its economy as a whole. In view of the progress in the horizontal division of labor and expansion
of trade and capital transactions between Japan and other Asian countries, this matter requires
due attention.
If we take a look at Japan's trade with Asian countries, Japan's exports to
Thailand have decreased significantly. However, there have not been any notable declines in
exports to other neighboring countries. In addition, Japan's other export markets such as the
United States maintain solid economic growth. On the foreign exchange market, the yen has
appreciated against Southeast Asian currencies following their shift to a floating exchange rate
system. However, the yen has, overall, remained in a stable range reflecting a gradual
depreciation against the U.S. dollar. Thus, Japan's export environment as a whole continues to
be favorable, and the currency and financial instability in Southeast Asia has, so far, not affected
the fundamental trend of Japan's exports in any significant way.
In addition, Southeast Asian countries have been adopting various measures,
some of which are internationally coordinated. On November 1, it was announced that the
International Monetary Fund (IMF) and other international organizations have agreed on a
financial package for Indonesia. In the foreign exchange markets, the monetary authorities of
Japan, Singapore, and Indonesia have confirmed that they will cooperate to stabilize the
Indonesian currency. The Bank of Japan strongly hopes that these and similar measures taken by
other countries will soon restore monetary and financial stability in these countries and
encourage a smooth economic adjustment. The Bank will continue to observe developments
carefully.
With regard to business fixed investment, this is likely to continue to expand as a
whole against the backdrop of sustained growth in corporate profits. Firms' projections of
earnings in fiscal 1997 indicate that smaller nonmanufacturing firms anticipate a decline in
profits for the first time in four years, strongly affected by a decline in public investment and in
personal consumption. In the manufacturing sector, however, both large and smaller firms
expect a continued rise in earnings and profits partly supported by solid export performance. In
addition, large nonmanufacturing firms project sustained growth in profits following the
favorable results in the manufacturing sector. Some of these profitable firms recently revised
their earnings outlook downward because of the recent deceleration in domestic demand.
However, on the whole, earnings and profits remain on an upward trend.
Against the backdrop of such developments in profits, overall investment plans in
fiscal 1997 seem to be firm, especially in the manufacturing sector, although business fixed
investment of smaller firms in the nonmanufacturing sector is expected to remain at a low level.
In view of the aforementioned profit trend, the positive outlook for returns on investment, and
the strong demand for information-related investment, it is fair to expect that business fixed
investment will continue to increase.
As I have discussed, the Bank believes that the trend of economic recovery has
not been undermined on account of gradual improvements in corporate profits, employment, and
income. The Bank, therefore, expects that as personal consumption recovers, inventory
adjustment will progress and the economy will resume a gradual recovery.
However, it is apparent that the virtuous circle in which increased production
leads to larger income, which in turn stimulates spending, has weakened due in part to the
effects of fiscal tightening. Should recovery in household expenditure be delayed, thus
prolonging economic deceleration, the strength of the self-sustained economic recovery might be
impaired. Bearing this possibility in mind, the Bank will watch cautiously economic
developments in the coming days, including such points as the pace of recovery in personal
consumption, progress in inventory adjustment, and developments in business and household
confidence.
B. Recent Monetary Condition
Looking at the recent monetary condition in Japan, stock prices dropped sharply
at the end of October amid a worldwide decline in stock markets triggered by the Hong Kong
market. The impact on the prices seems to have subsided in the markets, however, owing to
rebounds in the Southeast Asian markets.
The Bank has been informed that Sanyo Securities has decided to take legal
measures to liquidate its affiliated entities, and that due to losses on credits extended to these
affiliates, it has become difficult for Sanyo Securities to continue ordinary business.
On November 3, Sanyo Securities filed with the Tokyo District Court an
application for the commencement of reorganization proceedings. In response to the application,
the District Court has issued an asset preservation order halting the company's repayment
activities, but has allowed for exceptions with regard to such activities as return of customer
property. The Bank has been informed that customer property, including cash deposited by
customers, will be protected and that the property will be returned swiftly with the support and
cooperation of relevant parties, including the Securities Deposit Compensation Fund (a fund
established for compensating customers' losses in the event of a failure of a member securities
company) and the main banks of Sanyo Securities.
While the Bank regrets the failure of Sanyo Securities, the Bank acknowledges it
crucial that investors be protected and the stability of the securities market be secured through
the efforts of relevant parties in order to maintain confidence in the Japanese financial system at
home and abroad.
If I may now turn to developments in lending by financial institutions, there have
recently been views that financial institutions may have become too cautious with their lending,
and this as a result may be constraining the economic activity of private businesses. I would like
to briefly discuss the Bank's present views on this point.
It is true that an increasing number of financial institutions are strengthening risk
management and attaching more importance to profitability in order to improve the soundness
and efficiency of their management and operations. More specifically, they are revising their
screening systems to assess more rigorously the creditworthiness of borrowers. They are also
establishing lending rate structures that adequately reflect creditworthiness. These efforts are
essential to financial institutions if they are to accommodate themselves to the ongoing financial
globalization and deregulation over the long run. However, it may appear to firms that financial
institutions have significantly shifted their lending attitude, or have suddenly adopted a very
strict lending policy.
Having said that, financial institutions maintain a positive lending stance toward
firms showing sound business performance. In fact, the Tankan survey indicates that while an
increasing number of firms in certain sectors feel that the lending attitude has become "severe",
more firms feel that the attitude remains "accommodative". The average lending rates of
financial institutions have been linked to market rates at historically low levels.
In view of these circumstances, it is fair to assume that the recent slow growth in
lending by financial institutions is due to weak demand for funds arising against the background
of decelerating domestic demand. Therefore, the Bank considers that the lending attitude of
financial institutions is, at the moment, not constraining business activity, nor militating against
the economy.
The Bank will continue to monitor carefully the lending activity of financial
institutions focusing on (1) whether the stance of financial institutions is reaching a point where
even firms maintaining sound management find it difficult to borrow; and (2) whether squeezed
lending is leading to a general rise in interest rates.
C. Monetary Policy Management
After the effects of the rise in the consumption tax rate are excluded, prices can
be seen to have remained generally stable and are expected to remains so for some time.
In managing monetary policy under such a monetary and economic situation, the
Bank believes it appropriate to continue to watch developments carefully with an emphasis
being placed on further strengthening the foundation of the economic recovery.
III. Bank's Thinking Behind Its Continued Easy Stance of Monetary Policy
A. The Effects of Monetary Easing
I would like to use the remaining time to discuss the Bank's views on some of the
comments and questions the Bank has been receiving in relation to the prolonged low level of
interest rates.
First, there have been questions about the effects of monetary easing -- that is,
although low interest rates are conducive to improving corporate profits, it seems that businesses
are simply using those earnings to repay their debts, and therefore, the desired effects of
stimulating economic activity, such as increasing investment, have not been achieved. Some
even say that the low interest rates are only delaying the structural adjustment of the Japanese
economy.
If we take a look at the actual figures of corporate profits and business fixed
investment, cash flow of firms -- hat is, retained earnings plus depreciation -- increased by
approximately ¥7 trillion in the two years since fiscal 1995, when the official discount rate was
lowered to 0.5 percent. Business fixed investment also increased by approximately ¥7 trillion,
commensurate with the growth in corporate profits. During this two-year period, the low interest
rates have helped to improve the profitability of investment and to support corporate profits.
Therefore, the Bank believes that low interest rates have had the effect of generating an
appropriate increase in business fixed investment.
It should be noted, however, that in past phases of economic recovery, firms
borrowed from financial institutions to expand their business fixed investment in addition to
using their cash flow. This time, however, few firms have increased bank lending or issued
bonds for this purpose. Rather, in quite a few cases, firms have used the increase in profits to
repay their debt.
Thus, there has been no significant acceleration of business fixed investment
when compared to past recovery phases. One factor behind this seems to be the various
structural adjustment pressures that the Japanese economy faces today, notably persistent
balance-sheet adjustment pressures.
As you are aware, many firms borrowed actively from financial institutions
during the economic "bubble" period to engage in large-scale real-estate investment or securities
investment. Following the bursting of the economic "bubble", prices of real estate and stocks
plunged. The borrowings, however, remained. Thus, on corporate balance sheets, there was a
significant depreciation of assets at market value while liabilities remained unchanged. This
resulted in a decrease in the net worth of firms -- that is, assets less liabilities -- and this in turn
has limited the business risks that these firms can take on. Firms in this situation can rarely
conduct active investment in plant and equipment that leads to the expansion of their business
activity. This situation is often referred to as the "balance-sheet problem".
When we look at the relationship between balance sheets and business fixed
investment by sector and by the size of firm, large manufacturers are faced with only limited
balance-sheet adjustment pressures since they did not take on large debts during the "bubble"
period. These large manufacturing firms saw an early recovery in profits following the collapse
of the economic "bubble", and in fact, have been investing significant amounts in plant and
equipment since fiscal 1995.
Smaller firms, however, especially those in the nonmanufacturing sector,
continue to suffer heavy balance-sheet adjustment pressures, having borrowed heavily from
financial institutions during the "bubble" period to invest in real estate. The ratio of financial
liabilities to assets at market value of smaller nonmanufacturing firms remains at a high level.
As these firms have been most strongly affected by industrial restructuring, their profits as a
whole have been slow to recover. As a result, their business fixed investment has shown little
signs of improvement.
Yet, it cannot be said that low interest rates have proved ineffective to alleviate
firms' balance-sheet problems. The only ways to alleviate the balance-sheet adjustment
pressures is for firms to increase profits, and low interest rates have contributed broadly to
improving firms' profits. With increased profits, firms can repay borrowings and thereby
recover their net worth. Also, a forecasted rise in a firm's profits would facilitate the raising of
capital by that firm. Thus, increasing profits is most effective in improving the financial strength
of a firm, and the repayment of debt is an important process in allowing a firm to prepare for
future business activity.
Although in the current phase of economic recovery, low interest rates have not
yet triggered any significant rise in business fixed investment in the smaller nonmanufacturing
firms, these rates have steadily contributed to establishing the foundation of the recovery by
helping to improve firms' financial strength. Including such indirect effects, the Bank believes
that the low interest rates have in fact been firmly supporting the recovery of economic activity
in the corporate sector.
I would now like to go on to another often raised question about whether low
interest rates are delaying the structural adjustment. It is true that there may be firms that are
managing to survive despite a deteriorating business performance, owing to lower interest rates
alleviating the burden of paying interest. My view, however, is that structural adjustment of the
economy is achieved not just through natural selection of firms, where those with extremely
poor business performance are weeded out. Rather, I believe that it is achieved when the large
number of firms with high growth potentials enhance their activities. Therefore, in order to
promote structural adjustment, it is most important to pursue effective deregulation.
Monetary policy, by nature, is not aimed at promoting structural adjustment. It is
to be managed in accordance with economic and price developments with the aim of achieving
noninflationary, sustainable growth. However, monetary policy can realize a stable
macroeconomic environment, that in turn would facilitate structural adjustment. This is because
firms can confidently undergo forward-looking business transformation only when there is a
stable macroeconomic environment. Also, as I have already stated, monetary easing has been
contributing to the balance-sheet adjustment of firms.
The Bank believes that if interest rates were to be raised before economic activity
has sufficiently firmed, it may affect not only troubled firms but also growing businesses. In
view of the fundamentally weak earnings structure of venture businesses, which are expected to
be the driving force of the structural reform, it can easily be imagined that an untimely raising of
interest rates would make the progress of industrial restructuring even more difficult.
In other words, although monetary easing is not directly aimed at promoting
structural adjustment, by providing a stable macroeconomic environment, it does support the
management efforts of many firms with high growth potentials and thereby contributes to laying
the foundation for structural adjustment. I very much hope to gain your understanding on the
importance of this point.
B. Monetary Easing and Income Distribution
Another set of comments and questions that the Bank often receives in relation to
the low level of interest rates concerns the issue of income distribution. There have been
comments that low interest rates are sacrificing the household sector, or that they are aimed
solely at supporting the profits of financial institutions. As I have spoken on this subject on
various occasions already, I will give only a brief explanation of the Bank's views.
Monetary easing would have the impact of reducing interest earning on deposits
and bonds while lowering interest payments on mortgage loans and other liabilities. As the
household sector holds a larger amount of financial assets than financial liabilities, lower interest
rates would in fact to reduce the net interest income. It would not be appropriate, however, to
judge the effects of monetary easing based simply on the interest income. Lower interest rates
stimulate economic activity by improving returns on investment, increasing corporate profits,
and supporting asset prices. This in turn leads to an increase in employment and in employees'
income to thereby bring about a favorable impact on the household sector as a whole.
In fact, in the two years since fiscal 1995, when the series of monetary easing
measures was implemented, employees' income has increased steadily, and this increase has
significantly exceeded the net decrease in interest income. This implies that the monetary easing,
by stimulating economic activity, has had favorable effects on the entire household sector.
In reality, there are various types of households, and the Bank is fully aware that
the situation has been extremely difficult for those households that are heavily dependent on
interest income. However, I would like to emphasize that monetary policy should be managed
from a macroeconomic perspective for the purpose of achieving a self-sustained economic
recovery. When a self-sustained recovery is realized, benefits will accrue broadly to all sectors,
including the household sector.
In relation to the profits of financial institutions, monetary easing was not
implemented for the purpose of increasing financial institutions' earnings and the Bank has
absolutely no intention of managing monetary policy to aid financial institutions.
The misunderstanding over the Bank's intentions seems to derive from the fact
that operating profits of financial institutions tend to increase when interest rates decline. For
example, in fiscal 1995, when there was a sharp decline in interest rates, operating profits of
financial institutions rose significantly. This is partly due to the fact that when interest rates
decline, the prices of their bond-holdings rise, and therefore, their profits on sales tend to
increase. It is also due to the fact that lower interest rates are reflected immediately on the
liability side, whereas their effects appear more slowly on the asset side, since the average length
of maturity of assets, such as loans, tends to be longer than the average length of maturity of
liabilities such as deposits.
However, these effects are only temporary. For example, once the effects of lower
interest rates have worked their way through, sale of bonds will no longer generate new profits.
Moreover, if interest rates begin to rise, the sale of bonds will start creating losses. In addition,
maturity gap between assets and liabilities will cause profits to decline from the following
accounting term reflecting declines in the returns on interest-earning assets, which follow the fall
in the cost of financing liabilities. In fact, the operating profits of financial institutions, after
rising significantly in fiscal 1995, leveled off in fiscal 1996. In fiscal 1997, they are likely to
register a substantial decline as the effects of reduced interest rates will have diminished.
In the meantime, the net interest margin of financial institutions -- that is, the
differential between financing costs and investment returns -- remains at a level equal to the
average since the latter half of the 1980s. In other words, the decline in deposit interest rates has
not permanently widened the interest margin for financial institutions, which is only the
intermediate stage in the permeation of monetary-easing effects. Rather, the decline has
subsequently lead to lower lending rates. Through these channels, the effects of monetary easing
have been permeating steadily through the entire Japanese economy.
As I have explained, monetary policy is not aimed at supporting financial
institutions, and it is not possible to control the earnings of financial institutions by means of
monetary policy over an extended period. I would once again like to emphasize that monetary
policy is to be managed in accordance with the overall economic condition for the purpose of
ensuring price stability.
C. Monetary Policy Management from a Medium to Long-Term Perspective
I would like to turn to a third set of comments and questions received by the Bank
related to its monetary policy management. It is a question of whether the official discount rate
should have been raised sometime between 1996 and early 1997, when the economy was
recovering.
Monetary policy should, by its very nature, be monitored over a long period of
time. In addition, I believe it is not appropriate for the Bank, which is in charge of monetary
policy management, to give its own assessment casually. Today, therefore, I would like to
explain the basic thinking underlying the Bank's monetary policy management, including that on
the recent interest-rate policy.
The drastic monetary easing measures the Bank implemented in September
1995 -- including the lowering of the official discount rate to 0.5 percent -- was aimed at
preventing the occurrence of a deflationary spiral and was intended to place the Japanese
economy on a path of self-sustained recovery by strengthening corporate and household
confidence in the economy. Since the beginning of 1996, the Japanese economy has recovered
moderately. In the course of the recovery, the concern for a possible deflationary spiral has been
gradually dispelled, and the confidence of the corporate and household sectors has been
gradually regained. Looking back, it appears that the recovery in early 1996 was supported
significantly by the series of monetary easing measures and government economic packages
adopted in autumn 1995. It also cannot be denied that the growth rate from the second half o