Masaaki Shirakawa: Japan's economy and monetary policy
Speech by Mr Masaaki Shirakawa, Governor of the Bank of Japan, at a meeting held by the
Naigai Josei Chousa Kai (Research Institute of Japan), Tokyo, 4 June 2012.
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Introduction
It is a great honor to have this opportunity to address you today at the Naigai Josei Chousa Kai.
The last time I spoke here was in late May 2011. At that time, Japan's economic activity had
just started picking up from the sharp decline in production following the downturn resulting
from the Great East Japan Earthquake. The pace of the subsequent economic recovery was
much faster than initially expected thanks to firms' strenuous efforts. After the beginning of
autumn 2011, however, economic activity temporarily became flat due to the effects of the
slowdown in overseas economies, the appreciation of the yen, and the flooding in Thailand.
Since then, it has become increasingly evident that the economy is shifting toward a pick-up
phase, particularly in domestic demand, which shows signs of firming. Price developments
have gradually been improving as well. On the other hand, as evident in financial markets
recently, some nervousness has been seen in developments regarding the European debt
problem.
Today, I will first discuss economic and price developments. I will then explain the Bank's
conduct of monetary policy. After doing so, I will offer my thoughts on the importance of
engaging in efforts to overcome challenges facing Japan's economy, such as strengthening
the economy's growth potential and ensuring fiscal consolidation.
I. Current developments in and the outlook for economic activity and prices
Current developments in economic activity and prices
I will start with developments in economic activity and prices. Overseas economies obviously
have the largest impact on developments in Japan's economy. These economies have yet to
emerge from a deceleration phase, but some improvement has been observed. On the
whole, the U.S. economy is in the process of moderate recovery. As for domestic demand,
reconstruction-related demand including public investment has clearly started to increase. In
the corporate sector, business fixed investment has been on a moderate increasing trend,
with improvement in business sentiment reflecting a favorable turn in the outlook for
corporate profits. In the household sector, private consumption has been increasing
moderately against the background of improvement in consumer sentiment. Consequently,
as I mentioned earlier, the Bank judges that it has become increasingly evident that Japan's
economy as a whole is shifting toward a pick-up phase.
Reflecting these economic developments, gradual changes in prices start to emerge
(Chart 1). Deflation is often referred to when discussing developments in Japan's economy.
As for the consumer price index (CPI, all items less fresh food), the year-on-year rate of
change registered minus 2.4 percent in August 2009. Thereafter, the rate of decline
moderated at a steady pace, recovering to 0 percent in fiscal 2011. The year-on-year rate of
change in the CPI for the past two months, for which data is available, registered 0.2 percent.
Looking at a breakdown by item, the rates of change are negative for items that are
infrequently purchased and for which prices have declined substantially as a result of
technological innovation, such as personal computers and televisions, whereas they are
around 1.9 percent for those purchased more than about once a month. Focusing solely on
items closely related to consumers' daily lives, such as food, the year-on-year rate of change
has more clearly entered positive territory than in the case of other items.
Baseline scenario for the outlook through fiscal 2013
Next, I would like to talk about the outlook for economic activity and prices. At the Monetary
Policy Meeting (MPM) held at the end of April, the Bank released its assessment of the
outlook through fiscal 2013. An economic outlook undoubtedly entails various uncertainties
and depends on relevant assumptions. The most important assumption made in the latest
outlook rules out the possibility that an extreme intensification of the European debt problem
would trigger a significant downturn in the global economy through the turmoil in global
financial markets. On this basis, in the baseline scenario - that is, the scenario for economic
activity and prices considered to be the most likely by the Bank - Japan's economy is
expected to return to a sustainable growth path with price stability in the longer run.
More specifically, the economy is expected to return to a moderate recovery path in the first
half of fiscal 2012 as the pace of recovery in overseas economies picks up, led by emerging
and commodity-exporting economies, and as reconstruction-related demand after the
earthquake disaster gradually strengthens. In terms of figures, the growth rate of real GDP is
projected to be 2.3 percent and 1.7 percent for fiscal 2012 and 2013, respectively.
Concerning prices, as the level of economic activity continues to rise moderately, the
year-on-year rate of change in the CPI is expected to gradually rise to a range of above
0.5 percent and less than 1 percent by fiscal 2013, the latter half of the projection period.
Thereafter, it will likely be not too long before the rate reaches 1 percent, which is the
inflation rate that the Bank aims to achieve for the time being.
Upside and downside risks to the outlook
Such an outlook entails various uncertainties.
The first concerns developments overseas, including those in global financial markets
(Chart 2). Of these, the European debt problem should be a risk factor that requires the
closest attention. From the summer of 2011 to the end of that year, strains in global financial
markets intensified due to the effects of the European debt problem. Thereafter, financial
markets regained stability temporarily, mainly due to liquidity provision by the European
Central Bank (ECB). Recently, however, some nervousness has started to be seen once
again. In Greece, a re-election is scheduled for mid-June, as the government failed to form a
ruling coalition following the general election in May due to public opposition to fiscal
tightening measures. In Spain, concern about financial institutions' non-performing loan
problem has heightened with the delay in efforts toward fiscal consolidation. Reflecting these
circumstances, global investors have become increasingly risk averse on the whole.
Government bond yields in Greece and Spain have risen while those in the United States,
Germany, and the United Kingdom have recorded historical lows, or reached levels close to
them. As suggested by the Lehman shock in autumn 2008, whether a risk will materialize in
an extreme manner, leading to a significant economic downturn, largely depends on whether
stability can be maintained in interbank funding markets. So far, interbank funding markets
have generally been stable, mainly due to the massive liquidity provision by the ECB, a
situation that stands in sharp contrast to that observed around the end of 2011.
Nevertheless, liquidity provision by a central bank is a measure to "buy time", so to speak. It
is therefore vital that governments and authorities steadily proceed with efforts toward
achieving sustainable growth and stability in the European economy before time runs out.
In addition to risks stemming from developments in Europe, the global economy entails
various uncertainties. With regard to the U.S. economy, while business fixed investment and
private consumption have been firm, the effects of the bursting of the housing bubble remain
deeply ingrained and the pace of recovery in employment is weakening. Although inflation
rates have declined compared with some time ago, developments in emerging and
commodity-exporting economies - which are expected to lead the global economy - also
remain highly uncertain in terms of the extent to which they can grow without causing a
resurgence of inflation.
In terms of uncertainties, we monitor the recent appreciation of the yen. The development in
the foreign exchange market since last summer is closely linked to changes in global
investors' risk aversion against the background of the European debt problem. The
adjustment of the yen's appreciation from February to the first half of March reflected abating
risk aversion by global investors as the situation in Europe improved. The movement of the
yen thereafter was merely a reflection of the reversal of such investors' behavior. In any
case, the Bank carefully monitors the development of the foreign exchange rate from the
viewpoint of how it affects the economy through its impact on business sentiment.
Second, developments in reconstruction-related demand at home remain uncertain. The
portion of the budget earmarked for reconstruction amounts to about 19 trillion yen - a
sizable budget over five years - and most of this is ready for disbursement. This represents
about 4 percent of Japan's nominal GDP and 60 percent of the total nominal GDP of the four
severely disaster-stricken prefectures of Iwate, Miyagi, Fukushima, and Ibaraki. Steady
disbursement is expected to significantly increase demand. However, a bottleneck - such as
a shortage in construction workers - could also occur at various stages of implementation
given the large scale of the budget.
Third, there is uncertainty with regard to firms' and households' expectations or their degree
of confidence as pertains to the medium- to long-term growth outlook for Japan's economy.
Japanese firms are currently increasing production overseas against the background of high
growth in emerging economies. While this is a rational business strategy, medium- to
longterm growth expectations are bound to change in either direction depending on whether new
businesses will be created at home. With regard to problems concerning the supply and
demand of electric power, the issue for the time being is how businesses will operate during
the upcoming summer. Other important points to pay attention to are (1) whether concern
about electricity supply constraints and a rise in electricity costs would lead to an eventual
decline in medium- to long-term growth expectations, and (2) whether efforts to conserve,
create, and store energy would lead to a strengthening of growth potential.
Fourth, there is uncertainty with respect to various issues regarding Japan's fiscal
sustainability. Despite unfavorable fiscal conditions, some argue that the situation in Japan is
not a problem given the abundant domestic savings and little need to rely on foreign
investors. Having said this, no government can keep expanding its liabilities forever. The
current stable low level of the government bond yields reflects market participants'
confidence that Japan ultimately has the ability to work on fiscal consolidation. As I will get
into later, confidence in fiscal sustainability is the most fundamental prerequisite for stability
in prices and the financial system. Once damaged, it will adversely affect the economy. By
contrast, considering the possibility that concern about the outlook for the fiscal situation is
causing a decline in households' and firms' propensity to consume, a clear path toward fiscal
consolidation may in fact heighten economic growth over a relatively long term.
II. The Bank's conduct of monetary policy
The price stability goal in the medium to long term
I will now explain the Bank's conduct of monetary policy, taking into account the
aforementioned economic and price developments.
The Bank recognizes that the critical challenge for Japan's economy is to overcome deflation
and return to a sustainable growth path with price stability. Based on this recognition, it has
been implementing powerful monetary easing measures for a while. Looking at its policy
decisions since the beginning of 2012, it introduced "the price stability goal in the medium to
long term" in February while simultaneously further enhancing monetary easing. Taking
another step forward, the Bank decided to enhance monetary easing again at the end of
April. Let me explain in more detail.1
The first point is "the price stability goal in the medium to long term". The objective of
monetary policy is price stability. As stipulated in the Bank of Japan Act, the Bank conducts
monetary policy based on the principle that the policy shall be aimed at "achieving price
stability, thereby contributing to the sound development of the national economy". In light of
such principle, the price stability that the Bank aims to achieve must be one that is
sustainable in the medium to long term. Among major central banks, the need to place
importance on medium- to long-term price stability has been widely accepted. For example,
the United Kingdom - known for its adoption of inflation targeting - has continued to register
an actual inflation rate exceeding its goal by more than 1 percent for over two years. During
this period, however, its central bank has conducted monetary easing, not tightening.
Considering that the effects of monetary policy are transmitted with a time lag, price
developments in the medium to long term, not those in the short term, must be taken into
account, and policy conduct in the United Kingdom is based on its assessment that the
inflation rate is expected to decline, judging from the output gap.
The level of inflation at which prices can be perceived as stable in the medium to long term
depends on such factors as the characteristics of the economic structure of respective
countries and the perception of prices held by those who have adapted to such an
environment. Taking these into account, the Bank decided to express "the price stability goal
in the medium to long term" with a degree of latitude, judging it to be in "a positive range of
2 percent or lower in terms of the year-on-year rate of change in the CPI". Furthermore, the
Bank more specifically expressed that it set a goal of "1 percent for the time being" and that it
would aim to achieve this goal in conducting monetary policy. I will elaborate upon why we
chose "1 percent" later in my talk.
Pursuit of powerful monetary easing
The second point involves the specifics of the monetary easing measures. Given that the
overnight call rate, or the policy rate, is already virtually zero, generating easing effects in
terms of monetary policy calls for a new approach. This is where the Bank's comprehensive
monetary easing measures implemented in autumn 2010 come in. The first part of its efforts
focuses on its commitment aimed at generating policy duration effects - in other words, the
Bank's determination to continue with its monetary easing. The other involves working on
longer-term interest rates and risk premiums by establishing a program through which to
mainly purchase financial assets, such as Japanese government bonds (JGBs) and risk
assets. The Bank, establishing a link with its "price stability goal in the medium to long term",
clarified at the February MPM that it would aim to achieve the goal of 1 percent inflation in
terms of the year-on-year rate of increase in the CPI through the pursuit of powerful
monetary easing, conducting its virtually zero interest rate policy and implementing the Asset
Purchase Program (hereafter the Program) through the purchase mainly of financial assets,
and that it will continue with this powerful easing until it judges the 1 percent goal to be in
sight. As for the size of the Program, the Bank increased the amount by about 10 trillion yen
at the MPM in February and about 5 trillion yen at the MPM at the end of April. In doing so,
while reducing its funds-supplying operations with a 6-month term reflecting a decline in
market needs, it substantially increased its purchase of JGBs by about 10 trillion yen and
expanded the range of eligible JGBs and corporate bonds to be purchased from those with a
remaining maturity of up to two years, to those with a remaining maturity of up to three years.
Through these measures, the Bank intends to proceed with and complete its purchase of
financial assets under the Program, amounting to about 65 trillion yen by the end of 2012
and about 70 trillion yen by the end of June 2013 (Chart 3). Given that the amount
outstanding of the Program has recently been about 51 trillion yen, the Bank is to accumulate
nearly 20 trillion yen worth of financial assets in over a year from now and is currently in the
process of enhancing monetary easing every month. However, the simple truth about its
monthly efforts tends to be overlooked, since the Bank announces such efforts in advance in
a collective manner. In any event, this pursuit of powerful monetary easing is expected to
exert positive effects on economic activity and prices through the following transmission
mechanism, together with the cumulative effects of easing to date.
First, the Bank's purchases of financial assets through the Program and the clarification of
the policy time horizon mentioned earlier will encourage a decline in longer-term interest
rates and a reduction in risk premiums. For example, while yields on JGBs tend to rise in
accordance with an increase in maturity, those on JGBs with a remaining maturity of three
years have recently declined to around 0.1 percent, reaching levels close to money market
rates. Reflecting these developments in market interest rates, firms' funding costs have
decreased at a moderate pace.
Second, such effects of low interest rates in terms of stimulating the economy will strengthen
with improvement in economic conditions (Chart 4). Let us consider, for example, an interest
rate in two different environments: one in which it is difficult to make profits, and the other in
which an adequate return can be anticipated by investing with the use of loans. Of the two
cases, the latter provides a larger economic stimulus. Monetary easing effects in Japan are
expected to strengthen further in the future, considering that economic conditions and prices
are heading toward improvement.
Third, financial markets remain extremely stable compared to other countries, as market
participants have been reassured by ample fund provision. Reassuring firms and households
about their funding plays a role in supporting their confidence, especially at a time when we
are witnessing high uncertainty at home and abroad, particularly with regard to the European
debt problem.
III. Some points about monetary policy
So far, I have explained the Bank's powerful monetary easing and its effects. In the conduct
of monetary policy, we recognize that there are different opinions. One opinion is that the
Bank should pursue more aggressive easing. Another is that it is too risky to embark on such
aggressive measures. For our part, we listen to these opinions and conduct monetary policy
as we judge most appropriate. Bearing these differences in mind, let me explain our thinking
behind the conduct of monetary policy in order to facilitate better understanding of our policy
making.
Level of the "price stability goal in the medium to long term"
The first is the level of the price stability goal. The general public's perception of prices is
deeply ingrained and it influences their actions; thus, it is hard to imagine a situation that
does not take account of experiences over the decades (Chart 5).
Although the year-on-year rate of change in the CPI turned negative in 1998, the average
rate of inflation since the middle of the 1980s - after the effect of the second oil shock
dissipated - is nearly 0.5 percent. It has consistently been lower than the equivalent rates in
overseas economies. During the bubble period (1987-89) when the economy was booming,
the CPI inflation was 1.3 percent. Over the last 30 years or so, there were only three cases
when the year-on-year rate of change in the CPI reached 2 percent. The first was at the
beginning of the 1990s, when the remnants of the bubble were still in place. The second was
in 1997, when the consumption tax was lifted. The third was in 2008, when the sharp rise in
energy and food prices hit the household sector.
Notwithstanding these past benchmarks, simply announcing out of the blue that the Bank
aims to achieve 2 percent inflation is not enough. Above all, this might raise unnecessary
uncertainties for businesses and households. Furthermore, if the announcement was trusted
and inflation expectations rose accordingly, it is financial markets that would respond most
quickly. There would then be a risk of a premature rise in long-term yields before actual
prices and wages start to rise. Under such circumstances, the prices of Japanese
government securities, a large share of which is owned by financial institutions, would go
down, thereby heightening the risk of undermining such institutions' lending activities. Owing
to these concerns, we judged that it was best to leave the CPI inflation rate at 1 percent for
the time being and exert efforts to achieve that goal. On top of this, the Bank will review "the
price stability goal in the medium to long term" once a year while analyzing the level of
progress that has been made toward strengthening the growth potential and the changes
that have occurred in the general public's perception of prices.
Achieving the "price stability goal" and conduct of monetary policy
The second point concerns the timing of achieving the price stability goal and its relationship
with the conduct of monetary policy. In the Outlook Report published in April 2012, the
median of the Policy Board members' forecasts of CPI (all items less fresh food) for fiscal
2013 was 0.7 percent year on year. Our decision to enhance monetary easing at that time
was not made simply because our forecast fell short of the goal of 1 percent. Rather, given
that it will likely be not too long before the year-on-year rate of change in the CPI reaches the
Bank's "price stability goal in the medium to long term" of 1 percent for the time being, the
Bank judged from a somewhat long-term perspective that the likelihood of Japan's economy
returning to a sustainable growth path was fairly high. It was against such a background that
the Bank enhanced monetary easing. A central bank aims to achieve price stability in the
medium to long term, and no country has accepted the idea that its central bank must
achieve a certain percent of inflation by a certain period of time in an automatic manner.
Having said that, we are hoping that 1 percent inflation, specified as the Bank's "price
stability goal in the medium to long term" for the time being, is achieved at the earliest
possible time. However, there are structural and corrosive problems behind the cause of
deflation. Furthermore, one has to take into consideration that there is a long time lag before
the effects of monetary policy permeate the economy.
Under such circumstances, if the Bank presses on too aggressively with the purchase of
financial assets - the monthly purchase of JGBs, for example, has already reached a
significant level - this could hold down long-term yields temporarily; however, it subsequently
could trigger an event that would lead to a jump in such yields as a result of the government
bond market being too dependent on the central bank's purchases (Chart 6). This will have a
significant impact on financial institutions' management, and will jeopardize price stability as
well as the sound development of the economy.
The Bank continues to examine whether economic activity and prices are moving in the right
direction, and to assess risks including the accumulation of financial imbalances. The Bank
will conduct policy in an appropriate manner while carefully assessing the effects of further
monetary easing in the pipeline.
Large-scale purchase of government bonds and the credibility of currency
The third point is related to the large-scale purchase of government bonds and its
relationship with maintaining the credibility of currency. Related to this point, we sometimes
hear the criticism that once the purchase of government bonds by a central bank is perceived
as financing government debt, and not conducted for the purpose of monetary policy, this
could entail a risk of undermining the credibility of currency.
The Bank conducts such purchases for two different purposes. First, it regularly purchases
long-term government bonds under the ceiling of the amount of banknotes in circulation. This
is based on the rationale that, as long as such purchases are in line with an increasing trend
of demand for banknotes, the Bank should hold long-term assets instead of short-term
assets. From this viewpoint, a ceiling has been set that is equivalent to the amount of
banknotes in circulation.
The second purpose is to purchase long-term government bonds through the
aforementioned Asset Purchase Program, with a view to pursuing its powerful monetary
easing. Such purchase is aimed at encouraging a decline in longer-term market interest rates
on the basis of its conduct of monetary policy, and is not restricted to the ceiling of the
amount of banknotes. At the end of May, the amount of JGBs held by the Bank for this
purpose was about 10 trillion yen, and it will be increased by about 29 trillion yen by the end
of June 2013. Adding these values together, the total amount of the Bank's holdings was
approximately 73 trillion yen at the end of April 2012, is expected to total 92 trillion yen at the
end of this year, thereby exceeding the amount of banknotes in circulation, and reach
97 trillion yen at the end of June next year (Chart 7).
Given that special deficit-financing bonds issuance in fiscal 2012 is about 38 trillion yen, the
growth in size of the Bank's purchase of JGBs appears fairly straightforward. Nevertheless,
the Bank's purchase of long-term government bonds has never been - and will never be -
intended as financing government debt. I emphasize that the Bank's intention is crystal clear
on this point.
Considering the relationship between currency and government securities, it is important to
go back to basics.2 The Bank purchases the government securities because the banknotes it
issued against such purchases are ultimately accepted by the public, whose confidence in
banknotes is maintained. However, such confidence is backed by the government securities.
Put differently, it is hard to imagine a situation where public confidence in banknotes is
maintained but not that in the government securities. Hence, once the confidence in the
government securities is lost, so is that in banknotes. After all, if the central bank's purchase
of the government securities exceeds the amount of banknotes the public wishes to hold, this
will eventually lead to inflation. Alternatively, the anticipation of inflation will lead to a
preemptive hike in long-term yields, exerting a negative influence on the economy and the
financial system. Thus, the amount of the government securities that the Bank can purchase
has a ceiling that is specified by "confidence". The Bank has been purchasing a significant
amount of JGBs, but its operation rests on a subtle balance that is based on sustaining such
confidence. Above all, it is vital that steps toward fiscal consolidation make steady progress
in order not to create any room for misunderstanding the Bank's action as financing
government debt.
Role of monetary easing
The fourth point is the role of monetary easing and its relationship with other policies and
measures. Related to this point, we hear the view that insufficient monetary easing has
caused both the persistent deflationary pressure and the resurgent appreciation of the yen.
At the same time, we are aware of the opposing view that monetary easing has delayed
structural reforms in the economy and fiscal situation. Our thinking on this is clear: we need
to make efforts to strengthen growth potential and provide support from the financial side.
For our part, we will make our utmost efforts from the financial side.
Monetary easing permeates the economy through two stages. The first consists of the
central bank's action influencing financial conditions, and the second involves such
conditions inducing increased spending by firms and households. As far as financial
conditions are concerned, the levels of interest rates in Japan - whether they be interest
rates on loans or issuance rates of corporate bonds - are at least as low as those in the
United States (Chart 8). This is also the case whether they be nominal interest rates or real
interest rates adjusted for inflation expectations.
Nevertheless, the reason behind the recurring argument for insufficient monetary easing
comes from a misunderstanding concerning the amount of currency the central bank
supplies. Under a zero interest rate, the cost associated with holding either banknotes or the
central bank's current deposits is negligible; no matter how much money it supplies, this will
be held in such a form as the central bank's current deposits. In terms of quantity, this is
completely ineffective. In fact, Chairman Bernanke has stated that the degree of monetary
accommodation cannot be measured properly based on the quantity. Having said that, the
fact is that the quantity itself is the highest in Japan. Considering that Japan had been
increasing its quantity well before European countries and the United States, which started
boosting their quantities after the Lehman shock, perhaps the public has been used to such
an environment without being particularly aware of it. It is our strong desire that advantage
be taken of such accommodative conditions.
IV. Importance of strengthening growth potential
Up to now, I have explained our thinking behind the conduct of monetary policy. In order for
Japan's economy to overcome deflation and return to a sustainable growth path with price
stability, support from the financial side is an important and necessary condition, and the
Bank will do its utmost while examining the developments in economic activity and prices, as
well as assessing risks. Nevertheless, this is not enough to lead Japan's economy toward
overcoming deflation and returning to a sustainable growth path with price stability. Efforts to
strengthen growth potential are particularly important. With this in mind, I would now like to
change the subject and talk about how to strengthen growth potential.
Growth potential is the potential growth rate of real GDP. In the short run, the economy
fluctuates at a rate around the potential growth path, but will converge to that path in the long
run, say over 10 and 20 years.
The real GDP growth rate is decomposed into the growth rate of the workforce and the
growth rate of real per capita GDP. Japanese data for the last 10 years show that the
working-age population declined by 0.3 percent year on year and labor productivity increased
by 0.8 percent year on year. When combining these numbers, the real GDP growth rate
increased by around 0.5 percent. The decline in the workforce reflects the rapid aging that is
in progress. For the next 10 years, assuming that the labor participation of male/female
workers and that of different age groups remain constant, the working-age population is
expected to decline by 0.6 percent. Meanwhile, labor productivity in Japan increases at a
somewhat higher rate than in other major economies. With that in mind, there are only two
ways to boost economic growth: either raise the rate of growth in the working-age population
or raise labor productivity. Of course, the economic growth rate can still increase somewhat
once the output gap has been filled through the process of encouraging an unutilized labor
force to participate. According to the Cabinet Office, the recent output gap estimate is nearly
2 percent, and it appears that this does not provide enough impetus to lift the economic
growth rate once the output gap is filled (Chart 9).
Raising labor participation and productivity
Based on the information provided thus far, the direction in which we should be heading is
clear.
The first move would be to increase labor participation, or at least make efforts to stop its
decline. In particular, society has to take steps to allow more females and the elderly to
participate in the labor market. If, by 2030, (a) the labor participation of female workers
became as high as that in Sweden, (b) the participation of those at the age of 60-64 became
as high as those at the age of 55-59, and (c) the participation of those at the age of 65+ went
up accordingly, then the working-age population would rise by 0.2 percent in the 2010s, not
decline by the 0.6 percent that I mentioned earlier (Cha