Yoshihisa Morimoto: Economic activity and prices in Japan and
monetary policy
Speech by Mr Yoshihisa Morimoto, Member of the Policy Board of the Bank of Japan, at a
meeting with business leaders, Akita, 19 June 2014.
* * *
I. Recent economic and price developments
A. Japan's economy and prices
1. Current state of and outlook for the economy
I will begin by explaining the current state of and outlook for Japan's economy. Since the
start of fiscal 2014, a subsequent decline in demand following the front-loaded increase prior
to the consumption tax hike has been observed, mainly in private consumption, such as of
durable goods, but domestic demand including business fixed investment has remained firm
as a trend. Therefore, a virtuous cycle of economic activity has been operating firmly,
accompanied by steady improvements in supply and demand conditions in the labor market.
In this situation, the economy has continued to recover moderately as a trend. Specifically,
overseas economies - mainly advanced economies - are recovering, albeit with a lackluster
performance still seen in part of emerging economies. Japan's exports had been picking up
as a trend through early autumn 2013, but since then have been leveling off more or less,
partly due to temporary downward pressure, such as firms' stance of placing priority on
domestic shipments in response to the front-loaded increase in demand prior to the
consumption tax hike and the unusually severe winter weather in the United States, in
addition to the sluggishness in emerging economies. Looking at domestic demand, private
consumption and housing investment have remained resilient as a trend with improvement in
the employment and income situation, although a subsequent decline in demand following
the front-loaded increase has recently been observed. Business fixed investment has
increased moderately as corporate profits have improved; for example, on a GDP basis, it
increased in the January-March quarter of 2014 for the fourth consecutive quarter, and thus
is growing at an accelerated pace. Public investment continues to increase, due in part to the
effects of various economic measures, and has more or less leveled off recently at a high
level.
As for the outlook, Japan's economic growth rate for the April-June quarter is expected to
temporarily decline due to the subsequent decline in demand following the front-loaded
increase. However, the virtuous cycle among production, income, and spending is expected
to be maintained, as private consumption is expected to remain resilient as a trend, reflecting
improvement in the employment and income situation, and as exports and business fixed
investment are expected to follow a moderate increasing trend. Therefore, although the
economy will be affected by the front-loaded increase and subsequent decline in demand
prior to and after the consumption tax hike, the recovery will not stall, and the economy is
likely to continue growing at a pace above its potential as a trend. In the Bank of Japan's
April 2014 Outlook for Economic Activity and Prices (hereafter the Outlook Report), the
median of the Policy Board members' forecasts for the economic growth rate was
1.1 percent for fiscal 2014, 1.5 percent for fiscal 2015, and 1.3 percent for fiscal 2016.
2. Prices
Next, I will talk about price developments. The year-on-year rate of change in the consumer
price index (CPI) for all items less fresh food turned positive in June 2013, rose to
1.3 percent in December, and has recently been around 11⁄4 percent. The rate of increase for
April 2014 registered 3.2 percent, and on a basis excluding the direct effects of the
consumption tax hike, it marked 1.5 percent, which is somewhat higher than the rate for
March. Given this, the tax increase appears to have been passed on to prices on the whole,
on the back of resilient private consumption. As for the outlook, although the effects of the
upward pressure from energy-related goods that are directly affected by foreign exchange
rates are likely to subside through this summer, the year-on-year rate of increase in the CPI
(all items less fresh food), excluding the direct effects of the consumption tax hike, is likely to
be around 11⁄4 percent for some time. This is due to strengthening of the underlying upward
pressure on prices on the back of improvement in the aggregate supply and demand
balance, or the output gap. Thereafter, in a situation where the virtuous cycle of economic
activity continues to operate, the upward pressure on wages and prices is likely to become
stronger with the output gap following an improving trend, and medium- to long-term inflation
expectations are also likely to rise. Thus, the rate of increase in the CPI is likely to reach
around 2 percent - the price stability target - around the middle of the projection period,
which is from fiscal 2014 through fiscal 2016. Specifically, in the Bank's April 2014 Outlook
Report, the median of the Policy Board members' forecasts for the year-on-year rate of
increase in the CPI (all items less fresh food, excluding the direct effects of the consumption
tax hikes) was 1.3 percent for fiscal 2014, 1.9 percent for fiscal 2015, and 2.1 percent for
fiscal 2016.
B. Overseas economies
I would now like to give an overview of overseas economies. These are expected to
moderately increase their growth rates as advanced economies continue to see firm recovery
and its positive effects gradually spread to emerging economies. According to the projections
for global economic growth released by the International Monetary Fund (IMF) in April 2014
in its World Economic Outlook, global growth is projected to strengthen to 3.6 percent in
2014 and then to 3.9 percent in 2015, rising at a moderate pace to reach a rate exceeding its
long-term average.
Looking at respective major countries and regions, in the United States, real GDP for the
January-March quarter of 2014 decreased from the previous quarter, mainly due to the
effects of the unusually severe winter weather, but has returned to a moderate recovery
trend. As for the outlook, the pace of recovery is expected to gradually rise, led mainly by
private demand - such as firm private consumption - as accommodative financial conditions
are expected to be maintained and fiscal drag is likely to weaken. The euro area economy is
recovering moderately, registering positive growth for four consecutive quarters. Although
faced with structural problems such as excess debt, it is expected to continue recovering
moderately, supported in part by improvement in household and business sentiment.
Regarding risks to the economy, close attention needs to be paid to a possible prolonged
disinflationary trend and the effects of the situation in Ukraine and Russia. The Chinese
economy continues to see stable growth, although it has been growing at a somewhat
reduced pace, mainly in real estate-related areas. The Chinese authorities have taken the
stance of continuing to pay consideration to economic activity while progressing with
structural reforms, and already have taken some policy measures to underpin economic
activity. In addition, external demand is expected to continue improving moderately, mainly in
advanced economies, and thus the Chinese economy is likely to continue to see stable
growth, albeit at a slightly slower pace. Meanwhile, some of the other emerging and
commodity-exporting economies remain weak in a situation where they are facing issues
regarding, for example, current account balance and inflation rates. These economies will
likely continue to lack growth momentum for the time being, but are expected to gradually
increase their growth rates due to positive effects of the recovery in advanced economies, on
the assumption that global financial markets remain generally stable.
C. Major issues surrounding the outlook for economic activity and prices
Let me elaborate on several points that I think deserve particular attention in terms of
realizing the outlook for economic activity and prices that I mentioned earlier. I will first touch
on issues related to domestic demand, followed by those concerning external demand, and
then prices.
1. Household spending and the employment and income situation
I will first touch on household spending and its supporting pillar - the employment and
income situation. Regarding household spending, it is important to examine the effects of the
consumption tax hike in April 2014. Private consumption has remained resilient as a trend
with improvement in the employment and income situation. The effects of the decline in
consumption due to the front-loading of demand are likely to start waning from this summer.
Since April, a clear decline following the tax hike has been observed, mainly in purchases of
durable goods such as automobiles, demand for which increased substantially prior to the
tax hike. So far, however, many firms have indicated that the degree of the decline in
consumption following the tax hike has been broadly in line with expectations, and that
private consumption continues to remain resilient as a trend. Furthermore, retailers, such as
department stores and supermarkets, have indicated that the decline in consumption is
gradually shrinking. Also, sales in the food service industry and outlays for travel remain
steady. These views have been reflected in the Economy Watchers Survey. In the latest
survey, the diffusion index (DI) for future economic conditions for two to three months ahead
recovered to surpass 50, the borderline between improvement and deterioration. Of course,
it is necessary to continue to carefully examine the upcoming results of this survey. As for the
outlook, while the employment and income situation continues to improve, private
consumption is likely to stay on an increasing trend, albeit at a moderate pace, partly due to
active spending by the elderly - the baby-boomer generation in particular. Housing
investment is expected to remain resilient as a trend, supported by improvement in the
employment and income situation and accommodative financial conditions.
In this way, a sustained improvement in the employment and income situation is the key to
keeping private consumption and housing investment resilient. Taking a look at supply and
demand conditions in the labor market, the unemployment rate has fallen to 3.6 percent and
the active job openings-to-applicants ratio has risen to 1.08. These figures are both at around
the most favorable levels marked before the Lehman shock. Furthermore, in the March 2014
Tankan (Short-Term Economic Survey of Enterprises in Japan), the DI for employment
conditions (the proportion of firms responding that employment conditions are "excessive"
minus the proportion of those responding that they are "insufficient") for nonmanufacturing
showed the largest negative figure since December 1992, and that for manufacturing turned
negative, indicating a further tightening of supply and demand conditions in the labor market.
An increasing number of firms - mainly in the construction and retail industries, which are
increasingly experiencing a shortage of labor - are reviewing working conditions to secure
sufficient human resources, leading to more women and the elderly joining the workforce.
Although this recent addition to the workforce has mainly represented employees with short
working hours, such as part-time workers, this development will likely affect demand through,
for example, increased income, and eventually lead to a rise in the medium- to long-term
growth potential of Japan's economy.
The tightening of supply and demand conditions in the labor market is starting to influence
wages. Hourly cash earnings of overall employees have started to increase moderately,
albeit with fluctuations. According to the currently available aggregate results of wage
negotiations compiled by the Japanese Trade Union Confederation (Rengo), wage
negotiations this spring are expected to result in a rise by firms, including small firms, of
around 0.5 percent in base pay, and about 2.1 percent in overall wages. In addition, various
surveys show that summer bonuses are likely to increase. As for the outlook, in a situation
where Japan's economy continues to grow at a pace above its potential, firms have shown
more willingness to hire new recruits, including regular employees. Under such
circumstances, it is likely that the labor supply and demand conditions will further tighten, and
the unemployment rate is expected to continue declining to a level more or less close to the
structural unemployment rate - a state in which excess labor force has disappeared. In this
situation, it is increasingly likely that wages, as well as prices, will be put under upward
pressure.
2. Business fixed investment
I will now move on to business fixed investment. In order to achieve sustainable growth of
the economy, it is important that improvements in corporate profits and increases in demand
lead to firms' active investment. Corporate profits for fiscal 2013 rose significantly. As for
fiscal 2014, firms have relatively conservative fixed investment plans at present. However,
supported by a moderate increase in exports and developments in the foreign exchange
market, in addition to firm domestic demand, corporate profits are expected to continue their
improving trend. Under these circumstances, business fixed investment is likely to follow a
moderate increasing trend, given its noticeable growth on a GDP basis and the upward trend
in machinery orders, which represent a leading indicator of machinery investment.
Three factors are supporting the strength in business fixed investment. First is the
improvement in investment profitability. The extent of the monetary easing stimulus to
encourage investment is likely to strengthen, owing to a rise in the rate of return on capital
due to improvement in economic activity, combined with the decline in real interest rates that
mainly reflects a rise in inflation expectations. Second is the large potential demand.
Business fixed investment, which has increased for four consecutive quarters, has just
entered a recovery phase after dipping due to the effects of the Lehman shock and the Great
East Japan Earthquake. Therefore, increased economic activity will easily encourage latent
demand to materialize, such as for the maintenance and replacement of equipment. The
third factor is a likely rise in firms' medium- to long-term growth expectations, due partly to
the positive initiatives to strengthen the competitiveness and growth potential of Japan's
economy, such as the government's regulatory and institutional reforms and firms'
restructuring efforts.
Looking at business fixed investment overseas, the last one to two years have coincided with
the periods in which investment decisions that were made after the Lehman shock - when
the yen appreciated - proceeded to the actual implementation phase. Thus, the ratio of
overseas business fixed investment relative to domestic investment has increased rapidly. In
view of recent movements in the foreign exchange market, however, the pace of increase is
likely to decelerate somewhat.
3. Exports
I would now like to talk about developments in exports. Exports have leveled off more or less,
due partly to temporary downside pressure, such as the sluggishness in emerging
economies, particularly the ASEAN economies, which are closely linked to Japan's economy,
and the effects of the unusually severe winter weather in the United States. Moreover, the
recent weakness in exports is likely to be affected to some degree by structural factors such
as an increasing shift by Japanese manufacturers to move production overseas. From a
somewhat longer-term perspective, however, the correction in the appreciation of the yen to
date is likely to ease downward pressure on exports by putting a brake on the shift to move
production overseas. As for the outlook, exports are likely to start increasing, albeit
moderately, as overseas economies - mainly advanced economies - recover moderately on
the whole. It should be noted that exports might deviate either upward or downward,
depending on future developments in overseas economies. Therefore, it is necessary to
continue to closely monitor developments, such as in emerging economies, the European
debt problem, and the U.S. economy.
4. Prices and inflation expectations
I will now move on to developments in prices and inflation expectations. Excluding the direct
effects of the consumption tax hike, the year-on-year rate of increase in the CPI (all items
less fresh food) for April 2014 climbed to 1.5 percent. This was because, while the positive
contribution from prices of energy-related goods that are directly affected by foreign
exchange rates has peaked, improvements have become widespread for a broad range of
items other than energy-related goods, including those in the services industry, such as
accommodation charges, mainly on the back of an improvement in the output gap. On a
basis excluding the direct effects of the tax hike, the year-on-year rate of change in the CPI
for April, excluding prices of food and energy-related goods such as petroleum products,
climbed to 0.8 percent from minus 0.8 percent for March 2013. Improvement has become
pronounced, as the number of items for which prices have increased has been exceeding
50 percent of the total. As for firms' price-setting behavior, interviews with firms and other
relevant information have revealed that some firms have been successful in their efforts,
such as to raise selling prices while increasing value-added and tapping new potential
demand.
Against this background, there seems to be a gradual increase in the responsiveness of
prices to the output gap and in inflation expectations, including short-term ones. Let me note
that the Bank, in the March 2014 Tankan, surveyed the inflation outlook of firms for the first
time. Although there were disparities between the views of large firms and small ones,
results showed that the outlook for general prices of all firms in all industries for one year
ahead registered 1.5 percent on average, while those for three years and five years ahead
were both slightly above 1.5 percent, indicating firms' expectations of a further rise in
inflation. Given the current tightening of labor supply and demand conditions, mainly in
nonmanufacturing, inflation expectations of firms - as well as households - are susceptible
to gaining upward momentum. It should be noted, however, that the actual rate of inflation
does affect the medium- to long-term expected rates of inflation. If, through this summer, the
upward momentum of the CPI weakens due to a fall-off of the effects of the weak yen and to
a slack in supply and demand conditions resulting from the decline in demand following the
consumption tax hike, due attention should continue to be paid to how this will affect inflation
expectations, even during the process of the economy returning to a moderate recovery path
from the summer.
As I have explained, the Bank expects the inflation rate to increase gradually in a situation
where economic activity will improve in a balanced and sustainable manner, accompanied by
improvement in corporate profits and subsequent increases in employment, wages, and
business fixed investment. Recently, while domestic demand remains firm, the output gap in
Japan appears to have reached the past long-term average of about zero, reflecting factors
such as a low birth rate and aging population working in the direction of reducing potential
labor supply. In other words, supply-side issues have surfaced. Therefore, reinforcing supply
capacity has become an important challenge with respect to raising Japan's economic
growth in the medium to long term and achieving sustainable growth. To this end, it is
essential to steadily carry out measures to enhance productivity and thereby raise the growth
potential of the economy, such as by providing job opportunities for women and the elderly to
secure a sufficient labor force, encouraging firms' active investment, and also implementing
regulatory and institutional reforms. At the same time, it also is essential to continue creating
demand to match the increased supply capacity. The government is accelerating
implementation of its Japan Revitalization Strategy, which is designed to boost the growth
potential, and in view of the discussions made after the introduction of the strategy, it is
formulating a new growth strategy. The Bank, for its part, is actively proceeding with
measures such as provision of funds to support strengthening of the foundations for
economic growth. These endeavors will continue to be made steadily in an effort to address
the issues facing Japan's economy that I have explained, and medium- to long-term growth
expectations of firms and households are likely to rise accordingly.
II. Conduct of monetary policy
A. Quantitative and Qualitative Monetary Easing (QQE)
1. Framework of QQE
Next, I would like to turn to the Bank's monetary policy.
In order for Japan's economy to overcome deflation as early as possible and achieve
sustainable growth with price stability, the Bank introduced in January 2013 the price stability
target of 2 percent in terms of the year-on-year rate of change in the CPI. Then, in April of
the same year, the Bank introduced QQE to achieve the price stability target at the earliest
possible time, with a time horizon of about two years. With its steady continuation so far,
QQE has been exerting its intended effects. The Bank has announced that it is committed to
continuing with QQE, aiming to achieve the price stability target of 2 percent, as long as it is
necessary for maintaining that target in a stable manner. It will examine both upside and
downside risks to economic activity and prices, and make adjustments as appropriate.
The specific measures of QQE are as follows. First, with a view to pursuing quantitative
monetary easing, the Bank decided to increase the monetary base - which is the total
amount of currency it directly supplies to the economy (the sum of banknotes in circulation,
coins in circulation, and current account deposits held by financial institutions at the Bank) -
at an annual pace of about 60-70 trillion yen, thus doubling it in two years. Second, to
achieve this, the Bank has been purchasing Japanese government bonds (JGBs) so that
their amount outstanding increases at an annual pace of about 50 trillion yen. In doing so,
the Bank has been working on interest rates across the yield curve - including longer-term
ones - setting the average remaining maturity of its JGB purchases at about seven years.
And third, the Bank has been purchasing exchange-traded funds (ETFs) and Japan real
estate investment trusts (J-REITs) so that their amounts outstanding increase at an annual
pace of about 1 trillion yen and about 30 billion yen, respectively.
In conducting QQE, the Bank keeps in mind two key transmission channels: (1) lowering real
interest rates, which are obtained by subtracting expected rates of inflation from nominal
long-term interest rates; and (2) the portfolio rebalancing effect, which encourages financial
institutions and institutional investors to shift their asset portfolio toward lending and
investment in risk assets such as stocks. In lowering real interest rates, the Bank first applies
strong downward pressure on nominal long-term rates by tightening JGB market conditions
through its massive purchases of JGBs. Then, through a clear explanation of its
determination to achieve the price stability target at the earliest possible time and the
continuation of massive purchases of assets underpinning this determination, it aims to raise
inflation expectations by boosting people's expectations that the economy will become
revitalized. Consequently, real interest rates could be lowered if the extent of a pick-up in
nominal rates is contained within the extent of a rise in inflation expectations. In other words,
a decline in real interest rates would lessen firms' and households' interest burden relative to
the improved corporate profits and household income, thereby helping to increase firms'
investment and households' consumption. In order to achieve the price stability target, it is
important - with this mechanism functioning effectively - to maintain the virtuous cycle in
which prices rise moderately along with a balanced and sustainable improvement in
economic activity that is accompanied by increases in corporate profits, employment, and
wages. 2. Recent financial environment and the conduct of monetary policy I would now like
to turn to the financial environment in Japan. With the steady continuation of QQE, financial
conditions are accommodative. The monetary base has been increasing at a pace consistent
with the Bank's policy guideline of increasing it at an annual pace of about 60-70 trillion yen
and has been at a high year-on-year growth rate of around 45 percent. Through the end of
2014, the Bank plans to increase the monetary base to a level as high as about 270 trillion
yen, which is equivalent to about 60 percent of nominal GDP.
In this situation, firms' funding costs have been hovering at low levels. The average interest
rates on new loans and discounts for both the short and long terms have been at historical
low levels. In these circumstances, interest payments by firms have been at sufficiently low
levels in relation to their profitability. Financial institutions' lending attitudes as perceived by
large as well as small firms, in addition to the financial positions of both sets of firms, have
been on an improving trend. The levels of various DIs have been above the average for the
period since 2000. Domestic demand for working capital by firms has been rising. There has
also been an increase in demand for funds in sectors where there are prospects for growth,
such as the medical and nursing business, and demand for funds related to corporate
takeover activities. Against this backdrop, the year-on-year rate of increase in the amount
outstanding of bank lending has been at around 2.5 percent, and the year-on-year rate of
growth in the money stock has been in the range of 3.0-3.5 percent.
Looking at financial markets in Japan, interest rates - both long- and short-term - have
been at extremely low levels as the Bank continues with massive purchases of JGBs and
other measures. Money market rates - including those on term instruments with longer
maturities - have been below the 0.1 percent level. Long-term interest rates have been
stable even in the face of temporary rises in such rates in the United States and Germany,
and have been stable at around 0.6 percent on the whole. Japanese stock prices had risen
through end-2013, reflecting the rise in U.S. and European stock prices and further
depreciation of the yen. After the turn of the year, however, they declined and thereafter have
been more or less unchanged, albeit with fluctuations. In the foreign exchange market, the
yen depreciated against the U.S dollar through end-2013, and recently has been more or
less level in the range of 101-103 yen.
In this financial and economic environment, the Bank assumes that, amid a rise in observed
price and wage inflation, people's inflation expectations will rise further, and the effects of
monetary easing brought about by a decline in real interest rates will continue to strengthen.
In relation to developments in portfolio rebalancing, although growth in bank lending remains
marginal relative to the substantial decrease in financial institutions' holdings of government
securities, bank lending growth is expected to gradually increase with the strengthening of
the monetary easing effects, as a rise in business fixed investment has recently become
evident. At present, the virtuous cycle continues to operate as the effects of QQE on
economic activity are gradually becoming pronounced. Nevertheless, it is important to
carefully examine economic developments and the effects of monetary policy, including the
pick-up in economic activity after the decline in demand following the front-loaded increase
prior to the consumption tax hike.
Furthermore, as Japan faces serious fiscal imbalances, even by international standards,
establishing a sustainable fiscal structure is a critical prerequisite for achieving sustainable
growth of the economy. In this regard, the government has indicated that it aims to halve the
primary deficit-to-GDP ratio by fiscal 2015 and achieve a surplus in the primary balance by
fiscal 2020. Based on these targets, it is strongly expected that efforts toward fiscal
consolidation will continue to proceed steadily.
B. Loan support program
Next, I will discuss the Bank's Loan Support Program. To support full use of the
accommodative financial conditions by firms and households, the Bank - in addition to
implementing aggressive monetary easing measures - has established the Loan Support
Program through which it provides long-term funds at a low interest rate to financial
institutions. Specifically, the Bank has been providing funds through two measures that
constitute the program: the fund-provisioning measure to stimulate bank lending (hereafter
the Stimulating Bank Lending Facility) and the fund-provisioning measure to support
strengthening the foundations for economic growth (hereafter the Growth-Supporting
Funding Facility). At the Monetary Policy Meeting held in February 2014, the Bank decided to
enhance the two facilities.
Let me elaborate on the framework of these facilities. First, the Stimulating Bank Lending
Facility aims to prompt financial institutions to take a more active lending stance and
stimulate firms' and households' demand for credit. With this facility, the Bank provides funds
to financial institutions up to an amount that is twice as much as the net increase in their
lending at a fixed rate of 0.1 percent per annum for four years. There is no upper limit to the
total amount of funds provided by the Bank under this facility. The amount outstanding of
fund-provisioning under this facility is expected to reach about 13 trillion yen as of end-June
2014. According to the estimate made in February 2014 when the facility was enhanced, the
amount outstanding of fund-provisioning under the facility is projected to be around 30 trillion
yen if the growth rate of bank lending and the utilization rate of the facility remains more or
less unchanged.
I will now move on to the Growth-Supporting Funding Facility, which aims to support the flow
of funds to growth sectors. With this facility, the Bank provides funds - at a fixed rate of
0.1 percent per annum for four years for yen-denominated funds - to financial institutions for
their lending and investment to areas that are expected to contribute to strengthening
Japan's growth potential, such as medical and nursing care; environment and energy;
agriculture, forestry, and fisheries; and tourism. The maximum amount of its
fundprovisioning to financial institutions under the main rules and special rules is set as follows:
7 trillion yen under the main rules for financial institutions' investments and loans amounting
to 10 million yen or more; 500 billion yen under the special rules for financial institutions'
equity investments and asset-based lending (ABL), the latter of which uses assets such
as accounts receivable and inventories as eligible collateral; 500 billion yen under the
special rules for financial institutions' small-lot investments and loans; and 12 billion U.S.
dollars - equivalent to 1.2 trillion yen - under the special rules for a U.S. dollar lending
arrangement using the U.S. dollar reserves already held by the Bank.
Recently, with the virtuous cycle of economic activity continuing to operate, there has been a
growing impetus among firms to make active investment. I expect that firms will increasingly
make use of the accommodative financial conditions and thereby boldly seize new business
opportunities. The Bank, for its part, will continue to provide firm support that enables them to
meet their challenges.