Hidetoshi Kamezaki: Recent economic and financial developments in
Japan
Summary of a speech by Mr Hidetoshi Kamezaki, Member of the Policy Board of the Bank of
Japan, at a meeting with business leaders, Sapporo, 28 July 2010.
* * *
I. The economy and prices
A. The current economic situation
Following the precipitous deterioration in the wake of the Lehman shock in the fall of 2008,
Japan's economy, since bottoming out in spring 2009, has been showing signs of a
moderate recovery. The main driving force of the recovery has been improvement in
overseas economic conditions, as a result of which Japan's exports and production have
been increasing, while business fixed investment is showing signs of picking up. Moreover,
the government's economic stimulus measures favoring environment-friendly products have
contributed significantly to the pick-up in private consumption.
Overseas economies have continued to recover moderately, underpinned by the effects of
both stimulus measures adopted around the world and inventory restocking. Looking at
developments by region, the Chinese economy has continued to manifest high growth,
supported by the surge in fixed asset investment spurred by a large stimulus package of
4 trillion renminbi, although recently the pace of growth has slowed somewhat. The U.S.
economy has been recovering at a moderate pace, supported by a massive stimulus
package of 780 billion U.S. dollars. European economies overall are also picking up
- although there are some differences across countries - led by increases in exports and
production partly due to a decline in their currencies. Recovery in the euro area, however,
has been weaker than in other regions because stimulus measures adopted in the region
were relatively small in scale, economic structures lack flexibility, and credit uncertainty
triggered by the fiscal problems in Greece remains. Against this background, Japan's exports
to all regions continued to increase. This has brought about production growth, led business
fixed investment to pick up and caused household income to stop declining.
The key elements of the government's economic stimulus measures favoring energy-efficient
products are the eco-point system for electrical appliances, as well as tax reductions and
subsidies for purchases of environment-friendly cars. These measures, together with the
greatly improved cost performance of the products, the switchover from analogue to digital
terrestrial broadcasting, and the extended lifespan of automobiles, have tapped potential
replacement demand and had a significant positive effect on the sales of products covered
by these measures. In addition, it seems that the measures have provided consumers with
an incentive to visit retail stores and encouraged them to purchase products to which the
stimulus measures do not apply, such as DVD recorders that are compatible with flat-panel
TVs and the latest home cleaning robots. This increase in spending on durable consumer
goods has had a positive effect on the economy by increasing production.
In sum, Japan's economy has been supported by two major engines of growth, namely, the
improvement in overseas economic conditions and the government's economic stimulus
measures favoring environment-friendly products. However, because the recovery remains
weak in areas that have not directly benefited from these developments, many people have
yet to feel that the economy overall is recovering. Moreover, although Japan's economy
enjoyed relatively high growth of around 5 percent at an annualized rate from the end of
2009 through the beginning of 2010, the level of economic activity remains lower than before
the Lehman shock. It is, thus, too early to say that a self-sustaining upturn in domestic
private demand is fuelling a robust recovery.
B. The economic outlook
Next, I will talk about the outlook for Japan's economy. The effects of the two factors that
have so far been the engines of economic growth are likely to weaken. Specifically, overseas
economies, including those that currently are growing at a rapid pace, seem likely to slow to
more steady and sustainable rates of growth as the effects of inventory restocking and
stimulus measures abate. The uptrend in Japan's exports is expected to continue, but the
pace of increase is likely to moderate gradually. Durable goods consumption is expected to
fall temporarily in reaction to the termination of the government's economic stimulus
measures favoring energy-efficient products: subsidies for purchases of environment-friendly
cars expire at the end of September, while the eco-point system for electrical appliances
expires at the end of December.
New factors should be taken into account, however. For example, the government's child
allowances, which started in June, are expected to help support private consumption.
Moreover, business fixed investment and household income are likely to pick up, reflecting
an improvement in the capacity utilization rate and in corporate profits. Supported by these
factors, Japan's economy should assume a moderate recovery trend.
The outlook I just presented, however, is subject to various upside and downside risks.
One upside risk is that growth in emerging and commodity-exporting economies might
accelerate. Recently, a growing number of emerging and commodity-exporting economies
have been shifting away from accommodative monetary policies, while in China, the
government has implemented measures to curb the overheating of the real estate market.
However, if capital from industrialized economies - which are persisting with accommodative
monetary policies - continues to flow into these countries and thereby exacerbates
overheating in asset markets, it could boost growth. These developments could then pose an
upside risk to Japan's economy by means of an increase in exports. Such developments
would not be wholly desirable since overheating in emerging and commodity-exporting
economies would inevitably lead to a tightening of policies, which might then pose a
downside risk to Japan's economy.
When considering downside risks, the growing instability in global financial markets warrants
attention. The fiscal problems in Greece and some other European countries will not only
lead to a deterioration in domestic demand in these countries as a result of fiscal austerity
measures, but also exert downward pressure on European economies as a whole in a
number of ways. These include fiscal consolidation in other countries, as they attempt to
avoid a similar fate; the weakening of the financial intermediary function of financial
institutions that own sovereign debt issued by countries stricken by the crisis; and a decline
in the propensity to consume, as a result of uncertainties surrounding overall markets. The
direct impact on Japan's economy is likely to be minimal, as its lending to countries in the
region is inconsiderable, while exports to Europe account for only about 10 percent of the
total. However, for China and the United States - the major destinations of Japanese exports
- Europe accounts for about 20 percent of exports and Japan could, therefore, be indirectly
affected. Furthermore, it is necessary to be aware of downside risks, stemming from the
effects of the yen's appreciation against the euro, on Japan's export competitiveness, as well
as the impact of financial market instability on firms' funds procurement.
C. Price developments
I will now move on to prices. Commodity prices, which have a major impact on price
developments in Japan, have been on a rising trend, reflecting high growth in emerging
economies. As a result, recent import prices have been about 10 percent above year-ago
levels, after having plunged more than 30 percent year on year in summer 2009. In addition,
the domestic corporate goods price index (CGPI), which measures fluctuations in prices of
goods traded between firms in Japan, has risen somewhat above levels for the same period
a year ago.
The consumer price index (CPI) excluding fresh food (the core CPI), which measures the
price of goods and services purchased by households, has been declining on a year-on-year
basis since March 2009, indicating deflation. However, following the largest year-on-year
decline of 2.4 percent in August 2009, the pace of decline has been moderating as a trend.
Meanwhile, the pace of decline in the CPI excluding food and energy, or the core-core CPI,
which is not usually susceptible to commodity price fluctuations, has also been moderating
recently, after marking the largest fall of 1.2 percent at the beginning of 2010. These
developments, apart from the rise in commodity prices, probably occurred because the
Japanese economy bottomed out and started recovering around spring 2009, and the effects
of the narrowing of the negative output gap began to be reflected in prices with a lag of about
one year.
The year-on-year rate of decline in the core CPI is likely to continue slowing, reflecting the
rise in commodity prices and the narrowing of the negative output gap, and the rate of
change in the CPI may even enter positive territory in fiscal 2011. There are, needless to
say, both upside and downside risks associated with the outlook for prices, just as for
economic activity. The upside risks include an upswing in commodity prices caused by
stronger-than-expected growth in emerging economies. On the other hand, price
developments could deviate downward from the outlook if pessimism among the public
spreads due to a slower-than-expected recovery of the economy. A decline in the medium- to
long-term inflation expectations of various economic entities could trigger a fall in the actual
inflation rate. Thus, risks associated with price developments require careful monitoring.
II. Measures taken by the Bank
Next, I will elaborate on the Bank's policy measures since the start of the recent global
financial crisis.
A. Measures to address the rapid financial contraction
In order to address the rapid financial contraction triggered by the failure of Lehman
Brothers, the Bank successively conducted same-day funds-supplying operations and
introduced U.S. dollar funds-supplying operations as emergency measures to provide
liquidity for financial markets. Furthermore, the Bank decided to introduce outright purchases
of CP and corporate bonds, based on the recognition that a significant decline in the
functioning of markets, such as the serious shortage of liquidity in the CP and corporate bond
markets, was causing a tightening of overall corporate financing conditions. In addition, the
Bank introduced a series of temporary emergency measures to facilitate corporate financing,
including the easing of the rating requirement for corporate debt to be accepted as eligible
collateral and the special funds-supplying operation to facilitate corporate financing, through
which the Bank provided 3-month funds for an unlimited amount against the value of
corporate debt pledged as collateral at a fixed interest rate of 0.1 percent.
Furthermore, in order to ensure an accommodative financial environment, on both
October 31 and December 19, 2008, the Bank reduced the target level of the policy interest
rate (the uncollateralized overnight call rate), bringing it down from 0.5 percent to the current
0.1 percent. In order to provide ample liquidity through maintaining the policy interest rate at
this low level, the Bank also introduced the complementary deposit facility, whereby interest
is made payable on excess reserve balances held at the Bank by financial institutions.
At the same time, the Bank introduced temporary measures to secure the stability of the
financial system, given that the strains in global financial markets and the subsequent fall in
stock prices and rise in credit costs had greatly affected financial institutions' intermediary
function and financial soundness. Such measures include the purchase of stocks held by
financial institutions to help them reduce the market risk associated with stock holdings and
the provision of subordinated loans to banks to help them maintain sufficient capital bases.
Since then, the Bank has been gradually bringing to an end some of its temporary measures
as financial markets have regained stability. In May 2010, however, in order to address the
increased strains in global financial markets triggered by the fiscal problems in Greece and
some other European countries, the Bank re-established the U.S. dollar funds-supplying
operations that had been wound up at the beginning of February 2010.
B. Measures to address deflation
Although financial markets have been gradually regaining stability and the economy is
showing signs of a moderate recovery, the Bank recognizes that Japan's economy still faces
the critical challenge of overcoming deflation and returning to a sustainable growth path with
price stability. For this reason, the Bank reiterated its commitment to fight deflation.
Regarding the "understanding of medium- to long-term price stability" (the level of inflation
that each Policy Board member understands, when conducting monetary policy, as being
consistent with price stability over the medium to long term; hereinafter "understanding"), the
Bank, at the Monetary Policy Meeting held in December 2009, made it clear that the Policy
Board does not tolerate a year-on-year rate of change in the CPI equal to or below 0 percent,
and that the midpoints of most Policy Board members' "understanding" are around 1 percent.
On this basis, the Bank continues to maintain the policy rate at the extremely low level of
0.1 percent. Moreover, in order to ease monetary conditions further by encouraging a decline
in longer-term interest rates, the Bank in December 2009 introduced a new fixed-rate
fundssupplying operation against pooled collateral (hereinafter fixed-rate operation), whereby
funds with a maturity of three months are provided at an extremely low interest rate of
0.1 percent. The total amount of loans to be provided through the fixed-rate operation was
first set at approximately 10 trillion yen in December 2009, but this was increased to
approximately 20 trillion yen in March 2010.
C. Introduction of the fund-provisioning measure to support strengthening the
foundations for economic growth
Through the measures I have mentioned so far, the Bank has been providing ample funds to
financial markets and financial institutions. However, the funds have not been sufficient to
feed into the economy and bring about strong growth. Therefore, as the central bank, the
Bank examined ways in which it could support financial institutions, in their efforts in terms of
lending and investment, in a way that would help strengthen the foundations for economic
growth. As a result of deliberations, the Bank on June 15, 2010, decided to introduce a new
fund-provisioning measure to strengthen the foundations for economic growth.
The measure provides funds for financial institutions, reflecting their efforts in terms of
lending and investment to strengthen economic growth at a loan rate equivalent to the
Bank's policy interest rate, which currently is only 0.1 percent. The duration of each loan
provided by the Bank is one year in principle, and the maximum duration of the loans is four
years, including rollovers. With this measure, the Bank hopes to offer the broadest support
possible for the various efforts that financial institutions make on their own initiative. The
Bank will start providing funds by around the end of August 2010 and new loans will be
disbursed quarterly. The measure is temporary and the Bank set March 31, 2012, as the
deadline for new loan applications, so that financial institutions would accelerate their
implementation of lending and investment.
The Bank has already started making necessary preparations to provide funds through this
measure. On June 25, the Bank announced it had selected 66 counterparty financial
institutions for fund-provisioning through public application. Not only major banks, but also a
wide range of other financial institutions, including regional banks, became counterparties.
Each counterparty submitted its plan for strengthening the foundations for economic growth
to the Bank, which is currently evaluating each counterparty's eligibility based on the amount
of lending and investment carried out under the plan in the April-June quarter of 2010. Based
on the evaluation, the Bank will determine how much it will lend in its first disbursement.
Let me next explain the background to the Bank's decision to introduce this fund-provisioning
measure.
III. Strengthening the foundations for economic growth
A. Deflation
As I mentioned earlier, Japan is experiencing deflation. Price instability, including deflation,
has various negative effects on the economy and society. For instance, it reduces the
efficiency of resource allocation, restrains economic activity by making economic outlook
uncertain, and distorts income distribution by changing the real value of contracts, assets
and liabilities, which are typically in nominal terms. In addition, there are problems particular
to deflation. For example, it has been pointed out that debtors with a high propensity to
consume tend to restrain their spending when the real value of their debt rises, weighing
down the economy. In addition, due to the zero bound on nominal interest rates, real interest
rates do not fall to the level required by the level of economic activity.
Declining inflation rates are a trend shared by all major economies around the world. It is
only in Japan, however, that prices in terms of the CPI excluding food and energy (the
corecore CPI) have been falling. The main reason for this is the large output gap, which has
remained consistently negative since the second half of the 1990s. What is more, the gap
has been much larger than in other major economies. This is attributable to the excess
supply capacity that has not been adequately adjusted relative to the level of domestic
demand, which has stayed sluggish since the bursting of the economic bubble.
Weakness in domestic demand was prolonged by the delay in balance-sheet adjustments by
various economic entities and the lack of forward-looking expenditure since the bursting of
the economic bubble. In particular, the delay in the disposal of impaired assets by financial
institutions weakened their financial intermediary functions, impairing their ability to provide
sufficient funds for new areas of growth. The pressure on various economic entities to adjust
their balance sheets has more or less disappeared since the beginning of 2000. However,
the prolonged period of weak domestic demand has been compounded by the recent onset
of population decline, pushing down economic entities' expectations for economic growth
and forestalling forward-looking expenditure. The Lehman shock in 2008 dealt another
serious blow to demand and its impact continues to this day. One reason that supply
capacity has not been sufficiently adjusted despite stagnant demand is that, as a result of
various regulations and protection measures, factors of production have remained in areas
from which demand has shifted away.
There is a possibility that inflation expectations will lessen if expectations for future economic
growth continue to decline and the output gap does not narrow steadily. In this case,
consumers of goods and services may put off spending, while suppliers may cut prices
further to stimulate demand. Under these circumstances, although the output gap remains
unchanged, prices may fall further and deflation may become even more difficult to quell. At
present, medium- to long-term inflation expectations remain stable and it is important to
make sure that they do not decrease.
B. Overcoming deflation
In order for Japan's economy to overcome deflation, it is necessary to narrow the negative
output gap. To this end, demand has to be expanded. The task is not impossible and there
are various areas with potential demand to be tapped, such as sectors related to the
provision of healthy and safe food, the environment, and population aging. An example of
such latent demand is the recent government measures that sharply increased demand for
environment-friendly durable goods. Needless to say, it is also important to follow
developments in overseas demand. As I mentioned earlier, economic growth in emerging
and commodity-exporting economies has been astounding, and it is very likely that their
demand for Japanese goods and services still has much room for growth.
The issue at stake is how to tap such demand. The government's "New Growth Strategy"
and "Fiscal Management Strategy," both announced in June, may provide some pointers.
The "New Growth Strategy" aims to create a strong Japanese economy on the basis of the
measures for demand creation that I just mentioned, together with steps to overcome
constraints on the supply of goods and the circulation of funds to be implemented in
accordance with a specific timetable. The "Fiscal Management Strategy," meanwhile, aims to
restore a sound and sustainable fiscal structure in a way that is consistent with the "New
Growth Strategy." In any event, it is vital that these measures be implemented swiftly and on
schedule.
Moreover, private economic entities, in addition to tapping new areas of demand, need to
improve productivity through new manufacturing technology and by shifting capital and labor
to areas with higher productivity. The "New Growth Strategy" can support such efforts. It
could be argued that higher productivity will increase supply, which would cause a further
widening of the output gap. However, it should be pointed out that higher productivity would
raise the demand for products of highly productive firms and workers; that the anticipation of
such an increase in future demand would raise current demand; and that, thus, the efficiency
of resource allocation could be improved, which in turn would expand demand overall.
The Industrial Revolution in Britain provides evidence of the pivotal role played by increased
productivity in a nation's growth. During the Industrial Revolution in the early nineteenth
century, the Luddite movement emerged in which workers destroyed machines that deprived
them of their jobs. Mechanization, however, increased productivity and enhanced Britain's
growth potential, paving the way for the subsequent ascendancy of the British Empire. There
is no doubt that enhancing productivity is indispensable for Japan given the aging and
decline of the population. While it will be difficult to avoid the problems arising from a
declining population in the short term, increased productivity can help to avoid a decline in
the potential growth rate and maintain the vitality of the Japanese economy.
C. Measures taken by the Bank
The fund-provisioning measure to support strengthening the foundations for economic
growth introduced by the Bank on June 15, 2010, aims to support private financial
institutions' efforts of their own accord to provide funds required by private economic entities
to find new demand and enhance productivity. It is hoped that the move will help to increase
potential output growth, narrow the output gap, and eventually bring deflation to an end. In
this sense, the measure is consistent with the principle stipulated in Article 2 of the Bank of
Japan Act that the Bank will aim at "achieving price stability, thereby contributing to the
sound development of the national economy." Instead of merely expressing the objective in
words, the Bank is taking action in the belief that this policy will work as a catalyst for private
economic entities to join in to achieve a common goal.
I am constantly aware that the Bank always must be ready to proactively implement the
appropriate policies. Going forward, the Bank should continue to be proactive and do its
utmost to bring Japan's economy back to a sustainable growth path with price stability.