Economic Activity, Prices,
and Monetary Policy in Japan
Speech at a Meeting with Business Leaders in Fukuoka
Takako Masai
Member of the Policy Board
I. Developments in Economic Activity and Prices
I would like to start my speech with a look at developments in economic activity and prices.
Following the discussion at the Monetary Policy Meeting (MPM) held on October 30 and
31, 2018, the Bank of Japan published the Outlook for Economic Activity and Prices, or the
Outlook Report. In this report, the Bank presented its projections for Japan's economic
activity and prices through fiscal 2020.
I will explain developments in economic activity and prices by presenting the main content
of the Outlook Report.
A. Overseas Economies
Let me first touch on developments in overseas economies. The Bank's assessment is that
overseas economies have continued to grow firmly on the whole.
Looking at recent developments in overseas economies, their growth is losing momentum
compared to a while ago, when the global economy was widely referred to as seeing
synchronous growth. A virtuous cycle of overseas economic activity has been maintained,
however, as seen in the fact that domestic demand in many economies has been firm.
According to the World Economic Outlook (WEO) released in October 2018 by the
International Monetary Fund (IMF), the real GDP growth rate of the global economy is
projected to be 3.7 percent on a year-on-year basis for both 2018 and 2019. The projections
have been revised downward by 0.2 percentage point for each year from the previous ones
released three months before, and differences in growth rates among regions have widened
to some extent. Nonetheless, the growth rate of 3.7 percent is by no means low, as this
figure represents a level exceeding its past average.
Let me outline the Bank's outlook for overseas economies by major region. The U.S.
economy is expected to maintain its expansion, underpinned by expansionary fiscal
measures. The European economy is projected to continue recovering, albeit at a gradually
slowing pace. The Chinese economy is likely to broadly follow a stable growth path as
authorities conduct fiscal and monetary policy in a timely manner, although it is expected to
be affected to some extent by the United States having raised tariffs imposed on China.
B. Japan's Economy
1. Current situation
Now I would like to move on to developments in Japan's economy.
The Bank's assessment is that Japan's economy is expanding moderately, with a virtuous
cycle from income to spending operating.
The output gap -- which shows the utilization of capital and labor -- widened within positive
territory from late 2016, for seven consecutive quarters through the April-June quarter of
2018. Although the first preliminary estimate of the real GDP growth rate for the
July-September quarter -- released on November 14 -- was minus 1.2 percent on an
annualized quarter-on-quarter basis, this is considered to be largely attributable to the
temporary effects of natural disasters that occurred successively this summer. In fact,
exports and production decreased slightly following these disasters, but have been showing
recovery thereafter. Corporate profits have continued to follow their uptrend at record high
levels, and business fixed investment also has continued on an increasing trend. According
to the September 2018 Tankan (Short-Term Economic Survey of Enterprises in Japan),
business fixed investment plans for fiscal 2018 registered a year-on-year increase of 8.7
percent -- a level clearly exceeding the past average for the September Tankan surveys.
Meanwhile, labor market conditions have continued to tighten steadily and total cash
earnings per employee have risen moderately. Under these circumstances, the consumption
activity index (CAI) -- which is calculated by combining various sales and supply-side
statistics -- increased for the April-June quarter on a quarter-on-quarter basis and continued
to do so for the July-September quarter relative to the previous quarter.
2. Outlook
I will now look at the outlook for Japan's economy during the projection period, which
covers from fiscal 2018 through fiscal 2020. The economy is likely to continue its moderate
expansion.
In fiscal 2018, Japan's economy is likely to continue growing at a pace above its potential
growth rate, which is estimated to be in the range of 0.5-1.0 percent, mainly against the
background of highly accommodative financial conditions and the underpinnings through
government spending, with overseas economies continuing to grow firmly on the whole.
From fiscal 2019 through fiscal 2020, the economy is expected to continue on an expanding
trend, partly supported by external demand, although the growth pace is projected to
decelerate due to a cyclical slowdown in business fixed investment and the effects of the
scheduled consumption tax hike in October 2019. In terms of the median of the Policy
Board members' forecasts in the October 2018 Outlook Report, the real GDP growth rate is
1.4 percent for fiscal 2018, and 0.8 percent each for fiscal 2019 and 2020.
I also hold the view that the Bank's baseline scenario has been maintained, in which Japan's
economy is likely to continue its moderate expansion. As the reason for this, I would like to
highlight two positive factors for the economic outlook.
The first is the strength in business fixed investment, which I mentioned earlier. In addition
to the high growth in the investment amount itself, I am reassured by the fact that firms in a
wide range of industries have been planning a variety of investments, such as (1) that
intended for domestic capacity expansion, (2) that in research and development, (3) that
aiming at improving efficiency and saving labor, and (4) that aiming at enhancing business
continuity arrangements in preparation for times of disaster or other emergency.
The second positive factor is that, fortunately, the effects of this summer's natural disasters
on Japan's economic activity are likely to be only temporary. According to information we
obtained from, for example, interviews with firms conducted by the Bank's branches, many
of the firms for which production and distribution were undermined already have
accelerated their production to offset the impact of the disasters. Moreover, public
investment toward restoration and rebuilding is projected to take hold going forward.
Although the extent to which the disasters affect inbound demand was a matter of concern
at first, such demand has been showing faster recovery than expected, partly reflecting
successful results of the government's and the private sector's provision of relevant
information to the public. I believe that efforts that take advantage of lessons learned in the
past have been playing a role in post-disaster restoration and rebuilding this time as well.
3. Uncertainties regarding economic activity
Meanwhile, there are various uncertainties regarding the baseline scenario of the outlook for
Japan's economic activity. On this point, risks recently appear to be tilted to the downside,
particularly regarding developments in overseas economies.
Specifically, risks to overseas economic developments include the following: the U.S.
macroeconomic policies and their impact on global financial markets; the consequences of
protectionist moves and their effects; developments in emerging and commodity-exporting
economies including the effects of the two aforementioned factors; negotiations on the
United Kingdom's exit from the European Union (EU) and their effects; the fiscal problem
in Italy; and geopolitical risks.
Of these risks, I remain especially concerned about protectionist moves; in particular, the
trade friction between the United States and China. In fact, the deterioration in Chinese
firms' sentiment toward business conditions, particularly those related to exports and
imports, has been distinct. Although no significant changes have been evidenced, for
example, by Chinese statistics on exports and imports, some have pointed out the possibility
that China's trade activity has been buoyed temporarily by the front-loading of exports to
the United States prior to a looming rise in tariffs.
Thus far, the effects of the U.S.-China trade friction on Japan's economy have been limited.
There is an argument, however, that if it takes time to ease this tension, this may result in a
direct negative impact on Japan's economy through trade activity, and may adversely affect
the economy to a greater extent through such channels as the deterioration in business
sentiment and the destabilization of global financial markets. The IMF and other
international organizations have released similar results in their simulation analyses on the
effects of the U.S.-China trade friction on the global economy. According to these analyses,
the extent to which this trade friction directly impacts the economy through trade activity is
likely to be limited, but the effects of this issue would be larger when involving such
channels as the deterioration in business sentiment and the destabilization of global
financial markets. I believe that we should not be inclined toward extremely pessimistic
views in this regard, mainly because an agreement has been reached in the renegotiation of
the North American Free Trade Agreement (NAFTA) and there has been ongoing dialogue
between the United States and China toward easing the tension. However, I will continue to
closely monitor the effects of protectionist moves on economic activity overseas and in
Japan.
C. Price Developments
Next, I will turn to price developments in Japan.
The year-on-year rate of increase in the consumer price index (CPI) for all items less fresh
food slowed temporarily in early spring 2018, but it has been accelerating again since
summer, having risen to around 1 percent recently. Nevertheless, the year-on-year rate of
change in the CPI excluding energy in addition to fresh food has been at around 0.5 percent
of late, and the underlying trend in prices in Japan has continued to show relatively weak
developments compared to the economic expansion and the labor market tightening.
This is likely to be attributable to two main factors. The first is the deeply entrenched
mindset and behavior based on the assumption that wages and prices will not increase easily.
For this reason, firms' wage- and price-setting stance, as well as households' views toward
price rises, have remained cautious, and there has not yet been a clear change in this
situation. Behind such entrenched mindset and behavior lie Japan's fairly recent 15-year
experience of low growth and a mild but persistent decline in prices. In this sense, this first
factor can be regarded as people's price perception inherent in Japan, or a kind of social
norm in the country.
The second factor behind the relatively weak price developments is changes on the supply
side of the economy, including active labor-saving investment and intensifying competition
among firms, which have been brought about by the progress in digital technology, as well
as an increase in labor participation by women and seniors. For example, it has been pointed
out that retailers such as supermarkets maintaining their cautious price-setting stance is
partly due to the expansion of online shopping. Unlike the first factor, such intensifying
competition brought about by technological progress can be described as a structural change
observed globally, rather than only in Japan.
As I have explained, Japan has continued to see a situation where the underlying trend in
inflation does not rise easily. Nonetheless, with the output gap remaining positive and
operating firmly as a driver for a rise in inflation, the year-on-year rate of change in the CPI
is likely to increase gradually toward the price stability target of 2 percent. In terms of the
median of the Policy Board members' forecasts in the October 2018 Outlook Report, the
year-on-year rate of change in the CPI (all items less fresh food) is 0.9 percent for fiscal
2018 and -- on a basis excluding the effects of the scheduled consumption tax hike -- 1.4
percent and 1.5 percent for fiscal 2019 and 2020, respectively.
II. The Bank's Monetary Policy
A. The Basic Thinking behind the Bank's Policy
1. Continuing powerful monetary easing
Thus far, I have talked about Japan's economic activity and prices. Next, I will explain the
Bank's monetary policy.
In order to overcome prolonged deflation, the Bank introduced in April 2013 an
unprecedented and highly accommodative monetary policy, quantitative and qualitative
monetary easing (QQE). Since then, the Bank has supported firms' and households'
economic activity by maintaining highly accommodative financial conditions and
contributed to an improvement in the output gap. At present, Japan's economy has improved
significantly, and in terms of prices, it is no longer in deflation, in the sense of a sustained
decline in prices.
As I touched on earlier, the underlying trend in prices in Japan has continued to show
relatively weak developments compared to the economic expansion. Nevertheless, the
mechanism whereby an improvement in the output gap leads to a rise in inflation has
continued to operate and the momentum toward 2 percent inflation has not been lost.
Therefore, I consider it appropriate to persistently maintain the current highly
accommodative financial conditions so as to keep the output gap within positive territory
for as long as possible, thereby sustaining the positive momentum I just mentioned.
Specifically, I believe that it is necessary that the Bank persistently continue with powerful
monetary easing under the framework of QQE with Yield Curve Control, introduced in
September 2016.
This framework consists of two components: yield curve control and an
inflation-overshooting commitment. Yield curve control is a policy under which the Bank
aims to keep short- and long-term interest rates stably at low levels. Namely, in the
guideline for market operations, the Bank sets the short-term policy interest rate at minus
0.1 percent and the target level of 10-year Japanese government bond (JGB) yields at
around 0 percent, and conducts JGB purchases so as to achieve this target level. The
inflation-overshooting commitment is a policy under which the Bank commits itself to
continuing to expand the monetary base -- the total amount of money the Bank directly
supplies to the economy -- until the year-on-year rate of increase in the observed CPI
exceeds 2 percent and stays above that level in a stable manner. Through this commitment,
the Bank aims at increasing people's confidence in the achievement of the 2 percent price
stability target.
2. Policy effects and side effects
While monetary easing stimulates the economy, keeping interest rates low across the entire
yield curve for a prolonged period could exert adverse effects on the functioning of the JGB
market and profits of financial institutions. Therefore, the Bank deems it necessary to
proceed with policy conduct while examining policy effects and the possible side effects
from every angle, as well as carefully assessing their costs and benefits to the economy.
Based on this thinking, the Bank has pursued strong monetary easing by taking into account
the situation at the time. Moreover, at the MPM held on July 30 and 31, 2018, it decided to
further strengthen the framework of QQE with Yield Curve Control: the Bank introduced
forward guidance for policy rates and decided to conduct market operations as well as asset
purchases in a more flexible manner. As for the long-term interest rate, for example, the
Bank made clear that, while it would maintain the target level of "around zero percent," the
observed yields might move upward and downward to some extent mainly depending on
developments in economic activity and prices. As for exchange-traded fund (ETF)
purchases, it was announced that the Bank might increase or decrease the amount of
purchases depending on market conditions, while maintaining the annual target of increase
at about 6 trillion yen. I believe that conducting these flexible measures will lead to
maintaining market functioning.
The Bank intends to continue paying careful attention to the risks considered most relevant
to the conduct of monetary policy. With a view to achieving the price stability target, it will
conduct monetary policy in an appropriate manner, taking account of developments in
economic activity and prices as well as financial conditions.
B. Addressing Changes in the Economic Structure
So far, I have explained the Bank's monetary policy measures. In what follows, I would like
to talk about the points I keep in mind regarding the basic thinking behind monetary policy.
At each MPM, the Bank discusses the current situation of and outlook for developments in
economic activity and prices as well as financial conditions, and decides on the conduct of
monetary policy that is considered most appropriate for achieving the price stability target.
In such policy conduct, I consider it important to make a comprehensive assessment, giving
due consideration to various changes in the environment surrounding Japan's economy, such
as digital innovation.
Digital innovation in recent years has dramatically increased the quality and quantity of
information people can obtain in their daily lives. Although it has been only about a decade
since smartphones became prevalent among the public, they have disseminated explosively
worldwide. In Japan, more than 60 percent of Japanese people own them today. Men and
women of all ages carry in their pockets devices that are equivalent to the supercomputers
of the past, and can access worldwide information instantly. People's lifestyles are changing
significantly with smartphones: they enjoy listening to music and watching videos through
digital distribution; do shopping and make travel reservations; look up information more
quickly using their devices' search function; and spend leisure time communicating with
friends through social media and other digital tools. And it seems that such changes are
becoming more rapid.
Besides lifestyles, structural changes have been taking place in various aspects. In this
regard, let me mention the Federal Reserve Bank of Kansas City's Jackson Hole Economic
Policy Symposium held annually in August -- which may not be well known among the
public but draws significant attention of central bankers, academics, and economists. At this
year's symposium entitled "Changing Market Structure and Implications for Monetary
Policy," prominent academics presented interesting papers on the theme of recent shifts in
the market structure.1 The topics included increasing differences between firms, the rising
importance of intangible assets, and intensifying competition in the banking industry. Of
these, I would like to touch on the paper on intangibles.2 This posits that, in recent years,
intangible assets -- including software, intellectual property, and brand -- account for an
increasingly large share of total capital compared to traditional physical assets such as
equipment. The paper then points out that, in the existing data, which do not sufficiently
cover the increase in intangible assets, the amount of investment appears to be smaller than
the theoretically optimal level. I will not go into more detail, but the paper also refers to the
possibility that such an increase in intangible assets may weaken the effectiveness of
monetary policy.
A similar point of view has been presented from the business sector. Mr. Bill Gates, a
well-known co-founder of Microsoft Corporation, claims that, given the ever-increasing
importance of software and data in economic activity, policy authorities in each country
should debate more actively the important question of the best way to stimulate economic
activity.3
I think that it is by no means a coincidence that the same issue was raised within academia
and the business sector around the same time. This is probably evidence of how significant
these changes are and that they are rapidly occurring worldwide. Intangible assets literally
are difficult to measure. However, taking just one example -- namely, the importance of
these assets being discussed both within academia and the business sector -- reveals that it is
becoming hard to assess firms' investment activities and the effects of monetary policy
without considering the impact of these assets. Therefore, I believe that it is necessary to
adequately address these changes in the economic structure.
The actual economy that central banks face is very complex and changing dynamically. It is
of course very important to learn economic theories in textbooks and analyze past
experiences. However, when authorities and economic entities make decisions, it is my
view that they should pay due attention to various factors, such as these structural changes
that may not necessarily be evident from economic models, and continue to examine what
needs to be done at the time.