Takehiro Sato: Recent economic and financial developments and
monetary policy in Japan
Speech by Mr Takehiro Sato, Member of the Policy Board of the Bank of Japan, at a meeting
with business leaders, Kushiro, 2 June 2016.
* * *
Accompanying charts can be found at the end of the speech.
Introduction
Thank you for giving me this opportunity to exchange views with people representing the
political, economic, and financial communities of eastern Hokkaido, including Kushiro. I would
like to take this opportunity to express my sincere gratitude for your cooperation with the
activities of the Bank of Japan's Kushiro Branch and Obihiro Office.
In today's speech, I will begin by focusing on recent economic and financial developments in
Japan and abroad, as well as the Bank's monetary policy. I will then touch briefly on the
economy of eastern Hokkaido. Following my speech, I would like to hear your views on actual
conditions in the local economy and on the Bank's conduct of monetary policy.
I. Recent economic and financial developments in Japan and abroad
A. Global financial markets and overseas economies
Global financial markets -- which had been unstable since the turn of the year, affected by an
interest rate hike by the Federal Reserve in December 2015 -- have been gradually regaining
stability following the Group-of-Twenty (G-20) Finance Ministers and Central Bank Governors
Meeting in Shanghai (Shanghai G-20) in late February. Recently, crude oil prices have
rebounded despite adverse factors such as the stalled negotiation among oil-producing
countries over production cuts, while currencies and stock markets of emerging and
commodity-exporting economies have generally been recovering. This situation may be
described as a lull in the negative spiral of the strong dollar -- and the consequent
strengthening of Chinese yuan -- and the weak crude oil prices, which had increased the
uncertainty of the future prospects of the world economy. The communiqué issued at the
Shanghai G-20 indicated a consensus among the authorities of various countries on the need
to deal with the economic slowdown not only by implementing monetary policy measures but
also by taking every possible policy measure. As expectations have also spread that the pace
of U.S. interest rate hikes will be moderate, a sense of relief appears to have gradually grown
in the markets.
Even so, causes for concern remain. The problem -- posed by the financial market turmoil
caused by the Global Financial Crisis and the European sovereign debt crisis as well as its
spillover effects on the real economy -- was an acute disease, so to speak, so it was clear what
solutions should be prescribed. Meanwhile, the problem that has emerged recently can be
described as a chronic disease, given that dollar-denominated debts built up by emerging
economies, including China, and commodity-exporting economies during the period of
monetary easing in the United States are coming to the fore again as a debt overhang issue
since the start of a liftoff by the Federal Reserve. It will probably take a long time before this
problem can be cured.
Looking back at developments in the world economy during the recent period, the annualized
growth rate of the U.S. economy, which is the driving force of the world economy, was a low
0.8 percent in the January-March quarter because of the sluggishness in industrial production
accompanying the appreciation in the U.S. dollar and the decline in commodity prices and
because of unfavorable weather conditions in the winter. According to the nowcast by regional
Federal Reserve Banks and other forecasts, the growth rate appears likely to be somewhat
higher in the April-June quarter. However, the U.S. employment statistics for April, the latest
month for which the data is available, showed a slight slowdown in employment after a period
of firm growth.
With the economic recovery phase about to enter its eighth year, the economic cycle is
presumed to be gradually reaching maturity. Therefore, at the beginning of the year, there were
even voices of concern over a possible economic downturn. Although such fears have proved
unfounded, there is the risk that productivity growth will be sluggish as business fixed
investment continues to lack momentum amid the prolonged slowdown in emerging and
commodity-exporting economies. Under these circumstances, I am paying attention to the risk
that a squeeze on firms' profit margins may affect employment, income, and consumption if
wages increase too rapidly relative to the productivity growth because of tight labor market
conditions.
Meanwhile, the Chinese economy is generally regaining stability despite a slight slowdown
mainly in exports and production, as the effects of the economic stimulus measures taken by
the authorities are apparently starting to appear. The exchange rate of the Chinese yuan, which
became a source of the instability in the global financial markets since last year, has recently
stayed stable and the stock market is also in a state of calm. The somewhat moderate decline
in the yuan's effective exchange rate following the recent pause in the rise in the U.S. dollar is
apparently easing concerns over the future prospects of exports and production. In addition, a
sense of relief is apparently growing in the markets because the Shanghai G-20 has alleviated
concerns that the kind of abrupt change in the exchange rate system that was made in the
summer of 2015 may occur again.
Still, as the problem of excess production capacity in the manufacturing sector lurks in the
background, the low growth in fixed asset investment and inventory adjustments are expected
to continue for a while. As for prices, the disinflationary trend is likely to continue for a while,
as the supply-demand conditions remain easy, mainly with respect to goods.
As for overseas economies, as I have explained until now, the slowdown in emerging
economies, including China, and commodity-exporting economies is coming to a halt.
However, as the recovery of the U.S. economy, which is the driving force, lacks strong
momentum, the world economy is expected to remain in a state of slight deceleration for the
time being. While the negative spiral of the strong dollar -- and the strong Chinese yuan -- and
the weak crude oil prices is in a lull in the global financial markets, market liquidity has
apparently been reduced due to various financial regulations. In addition, the influence of
algorithmic trading and high-frequency trading (HFT) is apparently growing, so the possibility
cannot be ruled out that the markets will become unstable again because of the effects of the
U.S. economic developments and ensuing monetary policy conduct. Therefore, I continue to
pay attention to the possibility that these factors will affect such aspects as market confidence.
B. Japan's economy
Japan's economy grew by 1.7 percent in the January-March quarter this year on an annualized
quarter-on-quarter basis, after posting negative growth of 1.1 percent in the
OctoberDecember quarter last year; however, if the leap-year factor is excluded, the latest growth was
close to zero. Recently, private consumption has continued to be lackluster after
weatherrelated factors that affected consumption in the winter have dissipated. In addition, production
activity, which has recently been more or less flat or weaker due to the effects of the slowdown
in emerging economies, including China, and commodity-exporting economies and of an
accident at a steel plant, is showing some weakness, mainly in the transportation equipment
sector, whose supply chains have been disrupted by the damage caused mainly in Kumamoto
Prefecture by the earthquake. Production activity in the affected region has already partially
shifted to the recovery production phase thanks to the strength of Japanese manufacturing
industries' business continuity planning. In addition, restoration and reconstruction projects are
expected to be implemented under the recent supplementary budget, and reconstruction
demand is expected to emerge. Therefore, there will be no need to change the medium-term
scenario. However, diffusion indexes (DIs) of the Economy Watchers Survey, which is a
leading indicator of the short-term economic trend, declined to the lowest level since
immediately after the consumption tax hike in 2014 on a seasonally-adjusted basis because
of the impact of the earthquake in Kumamoto, among other factors.
Regarding the medium-term scenario, while Japan's potential growth rate continues to slump
in the range of 0.0-0.5 percent due in part to the sluggishness of capital stock accumulation,
the world economy lacks momentum as I mentioned earlier. I therefore am somewhat cautious
about the outlook compared with the Bank's baseline scenario in the April 2016 Outlook for
Economic Activity and Prices (Outlook Report). In fact, real GDP growth has recently been
fluctuating almost evenly between positive and negative growth. As the economic growth rate
continues to be low, the potential economic growth rate is less likely to rise.
Compared with the low growth rate of real GDP, aggregate income formation as measured by
real gross national income (GNI) and real gross domestic income (GDI) has so far remained
relatively firm. Moreover, because of the robustness of the aggregate income formation, it has
been presumed that Japan's economy is resilient to such shocks as the slowdown in overseas
economies. However, income receipts from abroad converted into yen terms are expected to
be eroded by the yen's appreciation since the beginning of the year, and the decline in
commodity prices that has until recently contributed to the improvement in the terms of trade
is generally coming to a halt. As the strong yen contributes to the improvement in the terms of
trade, it offsets the effects of the halt in the decline in commodity prices. All the same, it may
become difficult to emphasize the relative firmness of aggregate income formation compared
with expenditure-based GDP.
Meanwhile, as is indicated by the consumption activity index, which is compiled by the Bank's
Research and Statistics Department based on sales- and supply-side statistics, the actual
trend of private consumption may have stayed stable compared with private consumption in
terms of preliminary GDP data, which reflects demand-side statistics such as the Family
Income and Expenditure Survey. When demand-side statistics show weaker results than the
actual trend due to sample factors or for other reasons, the level of private consumption in
terms of revised GDP data is likely to be revised upward compared with the preliminary data.
Therefore, the perception of the recent consumption trend may also be changed when revised
GDP data are announced in one and a half years.
However, as the relatively firm aggregate income formation may lack momentum somewhat
due to the reason that I already mentioned, a scenario in which a virtuous economic cycle from
income to spending will pick up steam does not seem to be so persuasive. While firms are
earning record profits, they have until now been cautious about raising base salary or making
domestic business fixed investments because of the view that such bumper profits are a
temporary windfall brought by the weak yen and the improvement in the terms of trade. This
cautious trend may grow depending on the results of the recent developments in the global
financial markets.
After all, as Japan's economy, with its potential growth rate of nearly 0 percent, is so fragile as
to be liable to post negative growth even because of trivial external factors such as weather
conditions, I expect that its growth is highly likely to remain sluggish in the future while being
susceptible to developments in the global financial markets and overseas economies. Even
so, nonmanufacturing industries, which maintain relative firmness in terms of employment and
business fixed investment, will serve as a buffer against the weakness of manufacturing
industries, so I expect that recession can be avoided.
C. Prices
Regarding consumer prices, my outlook presented in the April 2016 Outlook Report continues
to be lower than the median of the Policy Board members' forecasts. This is because, due to
the various domestic and overseas downside factors that I mentioned earlier, it is difficult at
the moment to expect that the potential growth rate will clearly rise from the current level of
nearly 0 percent, leading to an inflation that is consistent with income growth. Although the
inflation rate will not reach the price stability target of 2 percent during the projection period
according to my forecast, I believe that it is unnecessary to achieve the price stability target of
2 percent at all costs. People are not hoping for inflation that is not accompanied by income
growth. We have learned from our experiences that if inflation rises ahead of income,
consumer sentiment dampens due to a decline in real income, producing negative effects on
consumption. Although the year-on-year growth rate in the SRI-Hitotsubashi Unit Value Price
Index, which I cited in my previous speech, has recently slowed down steeply, it stayed at
around 2 percent throughout last year. In short, this index, which is closer to people's
perception of inflation because it reflects the effects of changes in the volume of products and
minor product modifications, indicated a higher growth rate than consumer price statistics
compiled by the Ministry of Internal Affairs and Communications.
In order to achieve the price stability target of 2 percent at the earliest possible time, with a
time horizon of about two years, the Bank introduced quantitative and qualitative monetary
easing (QQE) in April 2013. Because more than three years have passed since the introduction
of QQE, I believe it is high time that we reviewed the significance of this commitment. In this
regard, I have been having uneasy feelings about the approach of aiming to achieve a specific
inflation rate within a specific time frame, given the time lag required for monetary policy effects
to be produced and the uncertainty over the effects. I have some doubts as to why Japan alone
should set a specific time frame amid the disinflationary trend around the world, including
emerging economies, and whether the target can be achieved through monetary policy alone.
For my part, I have not changed my position that the Bank should achieve the price stability
target of 2 percent as a medium- to long-term goal. I consider this as a rolling target, which
means that we should constantly aim to achieve it at the earliest possible time with a time
horizon of about two years. Based on this idea, I submitted a proposal to revise the description
in the April 2016 Outlook Report at the Monetary Policy Meeting (MPM) in April.
The recent environment surrounding consumer prices contains various unfavorable factors,
such as (1) an expected delay in the improvement in the output gap due to the slow recovery
in the real economy, (2) an expected lack of momentum in the pace of year-on-year wage
growth following the labor-management negotiations this spring, and (3) the possibility that the
yen's appreciation since the beginning of the year will affect the underlying inflation trend that
has been led by rising prices of food products and durable consumer goods. As is indicated by
the SRI-Hitotsubashi Unit Value Price Index, which I mentioned earlier, the year-on-year
growth in the goods price index based on the point-of-sale (POS) data collected through chain
stores appears to have slowed. The price index based on the POS data covers only around
20 percent of the consumer price index (CPI) in terms of its weight, so the trend in the POS
data-based index may not necessarily affect overall prices immediately. Service prices, which
have a substantial weight in the CPI, may have a pent-up potential for a rise following the
recent increase in hourly wages for non-regular employees. Unlike changes in food and
clothing prices, changes in prices of individual services, which are provided by many small
firms, are seldom featured in media reports, making it difficult to keep track of them. Therefore,
looking at consumer price statistics is the only way to examine the trend of overall service
prices.
As for the outlook, while the year-on-year growth rate of prices of food products and durable
consumer goods are expected to peak out as indicated by the POS data, the key will be the
extent to which prices of individual services, with their pent-up potential for a rise, can offset
that. However, house rent and imputed rent, which have a large weight in service prices, are
strongly correlated with wages, and given the results of the labor-management wage
negotiations this spring, it may be difficult to expect much of a rise in rents. House rent and
imputed rent are not adjusted for quality associated with the passage of time, so the presence
of a downward bias in consumer price statistics has been pointed out. With respect to public
service prices, which also have a large weight, there are various factors that constrain price
increases. One such factor is the norm applied to prices by those who are reluctant to tolerate
a hike in fees for public services.
In consideration of all these factors, it is highly uncertain whether or not an increase in service
prices will offset an expected drop in the year-on-year growth rate of goods prices, resulting in
a higher growth or a similar rate of growth in overall prices.
Although people's inflation expectations over the medium to long term are relatively stable,
their expectations over the short term have been affected in a backward-looking manner by
the recent price trend that reflects energy price movements. This is clearly apparent in firms'
inflation expectations indicated in the Tankan (Short-Term Economic Survey of Enterprises in
Japan). Furthermore, comments made by the respondents in the Economy Watchers Survey
suggest the possibility that people's sentiment has become cautious due to the introduction of
the negative interest rate policy. I assume that this reflects people's cautious outlook on future
supply-demand conditions, which I assume is also affecting people's inflation expectations.
II. Future conduct of monetary policy
A. Introduction of QQE with a negative interest rate
More than three years have passed since the introduction of QQE. My understanding was that
this measure was a kind of shock therapy intended to influence the formation of people's
expectations by resorting to a bold action. As was indicated by the fact that the time frame of
about two years was initially assumed, I at least did not expect that this measure would be
continued for a very long time. Therefore, I have had mixed feelings about the expansion of
QQE in October 2014 and the introduction of a negative interest rate in January this year. I
voted against both of these measures. As for the reason for my opposition to a negative interest
rate in particular, I believe that the expansion of the monetary base and the introduction of a
negative interest rate are essentially contradictory and their combination lacks sustainability.
Moreover, I believe that the negative interest rate policy has the effect of monetary tightening,
rather than an effect of easing. In addition, the negative interest rate policy could affect financial
system stability.
Let me elaborate on this point a little further. Under the current policy framework, a marginal
increase in the current account balance at the Bank, which accounts for most of the increase
in the monetary base, is subject to a penalty in the form of a negative interest rate. However,
maintaining the current pace of increase in the monetary base while imposing such a penalty
is illogical. I believe that introducing a negative interest rate would be meaningful only when
the monetary base target and the asset purchase target are gradually reduced, namely, when
tapering is implemented, so I cited this as the reason for my vote against the introduction of a
negative interest rate at the January MPM. I believe that it is desirable to maintain the system
in which balances in current accounts at the Bank are divided into three-tiers -- which was
adopted at the time of the introduction of a negative interest rate -- from a somewhat
longerterm perspective with an eye to a future exit from QQE. I therefore submitted a proposal to that
effect at the March MPM.
Next, I will explain my argument that the negative interest rate policy has the effect of monetary
tightening and may affect financial system stability. Soon after the MPM in January, stock
prices plunged, led by bank share prices, while the yen appreciated in the foreign exchange
market. In addition, there was a series of suspensions of subscription for and pre-maturity
redemption of safe investment instruments, such as money market funds (MMFs) and
mediumterm government bond funds. In response, people's sentiment deteriorated. This is presumably
not only because of concerns over a possible erosion of deposits but also because the wrong
perception has spread that Japan's economic conditions worsened so much that such an
extraordinary measure as the negative interest rate policy needed to be taken.
Financial institutions are facing the risk of a negative spread for marginal assets due to the
extreme flattening of the yield curve and the drop in the yield on government bonds in short-
to long-term zones into negative territory. When there is a negative spread, shrinking the
balance sheet, rather than expanding it, would be a reasonable business decision. In the
future, this may prompt an increasing number of financial institutions to take such actions as
restraining loans to borrowers with potentially high credit costs and raising interest rates on
loans to firms with poor access to finance. There is also the risk that financial institutions that
have problems in terms of profitability or fiscal soundness will make loans and investment
without adequate risk evaluation. From financial institutions' recent move to purchase
superlong-term bonds in pursuit of tiny positive yield, I detect a vulnerability similar to that seen
before the so-called VaR (Value at Risk) shock in 2003.
In the meantime, because of the decline in the function of the short-term money market,
distortion due to the concentration of funds raised in the call market in banks, trust banks in
particular, was seen. As a result, investment trusts and other risk-taking market participants
have given up on investing in short-term financial instruments, leading to a loss of diversity
among market participants. Such a weakening of the financial intermediary functioning could
affect the financial system's resilience against shocks in times of stress. In addition, an
excessive drop in bond yields in the super-long-term zone could also make the financial system
vulnerable by increasing the risk of a buildup of financial imbalances in the system.
The Bank is responsible for maintaining both price stability and the financial system stability.
Therefore, when a conflict is expected in performing these two mandates, it is necessary to
consider the respective pros and cons of the two mandates and pursue a finely-balanced policy
measure. However, as I already explained, the negative interest rate policy could disturb the
delicate balance.
B. Economic effects of QQE with a negative interest rate
The negative interest rate policy has been highly effective in lowering longer-term interest
rates, rather than in achieving the initial goal of further pushing down the yield curve by
lowering the short end of the yield curve. However, the steep drop in the yields in the
longterm and super-long-term zones reflects the fact that, in pursuit of a positive yield when yields
even in the long-term zone are negative, funds that have lost attractive investment destinations
are flowing into further longer-term zones, where the yields remain above zero, albeit barely.
Unfortunately, this is the opposite of portfolio rebalancing that was an intended purpose of the
negative interest rate policy.
Opinions are divided on the economic effects of the negative interest rate policy, and this is a
factor fueling worries among people over this measure. In this respect, it is a fact that as a
result of the decline in market interest rates, housing loan rates and firms' borrowing rates have
already dropped, so it may be possible to ease people's aversion to this policy measure if they
are presented with convincing evidence that it brings positive macro-level income effects by
facilitating housing loan refinancing and that it stimulates business fixed investment.
However, firms' fixed investment has long been kept within their level of cash flow and lending
rates that have already declined to extremely low levels cannot be expected to drop further on
the same scale as the drop in market interest rates. Therefore, I am skeptical about the idea
that the negative interest rate policy will stimulate business fixed investment. Rather, if an
investment project can only be profitable on the assumption of the continuation of an extremely
low interest rate, that is the problem.
While the interest rate decline was prominent in the long-term and super-long-term zones,
there are only a few private economic agents that are willing or able to raise funds with a
maturity ranging from 20 years to 40 years. Rather, the excessive interest rate decline in the
long-term and super-long-term zones could not only threaten the sustainability of the social
security system as broadly defined, including corporate pensions, through a drop in the
discount rate of pension liabilities, but could also undermine people's confidence by producing
significant negative effects on corporate finance.
C. Monetary base target and asset purchase target
As I mentioned earlier, I believe that it is desirable to aim to achieve the price stability target of
2 percent as a medium-to long-term goal and I expect that the road toward this goal will be
long. Therefore, I believe that the challenge from now on is reforming the policy framework,
which is intended to provide solutions in the short term, so as to adapt it to a long-term initiative.
The first thing the Bank should do for that purpose would be to make the asset purchase
operation more flexible and also explore flexible approaches to the monetary base target.
Let me cite a specific example. Since the introduction of the negative interest rate policy, there
have been some cases in which bid prices for the Bank's asset purchase offers were unusually
high compared with market prices or in which the difference between the minimum successful
bid rate and the average successful bid rate was very large. This situation represents the
realization of the theory that if the Bank offers a higher purchase price than the market price,
the offer always attracts willing sellers. Therefore, it may be said that the buildup of the
monetary base is proceeding even amid the negative interest rate environment. However, if
we look at the situation from another angle, it can be said that there is a reasonable chance
that unless the Bank continues to purchase assets at higher prices than market prices, this will
result in undersubscriptions, and the buildup of the monetary base will be impeded.
The Bank is taking such measures as eliminating abnormal bids, imposing bidding limits, and
excluding issues which were purchased at abnormal prices from eligible assets. I believe that
it is appropriate to give consideration to avoid distorting market price formation by flexibly
conducting these market operations as necessary. As a result of such operations, the Bank
may fall slightly short of its asset purchase target by asset class and the monetary base target
of 80 trillion yen. However, if the Bank is to ensure the sustainability of its current policy, I
believe that conducting such operations would be inevitable.
We must pay sufficient attention to the risk that the failure to achieve the targets will be
mistaken as tapering, triggering an unexpected reaction. However, given that the Bank's asset
purchases have proved to be so effective in lowering various interest rates, I take the view that
there would be no problem if the Bank's purchases fall slightly short of the targets as a result
of excluding abnormal bids that are far apart from market prices. Rather, it would be desirable
if this view gradually took hold in the market. While I voted against the expansion of QQE and
the introduction of a negative interest rate, it would not be desirable if concerns over the
sustainability of the Bank's asset purchases grew in the market at a time when the Bank
continues to purchase on such a large scale, and if the effects of the policy were undermined
by an unforeseen incident. It is my sincere hope that the Bank will conduct monetary policy
flexibly under the flexible price stability target while obtaining better understanding by the
market.
Concluding remarks: economic activity in Eastern Hokkaido
My concluding remarks will touch on the economy of eastern Hokkaido.
This region has a vast amount of land facing the part of the Pacific Ocean where the Oyashio
Current flows. Blessed with rich nature, this region has prosperous agricultural, forestry and
fishery industries and is one of the main food supply bases in Japan. Other industries that have
a large presence in this region include the food industry, whose main items are dairy and
processed fishery products; the civil engineering and construction industry, which undertakes
public works and private construction; and the transportation industry, which supports
longdistance distribution. Tourism also supports the local economy, as Tokachi, Kushiro, and
Nemuro have their respective tourism resources of global value.
Looking at the local economic conditions, in relation to fishery, the situation of fishing of major
fish such as salmon, trout, and Pacific saury is severe. However, although public investment
has been decreasing, business fixed investment as a whole has been increasing against the
backdrop of strong corporate earnings. In addition, private consumption has been resilient. An
increase in agricultural income and stable fuel prices are also positive factors for this region,
so the local economy has been steadily picking up.
Under these circumstances, to achieve longer-term growth, the region takes initiatives to
enhance productivity and increase added value by taking advantage of its strengths and to
invigorate trade and other exchanges both within and outside the region. For example, with
respect to distribution, the Doto Expressway, which connects central Hokkaido with eastern
Hokkaido, has been extended to the Akan area, representing the improvement of the
distribution network and the integration of eastern Hokkaido. In addition, the expansion work
of Kushiro Port, which has been designated as an International Strategic Bulk Port, has got
into full swing. As for tourism as well, the region's efforts are bearing fruits. For example, this
region has been selected as part of a broad-area sightseeing tour route and as a showcase of
Japan's strength as a tourism-oriented country, and the Food Valley plan is making progress.
Furthermore, there are activities led by the private sector, including exporting agricultural and
fishery products such as Chinese yams and Pacific saury, and increasing the value added to
dairy and livestock products. There are also activities to enhance the region's growth potential,
such as exploring for tourism resources -- including the Hokkaido Garden Path, whale and bird
watching, and making use of national parks -- as well as constructing a thermal power plant
using the only underground coal mine in Japan. I understand that regional financial institutions
are not only providing financial support but also enhancing their own advisory function and
helping to search for new customers.
I hope that while these initiatives are continued, progress will be made in fostering new leaders
and strengthening broad-area cooperation, and that the economy of the eastern Hokkaido will
be further invigorated.
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