December 5, 2019
Bank of Japan
Economic Activity, Prices,
and Monetary Policy in Japan
Speech at a Meeting with Business Leaders in Oita
Yutaka Harada
Member of the Policy Board
Introduction
Thank you for giving me this opportunity to exchange views with you and for having taken
the time to be here despite your busy schedules. It is indeed a great honor to be here today.
Please allow me to express my gratitude for your great cooperation with the business
operations of the Bank of Japan, particularly of the Oita Branch.
The Bank has implemented quantitative and qualitative monetary easing -- or QQE for short
-- since April 2013 and introduced various additional measures such as the negative interest
rate policy, yield curve control, strengthening the framework for continuous monetary
easing, and clarification of forward guidance for policy rates, all with the aim of achieving
the inflation target of 2 percent.
As a result of these measures, Japan's economy has been improving. It is true that the
economic expansion has not exactly been robust, reflecting such events as the consumption
tax hike in fiscal 2014 from 5 percent to 8 percent, the latest hike in October 2019 from 8
percent to 10 percent, the slowdown in the global economy observed from mid-2015
through early 2016 and from the second half of 2018 to the present, and the downtrend in
the working-age population. Nevertheless, the economy has managed to continue its
expansion so far.
Today, I would like to explain monetary policy measures conducted by the Bank and what
they have achieved. First and foremost, the achievements are obvious. The unemployment
rate has declined to its lowest level in nearly three decades and productivity has been
increasing. The challenge lies elsewhere; namely, in the fact that prices have not been rising.
It is increasingly being argued that interest rates consequently have remained low, eroding
banks' profitability. However, I believe that the deterioration in banks' profitability is caused
by the structural problem that banks are accumulating more deposits than they can lend.
Banks therefore need to deal with this problem. Moreover, if interest rates were raised, this
would lead to a decrease in the demand for loans, a decline in prices, an appreciation of the
yen, an economic downturn, an increase in bankruptcies (raising banks' credit costs), and so
forth. Therefore, raising interest rates would not solve the problem. Considering that the
current low interest rates are partly attributable to the deflationary monetary policies
pursued in the past, as I will describe later, the only way out is to maintain the current
accommodative monetary policy in order to achieve sustained expansion of economic
activity until we see increases in prices and interest rates.
I. Monetary Easing Measures
Table 1 presents an outline of the monetary policy measures conducted by the Bank since
April 2013, when it introduced bold monetary policy.
Table 1 Timeline of the Bank's Monetary Policy Measures
Jan 13 Introduction of the "price stability target" of 2 percent
Introduction of QQE
Apr 13 - Monetary base: increase at an annual pace of about 60 to 70 trillion yen
- Amount outstanding of the Bank's JGB holdings: increase at an annual pace of about 50 trillion yen
Expansion of QQE
- Monetary base: increase at an annual pace of about 80 trillion yen
Oct 14
- Amount outstanding of the Bank's JGB holdings: increase at an annual pace of about 80 trillion yen
Introduction of "QQE with a Negative Interest Rate"
Jan 16 - A negative interest rate of minus 0.1 percent is applied to the Policy-Rate Balances in current accounts
held by financial institutions at the Bank.
"Enhancement of Monetary Easing"
Jul 16
- Amount outstanding of the Bank's ETF holdings: increase at an annual pace of about 6 trillion yen
Introduction of "QQE with Yield Curve Control"
- Yield curve control
The Bank will purchase Japanese government bonds (JGBs) so that 10-year JGB yields will remain
Sep 16
more or less at the current level (around zero percent). With regard to the amount of JGBs to be
purchased, the Bank will conduct purchases more or less in line with the current pace.
- Inflation-overshooting commitment
"Strengthening the Framework for Continuous Powerful Monetary Easing"
- Introduction of forward guidance for policy rates
The Bank intends to maintain the current extremely low levels of short- and long-term interest rates
for an extended period of time, taking into account uncertainties regarding economic activity
and prices including the effects of the consumption tax hike scheduled to take place in October 2019.
Jul 18
- Yield curve control
The yields may move upward and downward to some extent mainly depending on developments in
economic activity and prices.
With regard to the amount of JGBs to be purchased, the Bank will conduct purchases in a flexible
manner so that their amount outstanding will increase at an annual pace of about 80 trillion yen.
Clarification of forward guidance for policy rates
The Bank intends to maintain the current extremely low levels of short- and long-term interest rates
Apr 19 for an extended period of time, at least through around spring 2020, taking into account uncertainties
regarding economic activity and prices including developments in overseas economies and the effects
of the scheduled consumption tax hike.
Introduction of new forward guidance for policy rates
As for the policy rates, the Bank expects short- and long-term interest rates to remain at their present
Oct 19
or lower levels as long as it is necessary to pay close attention to the possibility that the momentum
toward achieving the price stability target will be lost.
As a result of these measures, real interest rates -- nominal interest rates minus expected
inflation rates -- have greatly declined due to the decrease in nominal interest rates and the
rise in inflation expectations.
The decline in real interest rates has stimulated investment, boosted stock prices in Japan,
and led to a depreciation of the yen. Rising stock prices further raise investment and lead
households that have become wealthier to increase their consumption expenditure. It is
through these channels that economic activity started to improve.
Next, I would like to explain my stance on the new forward guidance introduced in October
2019, which is shown in Table 1. The forward guidance in April 2019 stated that the Bank
"intends to maintain the current extremely low levels of short- and long-term interest rates
for an extended period of time, at least through around spring 2020." While I thought that
clarifying the forward guidance was desirable, I opposed the policy proposal on the basis
that the Bank should indicate data-dependent guidance to further clarify its link with the
price stability target.1 Under the new guidance, the Bank "expects short- and long-term
interest rates to remain at their present or lower levels as long as it is necessary to pay close
attention to the possibility that the momentum toward achieving the price stability target
will be lost." Although it is somewhat ambiguous, I voted for this proposal because the
guidance became more akin to data-dependent guidance, in which the link to the price
stability target is clearer, and allowed for the possibility of a future interest rate reduction.
However, I continued to oppose allowing long-term yields to move in a more flexible
manner. Since I already have elaborated on my reasons for this in the past, let me move on
to the next topic.2
II. Achievements of Bold Monetary Easing
Improvement in economic activity can be seen in various fields. There are a lot of indicators
that show improvement, such as employment, productivity, fiscal conditions, investment,
exports, corporate profits, and wages; moreover, perceptions that the economy is recovering,
the suicide rate, the income distribution, and women's entry into the labor market provide
further indications of improvement.3 Of these indicators, I would like to talk today about
the improvements in employment, productivity, and fiscal conditions.
Improvement in Employment
The improvement in employment is clear from the rise in the active job
openings-to-applicants ratio, the decline in the unemployment rate, the increase in the
number of employees, and other indicators. The increase in the number of employees is due
to the rise in the employment rates of women and the elderly in particular. While there
remains the issue that many of the women and the elderly are not regular but non-regular
employees and only work short hours, the situation certainly is an improvement from the
past. In an aging society, the fact that the employment rate of the elderly actually has risen
holds great importance. The problem with an aging population is that the number of people
who cannot work because of old age is increasing relative to the number of working-age
people. It is worrying that it seems the ratio of the elderly (those aged 65 and over) to the
working-age population (those aged 15-64) will rise from 47 percent in 2018 to 70 percent
in 2045 (and then further rise moderately to 75 percent in 2065). However, if we assume
that the working-age population comprises those aged 15-69 and the elderly population
consists of those aged 70 and over, the ratio of the elderly to the working-age population
will reach only 49 percent in 2045 and 55 percent in 2065. Looked at this way, the increase
in the employment rate of the elderly brought about by monetary easing can be regarded as
good news for Japan's aging society.
Next, I would like to look at the employment situation, focusing on the employment
environment for the young. Chart 1 shows the unemployment rate, the youth unemployment
rate, and the job offer rates for university students as of October and December of the year
before they graduate and as of February and April of the year of graduation.4,5 As
mentioned earlier, the overall unemployment rate has declined almost consistently, marking
2.4 percent in October 2019. While the youth unemployment rate usually is higher and
tends to be more volatile than the overall unemployment rate, this also has been declining
steadily. In addition, the job offer rates for the respective months have registered record
highs. While figures for the job offer rates are only available from 1997, the rates must have
been high during the bubble period and lower after the burst of the bubble, given that they
are negatively correlated with the youth unemployment rate. The shaded areas in the chart
represent the so-called "employment ice age."6 If the unemployment rate had been lowered
through monetary policy, there might not have been such an employment ice age, or at least
it might have been mitigated.
Chart 1 Unemployment Rates and Job Offer Rates
% %
11 100
95
90
85
80
75
70
65
60
55
10987654321 50
1980 1983 1986 1989 1992 1995 1998 2001 2004 2007 2010 2013 2016 2019
CY
Unemployment rate Youth unemployment rate (15-24 years old)
Job offer rate (October, right scale) Job offer rate (December, right scale)
Job offer rate (February, right scale) Job offer rate (April, right scale)
Notes: 1. Job offer rates are for university students that are expected to graduate.
2. Figures for job offer rates (February, right scale) for 1997, 1998, and 1999 are those for March.
3. The shaded areas represent the so-called "employment ice age."
Source: Ministry of Education, Culture, Sports, Science and Technology and Ministry of Health, Labour
tanki daigaku, kōtō senmon gakkō oyobi senshū gakkō sotsugyō yoteisha
and Welfare, "Daigaku,
no shūshoku naitei jōkyō
chōsa."
6
Per its support plan for the employment ice age generation, released on May 29, 2019, the
Ministry of Health, Labour and Welfare defined people who graduated from university from around
1993 to 2004 as the "employment ice age generation." The period of a few years from the outbreak
of the global financial crisis in 2008 is also regarded as a reemergence of the employment ice age,
Shūshoku
according to the following report. Genda Yuji et al., hyōgaki sedai no keizai, shakai e no
eikyō to taisaku ni kansuru kenkyū iinkai hōkokusho
(Tokyo: Japanese Trade Union Confederation
Research Institute for Advancement of Living Standards, November 2016). Regarding the impacts of
the employment ice age, see Saeko Maeda et al., "How does the first job at graduation matter for
female workers in Japan?" ESRI Discussion Paper Series, no. 234, March 2010.
The Bank started QQE in April 2013, but if it had been introduced earlier, the
unemployment rate in Japan without doubt would have remained in the range of 2.0-3.0
percent throughout. Since the unemployment rate from the mid-1990s to 2012 on average
was roughly 4.5 percent, the current unemployment rate of 2.4 percent means that the
unemployment rate has almost halved. This decline in the unemployment rate also has
helped to raise productivity, which I will touch on next.
Productivity Growth
Productivity also has been rising in tandem with the improvement in employment. Since I
have talked about this in the past, here I only would like to note that it has been rising.7 Let
me just briefly summarize the reason behind this occurrence. When an economy is in
recession, firms curtail investment in physical assets, human resources, and research and
development. Young people caught up in the employment ice age missed out on on-the-job
training opportunities. Although it is impossible to make up all the lost ground, some of it
can be slowly gained over time, helping to gradually raise the productivity of the economy.
Improvement in Fiscal Conditions
Bold monetary easing has stimulated economic activity, increased tax revenues, and
improved fiscal conditions. Chart 2 presents the ratios relative to nominal GDP of the
general government fiscal balance, gross government debt outstanding, and net government
debt outstanding. The GDP ratio of the general government deficit has decreased by 5.6
percentage points from 8.3 percent in fiscal 2012 to 2.7 percent in fiscal 2017, and the GDP
ratio of net government debt, which had been increasing sharply, is more or less unchanged
at around 121 percent since fiscal 2012.8
Let me explain the importance of net government debt.9 Net government debt is calculated
by subtracting government financial assets from gross government debt. It used to be
argued that, although Japan's gross government debt was substantial, this was not a problem
because net government debt was not that large. However, at present, net government debt
is actually also fairly large. Net government debt matters when considering the possibility
of government debt default. While some argue that, given the large amount of government
debt, even a small increase in interest rates could cause serious problems, it is important to
think about the impact in terms of net debt. The reason is that when interest rates rise,
interest receipts on financial assets held by the government also increase, partly cancelling
out the impact on gross government debt.
Chart 2 General Government Fiscal Balance, Gross Government Debt, and Net
Government Debt (Ratios Relative to Nominal GDP)
%
%
0 300
-2 250
-4 200
-6 150
-8 100
-10 50
-12 0
FY
1994 96 98 00 02 04 06 08 10 12 14 16
Fiscal balance
Gross government debt outstanding (right scale)
Net government debt outstanding (right scale)
Source: Cabinet Office, "System of National Accounts."
III. Why Interest Rates Are Low
Since the introduction of QQE, employment has been improving, productivity has been
rising, and fiscal conditions have been improving. What, then, is at the core of the problem
of bold monetary policy? Simply put, prices have not been rising. Prior to the introduction
of QQE, the Bank decided that it would aim to achieve inflation of 2 percent. However, the
year-on-year rate of change in the consumer price index (CPI) excluding fresh food for
October 2019 is 0.4 percent, a long way off the target.10 You might think that it is not a
problem that prices are not rising if employment is improving, productivity is rising, and
fiscal conditions are improving. However, if prices do not rise, neither will interest rates,
which poses a problem for financial institutions.11
When asked "Why are interest rates in Japan low?" one might answer: "Because that is the
Bank's very intention." However, this is not necessarily the case. From a theoretical
perspective, maintaining interest rates at low levels will cause the economy to overheat and
prices to rise, possibly resulting in inflation that significantly exceeds 2 percent. In order to
avoid this, interest rates will need to be raised. Alternatively, they will rise over time in due
course. In a nutshell, in the long term, a low interest rate policy brings about increases in
prices and nominal interest rates. Looked at from a different angle, what this means is that
Japan fell into deflation and a situation of low interest rates because interest rates were not
lowered sufficiently during economic downturns in the past.12 Moreover, this decline in
interest rates is actually not unique to Japan, but rather a global phenomenon.
Chart 3 shows 10-year government bond yields for major countries. For visual clarity, each
point represents a five-year average. Interest rates have been declining globally and,
although not visible in the chart, 10-year government bond yields have been negative in
Japan, Germany, and France since around the middle of 2019.
Chart 3 10-Year Government Bond Yields for Major Countries
%
16
14
12
10
8
6
4
2
0
-2
1981-85 1986-90 1991-95 1996-00 2001-05 2006-10 2011-15 2016-19
CY
France Germany Japan United Kingdom United States
Note: Figures for Japan through 1988 are based on those of the Cabinet Office.
Sources: OECD; Cabinet Office.
12
Harada Yutaka, "Naze nihon no kinri wa hikui no ka," Keiki to saikuru, no. 62, Japan Association
of Business Cycle Studies, November 2016. Yutaka Harada, "Economic Activity, Prices, and
Monetary Policy in Japan: Speech at a Meeting with Business Leaders in Ishikawa," Bank of Japan,
July 2018. Hibiki Ichiue and Yuhei Shimizu, "Determinants of long-term yields: A panel data
analysis of major countries," Japan and the World Economy 34-35 (2015) 44-55. While this paper
argues that declines in long-term interest rates can be explained by decreases in expected inflation
rates and expected labor productivity growth rates, the same can be said of declines in observed
inflation rates and labor productivity growth rates as these are also capable of pushing down the
expected rates. Ben S. Bernanke, "Why are interest rates so low?" Brookings Institution, March 30,
2015, https://www.brookings.edu/blog/ben-bernanke/2015/03/30/why-are-interest-rates-so-low/.
Low interest rates reflect low rates of both real economic growth and inflation. Let us look
at the nominal GDP growth rate, which is the sum of these two rates. As can be seen in
Chart 4, nominal GDP growth rates of major countries have been declining on the whole.
Chart 4 Nominal GDP Growth Rates of Major Countries
%
12
France
10
Germany
8
Japan
6
United Kingdom
4
United States
2
0
-2
1980-85 1985-90 1990-95 1995-00 2000-05 2005-10 2010-15 2015-19
CY
Note: Figures for Germany from 1990 to 1995 are calculated by using the data from 1991 to 1995,
since there is a data gap between 1990 and 1991 due to German Unification.
Source: IMF, "World Economic Outlook Database."
While nominal GDP growth rates have indeed been declining, this alone cannot fully
explain the decline in interest rates. In Chart 5, the vertical axis represents 10-year
government bond yields, while the horizontal axis represents the nominal GDP growth rates
of major countries. Each dot in the chart depicts the five-year average for each country from
1990 to the present. Up until the 2000s, interest rates moved in sync with nominal GDP
growth rates and were around 2 percentage points higher than them. However, looking at
the trend since the second half of the 2010s, interest rates have fallen 2 percentage points
below nominal GDP growth rates and have failed to rise substantially when nominal GDP
growth rates increased to some extent. However, because it is only since the start of 2010
that interest rates have been below nominal GDP growth rates, the situation might change
quickly and interest rates may rise swiftly if nominal GDP growth rates increase. Therefore,
we might not have to expect the situation of the past five to ten years to last forever.
Chart 5 Nominal Interest Rates and Nominal GDP Growth Rates
10-year government bond yields, %
12.0
10.0
8.0
1990s
Germany, 2010-'14
6.0
France, 2000s
2010-'14
UK, 2010-'14 2010s
4.0
Japan,
US, 2010-'14
2010-'14
US, 2015-'19
2.0
UK, 2015-'19
Germany, 2015-'19
0.0
Japan, 2015-'19
France, 2015-'19
-2.0
-2.0 0.0 2.0 4.0 6.0 8.0 10.0 12.0
GDP growth rate, %
Note: Dots in the chart show 5-year average of 10-year government bond yields and
nominal GDP growth rates.
Sources: IMF, "World Economic Outlook Database"; OECD.
Why did interest rates fall more than the nominal GDP growth rate? Proposed explanations
for the decline in interest rates, in addition to the decline in the rates of inflation and real
GDP growth, include changes in the saving-investment balance.13 Various factors are said
to be responsible for such changes: demographic forces; higher inequality; the glut of
precautionary saving by emerging markets; the decline in the relative price of capital; the
high profitability of large IT firms and their large cash reserves; lower public investment;
the shortage of safe assets; and the improvement in fiscal conditions.14 Some argue that the
recent decline in interest rates is cyclical and changes in the saving-investment balance
might be due to the decline in investment and increase in savings, and that this has led to the
decline in interest rates.
Among the reasons behind the decline in interest rates mentioned earlier, I will focus on the
effects of the improvement in fiscal conditions in Japan. First, let us assume that interest
rates in Japan are determined by the saving-investment balance in Japan. Another
assumption is that a change in fiscal conditions does not affect private-sector decisions with
regard to saving and investment.
In fiscal 2012, long-term interest rates in Japan were 0.8 percent, while gross national
savings, which equal total investment -- the sum of domestic and foreign investment --
amounted to 115 trillion yen. The general government deficit declined by 26 trillion yen
from fiscal 2012 to fiscal 2017. Due to this decline, gross national savings should have
increased by 26 trillion yen. Chart 6 shows the relationship between interest rates and gross
national savings, which equal total investment. As the interest elasticity of savings is said to
be small, the supply curve of savings is almost vertical. Meanwhile, the investment demand
curve is drawn assuming that the interest elasticity of investment is one. The chart indicates
that interest rates declined by 0.18 percentage points due to the decline in the general
government deficit by 26 trillion yen.15
Chart 6 Fiscal Balance and Interest Rates
long-term interest rates,%
2.0
1.5
1.0
0.18%pts.
FY 2012
0.5
26 tril. yen
0.0
0 50 100 150 200
gross national savings / total investment, tril. yen
Sources: Cabinet Office, "System of National Accounts"; Bloomberg.
While it is difficult to judge whether this decline in interest rates is large or small, what is
clear is that, if the government deficit led to a rise in interest rates, this would pose a major
problem, as it would reduce important investment and damage Japan's economy in the
future; on the other hand, if the government deficit does not lead to a rise in interest rates, it
also does not reduce important investment, and would not be a major problem.
Arguments That Low Interest Rates Cause Problems
In addition to the debate surrounding low interest rates mentioned earlier, it has been argued
that the low interest rate policy allows inefficient firms to survive, leading to a decline in
productivity and, consequently, a decline in the natural rate of interest. This could be called
the "zombie firm argument" -- that is, the argument that low interest rates artificially keep
inefficient firms alive.16 Yet another argument is that the current low interest rates are due
to low interest rates in the past that brought about a "frontloading" of demand and resulted
in a further decline in interest rates.17
First of all, it needs to be noted that these arguments focus on real, not nominal, interest
rates. Thus, as for the first argument that the low interest rate policy allows inefficient firms
to survive, leading to a decline in productivity, this is implausible given that productivity
has been rising as a result of QQE. In addition, if inefficient firms were forced to exit the
market because of higher interest rates, this would lead to employment issues. In contrast,
Japan's economy is currently facing labor shortages due to monetary easing. If inefficient
firms are to be forced to exit the market, it is much better if this occurs through labor
shortages and upward wage pressures.
With regard to the second argument that the current low interest rates are merely the result
of a "frontloading" of future demand, both production and people's incomes have been
rising. I assume that when people have higher incomes, they are likely to demand a higher
standard of living in the future as well. Owing to the stable exchange rate environment
brought about by QQE, more foreign visitors have been coming to Japan. I feel that it is
rather strange to think that Japan has merely attracted visitors that were expected to come in
the future and that, since these visitors will not come in the future, this would lead to a
decline of the economy in the future.
When the Bank introduced QQE, I assumed that achieving the inflation target of 2 percent
would not take much time. If the inflation rate were to approach 2 percent, the Bank would
have to raise interest rates. I therefore did not expect interest rates to stay at around 0
percent or in negative territory for such a long period of time. It seems that many
economists had similar expectations.18
Let me go back to the discussion regarding the factors underlying low interest rates. Given
that interest rates have fallen 2 percentage points below nominal GDP growth rates, the
decrease in the fiscal deficit mentioned earlier cannot fully explain the low interest rates. In
fact, the reasons why interest rates have fallen so much are not yet fully understood.
However, given that interest rates in the United Kingdom and the United States -- where
inflation rates of around 2 percent had been successfully maintained -- have remained
higher than interest rates in Japan, it is clear that Japan's past deflationary monetary policy
has led to the decline in interest rates. In addition, it is only for the last five or ten years that
interest rates have been 2 percentage points below nominal GDP growth rates. Therefore,
we might not have to expect this situation to last forever.
18
For example, Hayakawa argues that private banks currently hold huge amounts of government
bonds. In terms of quantity, major banks have substantial amounts of government bonds, but the
duration of their bonds is little more than two years. Meanwhile, the duration of the bonds held by
regional financial institutions is around four years -- longer than that of bonds held by major banks.
Since there is little demand for credit from regional financial institutions, such institutions' only
option is to buy bonds, which extends the duration of their bonds. If prices of government bonds
were to fall, it is regional financial institutions that would incur the greatest losses, not the major
details, see Hayakawa Hideo, "Waga kuni kin'yūgyō no kadai,"
banks. For Shin kokusaku, Research
Institute for National Policy, November 2012. This argument is based on the assumption that
monetary easing eventually increases interest rates. Also, the idea that government bonds with a
duration of four years entail risks reflects the assumption that, in about four years, prices will rise,
thereby leading to an increase in interest rates.
IV. Low Interest Rates and Banks' Profitability
Although it is not clear why, interest rates have fallen globally and are negative, not only in
Japan but also in many European countries. Banks are dissatisfied with low interest rates.
While these have improved the employment situation and boosted productivity, it
frequently is argued that they undermine banks' profitability.19
Functions of Banks
Before considering the relationship between low interest rates and banks' profitability, I
would like to explain banks' functions. How do banks make profits? Textbooks on finance
define the functions of banks as consisting of information production and asset
transformation and explain banks' profits as the result of performing these two functions.20
As for information production, banks, on behalf of depositors, examine borrowers' future
profits from investments and the quality of their assets, assess whether the projected
outcome has been achieved after a loan was made, and check whether borrowers'
accounting information is correct. Banks demand collateral and/or personal guarantees from
borrowers. Sufficient collateral and personal guarantees alleviate banks' burdens of
monitoring firms' accounting information and therefore reduce the cost of information
production. Since depositors cannot demand collateral or personal guarantees, the function
of information production falls on banks. If firms provided more detailed accounting
information, given that they are sufficiently large, they could obtain funding through capital
markets and would not have to rely on bank lending. The reason that in practice most large
firms in Japan borrow from banks is that banks provide inexpensive lending to them. This
means that lending to large firms is less profitable for banks.
While it is very difficult to project future profits to begin with, there are certain firms other
than banks that can project the future profits of another firm more accurately. For instance,
a large assembler to a certain extent knows the sales figures of its suppliers. The simple
reason is that the assembler procures orders from the supplier. Similarly, trading and other
companies that take part in the management of particular firms may also be better placed to
project their future profits. Banks compete with such firms with information advantages.
Even if the firms they lend to are very successful, the margin that banks can earn is very
small. Since banks are not allowed to invest depositors' money, they cannot invest in
venture firms and earn returns that are considerable multiples of their outlays.
If banks try to assess the future profits of a firm, which are unknowable, it is the person
with the greatest authority that ultimately makes the assessment. If a firm is not managed
properly, it likely would face a situation illustrated in the world of novels -- that is, the
credit examination division would stop functioning and the human resources division,
which is responsible for assessing personnel, would engage in internal power struggles.21 If
banks instead provide loans based only on observable and objective criteria such as
collateral, they could cut costs by substantially downsizing their credit examination division
and/or human resources division. That is, banks should lend based on observable and
objective criteria and examine future profits of firms only in exceptional circumstances.22
Even by focusing only on the examination of observable and objective criteria, banks would
be doing something that depositors cannot.
Asset transformation -- banks' other function -- consists of two components. The first is the
act of accumulating short-term deposits and transforming them into long-term lending.
Since borrowers use funds to buy machinery or construct buildings, they cannot pay back
the money on short notice. Banks can lend over the long term by accumulating deposits
from a large number of depositors. The second component is the transformation of loan
assets, which entail the possibility of default, into risk-free deposits. As a result, depositors
can rest assured that their funds are safe when entrusting them to banks. This means that
banks transform assets that involve risks into safe assets through the function of information
production.
To what extent can banks maintain the amount of loans by utilizing these functions? There
are some landowners that only have a small amount of deposits, bu