Makoto Sakurai: Economic activity, prices, and monetary policy in
Japan
Speech by Mr Makoto Sakurai, Member of the Policy Board of the Bank of Japan, at a meeting
with business leaders, Hakodate, 18 October 2017.
* * *
I. Economic Activity at Home and Abroad: Recent Developments and the Outlook
A. Overseas Economies
Let me start with developments in overseas economies.
Overseas economies have continued to grow at a moderate pace. Trade activity was sluggish
globally following the financial crisis of 2008, but has recovered since the second half of 2016,
providing support for the recent growth in the global economy. In many countries, business fixed
investment has been increasing, accompanied by an improvement in corporate profits. Private
consumption has also been solid against the background of an improvement in the employment
and income situation. Global financial markets have responded temporarily to the increasing
seriousness of the situation regarding North Korea, but so far, there have been only limited signs
of investors' risk aversion.
Let me elaborate on developments by region. The U.S. and European economies have continued
to recover firmly. Exports have been increasing moderately as global trade activity has
recovered. Private consumption has been on a trend increase against the background of an
improvement in the employment and income situation. Meanwhile, an upturn in business fixed
investment has continued, accompanied by an improvement in corporate profits. Although
economic activity in the United States is likely to be temporarily slowed by the effects of the
recent powerful hurricanes, experience suggests that the economy will maintain its momentum
toward recovery, underpinned in part by demand for reconstruction. The European economy has
been experiencing a further increase recently in its cyclical momentum toward recovery, in a
situation where uncertainties have been easing following events such as elections in major
countries in the region.
Let me turn to emerging economies. The Chinese economy has continued to see stable growth
on the whole. The momentum for growth in fixed asset investment in the private sector has
slowed, due in part to the cumulative effects of monetary tightening, but public investment has
maintained high growth under fiscal policy conducted in a timely manner. Exports have been on a
pick-up trend, and private consumption has been resilient against the backdrop of a favorable
employment and income situation. In the NIEs and ASEAN countries, with an uptrend in exports,
domestic demand has been resilient, on the back of an improvement in business and household
sentiment and the effects of economic stimulus measures in these countries. A recovery trend in
commodity-exporting economies has been apparent recently, partly reflecting a bottoming out of
commodity prices.
In terms of the outlook, moderate growth in overseas economies as a whole is projected to
continue. Advanced economies are likely to continue growing steadily, and a recovery in
emerging economies is expected to take hold on the back of the steady growth in advanced
economies and the effects of policy measures taken by emerging economies. According to the
October 2017 World Economic Outlook (WEO) released by the International Monetary Fund
(IMF), the global growth projection represents an upward revision from the previous estimate
made in July 2017; global growth is now expected to rise from 3.2 percent in 2016 to 3.6 percent
in 2017 and 3.7 percent in 2018, picking up pace.
Needless to say, the outlook is not free from uncertainty. For example, particular uncertainty
seems to remain in the United States over economic policy management, including tax reform. In
a situation where further normalization of monetary policy by the Federal Reserve is in sight, the
impact of U.S. interest rate hikes on the global flow of funds is an issue which also calls for close
attention. As massive capital inflows have been observed in some emerging economies since
2016, there is the risk of an increasing impact should there be a reversal of funds. Moreover,
geopolitical risks have been heightening, including with regard to North Korea. Negotiations on
the United Kingdom's exit from the European Union (EU) and the effects they will have are also
risks to the outlook. In the longer run, I believe that particular attention must continue to be paid to
the growing protectionist mood of recent years. The establishment of supply chains through
trade and direct investment has long been driving global economic growth. If the protectionist
mood gains traction, this will limit trade and direct investment, making it necessary to rebuild
existing supply chains. This could cause significant disruption to the global economy and deprive
it of its main growth engine. Keeping a watchful eye on these uncertainties, I will continue to
carefully monitor overseas developments.
B. Recent Developments in Japan's Economy
Next, I will discuss developments in Japan's economy.
The economy is expanding moderately. Exports have continued on an increasing trend, reflecting
moderate growth in overseas economies. The implementation of the government's large-scale
economic stimulus measures has made progress, and the synergy effects between monetary
and fiscal policies have become profound. A virtuous cycle operating from income to spending
has become stronger in both the corporate and household sectors, and economic growth is in
the process of shifting from one led by external demand, to a more self-sustaining one
accompanying a recovery in domestic demand. Improvements have been seen in wider sections
of the economy; from urban areas to regional areas, and from large firms to small firms. In this
way, I feel that the robustness of the economy has been further enhanced. The GDP growth rate
has increased for six consecutive quarters for the first time since 2006; the annualized rate of
average quarterly growth during this period marked relatively high growth of 1.7 percent, thereby
maintaining a significantly higher figure than the potential growth rate, which is estimated to be in
the range of 0.5-1.0 percent. This shows that the output gap - an indicator of the utilization of
capital and labor - has clearly improved. This consecutive growth for several quarters also
seems to have steadily exerted a positive influence on household and business sentiment.
Looking at developments in detail, in the corporate sector, exports have followed an increasing
trend, particularly in automobile-related and capital goods. Corporate profits have been improving
markedly since the second half of 2016. According to the Financial Statements Statistics of
Corporations by Industry, Quarterly (FSSC), the seasonally-adjusted ratio of current profits to
sales for all industries and enterprises reached the historically high level of 6.16 percent in the
April-June quarter of 2017. Business sentiment has also been improving. In the Bank's
September 2017 Tankan (Short-Term Economic Survey of Enterprises in Japan) released on
October 2, the diffusion index for business conditions for all industries and enterprises - the
proportion of firms responding that business conditions were "favorable" minus the proportion of
those responding that they were "unfavorable" - reached its highest level since 1991, when the
economy was experiencing an asset bubble. Improvements in economic activity have been
observed in many regions and firm sizes, making it possible to conclude that the recovery has
been spreading across wider economic entities. I believe this is one of the salient characteristics
of the current economic expansion phase. In this situation, business fixed investment has been
on a moderate increasing trend, mainly in investment related to the Olympic Games and the
redevelopment of urban areas, and labor-saving and efficiency-improving investment to address
labor shortages. Firms planned to substantially increase their business fixed investment for fiscal
2017 compared with the plans they made in the previous fiscal year. The rate of increase was up
6.9 percent for all industries, including the financial industry, according to the September Tankan,
and up 11.2 percent for major firms in all industries, according to a survey conducted by the
Development Bank of Japan.
Let us turn to the household sector. Labor market conditions have tightened steadily, as the
number of employees has continued to increase. The active job openings-to-applicants ratio
registered 1.52, exceeding the peak level observed during the bubble period, and reaching the
even higher level seen in the first half of the 1970s. The unemployment rate is currently 2.8
percent, which essentially represents a situation close to full employment. Wages of part-time
employees, which are responsive to labor market conditions, have risen markedly, but wages of
regular employees - the majority of employees - have only increased moderately. Private
consumption has increased its resilience against the background of improvement in the
employment and income situation. This resilience seems to have been underpinned by, for
example, the replacement of durable goods, which consumers were encouraged to purchase by
a number of demand-boosting measures implemented following the financial crisis, including the
eco-point system for energy-efficient household electrical appliances. Private consumption has
also been supported by large-scale economic stimulus measures carried out last year to support
households, such as lowering employee insurance premiums. As seen also in Hakodate,
consumption by foreign visitors to Japan - which has been on an uptrend in recent years - is
contributing to sales at retail stores and in the services sector, not only in urban areas but across
wider regions in Japan.
On this basis, from an overall perspective, despite the steady improvement evident in economic
activity as a whole, wages have been slow to recover. Some people suggest that this is due to
Japan's employment practice, which places importance on securing jobs. Firms are cautious
about raising regular employees' wages because they are difficult to cut even during periods of
recession, and labor unions seem to be reluctant in general to demand sharp wage hikes, since
they prioritize stability of their employment in the long run. Moreover, an increase in the labor
supply in recent years - resulting in part from the government's initiatives to promote the
empowerment of women and the elderly - has been another factor in easing any upward
pressure on wages. Especially, in practice, considering that wages paid to women and the
elderly tend to be low, my view is that firms facing a labor shortage have consequently been able
to obtain low-cost labor.
C. Outlook for Japan's Economy
As for the outlook, Japan's economy is likely to continue its moderate expansion, mainly
supported by the growth in overseas economies and the synergy effects between monetary
easing measures and stimulative fiscal measures.
In the corporate sector, profits are projected to follow an increasing trend due to growth in
demand at home and abroad. Exports are likely to maintain their increasing trend as global trade
activity continues to recover. Business fixed investment is expected to continue to see a
moderate increase on the back of the improvement in corporate profits and accommodative
financial conditions.
As for the household sector, upward pressure on wages is likely to strengthen further with the
increase in demand for labor. Private consumption is expected to follow a moderate increasing
trend as there will continue to be replacement demand for durable goods, and the employment
and income situation will continue to improve.
In the light of these developments, the positive output gap is also expected to widen further, as
the economy is likely to continue growing at a relatively high pace above its potential.
II. Prices
A. The Current Situation of Prices
Next, I will turn to price developments, an issue of much interest in Japan recently.
The year-on-year rate of change in the consumer price index (CPI) for all items less fresh food
has increased to 0.7 percent. The rise in energy prices has contributed to the increase in the
CPI, against the background of a pick-up in crude oil prices since the spring of 2016. It must be
noted, however, that developments in the CPI for all items less fresh food and energy remain
relatively weak, with the year-on-year rate of change standing at 0.2 percent.
In a situation where wages are increasing, albeit moderately, firms are facing higher labor costs.
However, instead of directly passing on the cost increases to sales prices, most firms are trying
to absorb these increases by improving productivity. Among the initiatives they have adopted are:
(1) streamlining of excessive services and inefficient business procedures, including
discontinuation of late-night business and reduction of parcel delivery time slots; (2) more
efficient reallocation of human resources, including sending staff temporarily to different
departments when necessary, for example, from an administrative to an operational section; and
(3) investment in labor-saving and efficiency-improving machinery and equipment, including
installment of self-checkout machines, full automation of distribution facilities, and adoption of
online booking systems.
Behind firms' reluctance to pass on cost increases to sales prices is the fear of losing
customers. While this is not surprising given the highly competitive business environment they
are in, I believe that the following factors are responsible for further heightening this fear. First,
given that the inflation rate has remained stable at an extremely low level for the past few
decades, I believe firms have become increasingly afraid to raise prices because consumers are
not accustomed to price hikes, or because firms anticipate a negative reaction to price rises
from those consumers. And second, the widespread use of smartphones and the expansion of
e-commerce may have had an impact. Consumers can now easily refer to and compare a wide
range of information on prices at the press of a button, and purchase goods and services as
necessary, even from a distance. I believe these changes have increased convenience for
consumers while, at the same time, increasing their responsiveness to prices, consequently
somewhat accelerating price competition among firms.
B. Outlook for Prices
That being said, I do not believe that firms will be able to avoid price hikes forever. Cost cutting
efforts such as streamlining of business processes and efficient reallocation of human
resources have their limitations. It will gradually become difficult for firms to absorb increases in
labor costs even if they are reluctant to raise prices. In this situation, competing firms in the
same environment are likely to be faced with similar limitations. Therefore, I believe there will be
cases of a price hike starting at an individual firm, followed by hikes at competing firms. Once
price hikes actually start to become common, consumers are, to some extent, likely to accept
increases in prices as a matter of course. Subsequently, there will be even greater room for
firms to raise prices. Employees will then start to demand a raise in wages to reflect these price
increases. Under such a cyclical mechanism, the uptrend in the inflation rate is likely to gradually
strengthen toward the 2 percent price stability target.
It is difficult to predict precisely when such a cyclical mechanism will start to operate. Having said
that, however, I would like to point out that some firms, in the transportation and food service
industries for example, have begun to raise prices due to increasing labor costs. There are also
frequent news reports that more firms are considering raising prices in the near future. While the
situation may differ largely by industry, my view is that, in general, the momentum toward price
hikes is starting to increase. Moreover, I feel that the perception of the general public toward price
hikes has gradually become more positive recently, as reflected in major rises in the price of
stocks of firms that have announced price hikes. In other words, given the evidence of
successful cases of price increases, more people have begun to think that firms do not always
lose customers by raising the price of the goods and services they offer. Consumers might be
gradually showing their understanding of the situation firms are placed in, hearing more frequent
news reports of labor shortages.
In sum, despite the relatively weak price developments at present, a cyclical mechanism toward
price increases is likely to operate going forward, as labor market conditions tighten further with
improvements in economic activity. There are signs of such a mechanism working, and in my
judgment, a process toward price increases has been evolving steadily.
III. Monetary Policy
A. Quantitative and Qualitative Monetary Easing (QQE) with Yield Curve Control
In September 2016, the Bank introduced QQE with Yield Curve Control as a new framework for
strengthening monetary easing. The framework consists of the two components of an
inflationovershooting commitment and yield curve control.
Under the inflation-overshooting commitment, the Bank commits itself to continuing to expand
the monetary base until the observed year-on-year rate of increase in the CPI, for all items less
fresh food, exceeds the price stability target of 2 percent and stays above the target in a stable
manner. For people to regard a rise in prices of around 2 percent every year as a matter of
course, I believe it is important that the Bank shows such strong commitment and that people
actually experience an inflation rate of above 2 percent.
Under yield curve control, the Bank facilitates the formation of short- and long-term interest rates
that are considered most appropriate in light of the 2 percent price stability target. In the Bank's
current guideline for market operations, the short-term policy interest rate is set at minus 0.1
percent and the target level for yields on 10-year Japanese government bonds (JGBs) is set at
around 0 percent. Since the introduction of yield curve control a year ago, short- and long-term
interest rates have thus far been maintained at levels consistent with the guideline for market
operations. Meanwhile, with the shift in the Bank's main operating target from quantity to interest
rates, I believe that the following points have been confirmed. First, the amount of the Bank's JGB
purchases varies according to financial market conditions at the time and the progress in its
cumulative purchases of JGBs. And second, as a result of this, the sustainability of the Bank's
policy framework has increased.
B. Future Conduct of Monetary Policy
At present, price developments are relatively weak, and the inflation rate is fairly distant from the
2 percent price stability target. The Bank should face this fact with sincerity. Nevertheless, as I
discussed earlier, Japan's economy has been improving solidly and the process toward price
increases has been evolving steadily. When long-term economic growth potential is increasing
and people's views on prices are changing, the real interest rate level that is considered to be
neutral to economic activity - the natural rate of interest - will rise and the observed real
interest rates will decrease. This, in turn, is expected to further enhance the effects of monetary
easing. Taking these points into account, I believe that it is important that the Bank, for the time
being, continues to firmly pursue powerful monetary easing under the current policy framework.
Recently, some have come to believe that the price stability target of 2 percent is too high, due in
part to improvements in economic activity. I, however, am of the opinion that the Bank should not
readily change the 2 percent price stability target, because this target was set after giving due
consideration to domestic and overseas circumstances. Let me elaborate on this point. First, the
CPI has a statistical tendency to assert a higher inflation rate than the inflation that people
actually experience. Therefore, in order to ensure that people actually experience price stability,
the rate of change in the CPI should be sufficiently positive. Second, the room for monetary
policy responses is not symmetrical on the upside and downside, and there is relatively limited
scope for responding to deflation, compared with inflation, because it is difficult for the Bank to
lower interest rates to a level substantially below zero. That is why it is considered desirable,
under normal circumstances, to ensure that the inflation rate be positive, to a certain extent. And
third, targeting inflation at 2 percent is a global standard shared by major advanced economies.
Pursuing the same rate of inflation at 2 percent will contribute to the stability of foreign exchange
rates in the long run, as well as price stability.
IV. Expansion of the Economy's Supply Capacity
I have pointed out various factors behind the delay in improvements in wages and prices. To
summarize, I consider one of the major reasons behind the delay to be the expansion of the
economy's supply capacity caused by an increase in the labor supply and by firms' efforts
toward increasing productivity. I would like to elaborate on this, because it is particularly important
in considering the outlook for economic activity and prices in Japan.
Starting with labor supply, the labor force participation rate in Japan rose by 1.8 percentage
points over the five years to August 2017. Over the same period, the size of the labor force
increased by 1.92 million, and this accounts for nearly 70 percent of the 2.82 million increase in
the number of employed persons. The trend in the labor force participation rate started to rise
markedly from around 2012. Indeed, the growth in labor force participation was remarkably rapid,
considering the downward pressure on the participation rate stemming from an increasingly
aging population. This reflects various structural changes in the economy resulting from, for
example, measures to promote the empowerment of women and the elderly, including the
provision of child-rearing and nursing care facilities, as well as extending the retirement age or
abolishing traditional retirement systems amid the increase in life expectancy. I believe that these
structural changes have eased the upward pressure on wages and prices by providing additional
labor force to firms facing labor shortages.
Japan's productivity has shown relatively high growth in recent years, compared with other major
advanced countries, as reported for example by a U.S. private institute, although productivity
figures should be regarded as being subject to a considerable margin of error because of their
large measurement bias. It has been said that Japan's productivity is low, but this could also be
taken to mean merely that there is large room for improvement. As I have already mentioned,
most firms are currently trying to improve productivity, and my assessment of the current
situation in Japan is that, due to labor shortages, productivity is growing sharply to catch up with
other countries.
Naturally, such an expansion in supply capacity raises the economy's long-term growth potential.
Enhancing growth potential is an extremely important issue for Japan, which is facing a decline in
population. A fall in growth potential can lead, for example, to concerns about fiscal sustainability
and to restraints in firms' and households' spending due to anxiety about their long-term
economic outlook. In this regard, although recent developments in supply capacity may exert
downward pressure on wages and prices in the short run, they will definitely bring positive effects
to the economy as a whole. I believe that the recent GDP growth - which was positive for six
consecutive quarters - is attributable not merely to cyclical factors but also to these structural
changes in the economy. The Bank, for its part, does not focus solely on raising prices. I believe
that it is essential to achieve price stability while the virtuous cycle in the economy continues to
operate and the quality of people's lives improves. A joint statement released by the government
and the Bank in 2013 stated that they aim "to overcome deflation early and achieve sustainable
economic growth with price stability." My assessment of recent developments in the economy is
that they are in line with such an objective.
Even if we focus on how wages and prices are affected by the increase in supply capacity, I do
not think that it necessarily exerts a negative effect in the long run. As I explained earlier, there is
a natural limit to the rise in the labor force participation rate, the streamlining of firms' business
processes, and the efficient reallocation of human resources. Therefore, the downward pressure
on wages and prices resulting from such efforts will dissipate eventually. Let me also note that, in
the long run, there are mechanisms through which an expansion in supply capacity leads to an
increase in wages and prices. First, firms' expectations of higher profits and a rise in households'
permanent income stimulates the demand side of the economy, such as business fixed
investment and private consumption. Second, when firms' long-term outlook for the business
environment starts to improve, they are likely to shift their stance toward raising wages. Third,
since the rate of growth in labor productivity corresponds to the rate of increase in real wages in
the long run, a rise in productivity also exerts upward pressure on wages. And fourth, an increase
in the economy's long-term growth potential leads to a rise in the natural rate of interest,
enhancing the effects of accommodative monetary policy measures. Given these points, it is
likely that, as time passes, the long-term positive effects of an increase in supply capacity will
gradually outweigh the short-term negative effects on wages and prices. In other words, although
an expansion of the economy's supply capacity may delay rises in wages and prices, I do not
think that it will hold them back for any protracted period.
In my view, therefore, Japan's economy is currently experiencing adjustments arising from
positive structural changes. There is no need to be unduly pessimistic simply on account of the
current low growth rates in wages and prices. Rather, I personally find the current state of the
economy to be very promising, since both demand and supply are improving in a balanced
manner, and developments in wages and prices are steadily making progress toward increases.
What is crucial in this situation is not to hinder these positive developments. To this end, I think
that it is important that the Bank continues to pursue powerful monetary easing under the current
framework for monetary policy. At the same time, I hope to see continued progress in the various
initiatives and efforts by the government and firms toward strengthening the economy's growth
potential, including structural reforms.