Masaaki Shirakawa: Global financial crisis and policy responses by the
Bank of Japan
Speech by Mr Masaaki Shirakawa, Governor of the Bank of Japan, to the Board of
Councillors of Nippon Keidanren (Japan Business Federation), Tokyo, 22 December 2008.
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Introduction
I am honored to have this opportunity to speak before business leaders in Japan here today.
Time flies, and it is only about a week before the turn of the year. Looking back, this year has
been a particularly severe one both for overseas economies and Japan's economy. The
slowdown in the world economy gradually became pronounced, reflecting the turmoil in
global financial markets since the summer of 2007, and the situation changed significantly
especially since the bankruptcy filing of Lehman Brothers in mid-September. Many in
corporate management have expressed the view that the sharp downturn in overseas
economies and Japan's economy over the past several months is one they have never
experienced before, and the severity of the situation is clearly shown in the recent economic
data. Today, I would like to take this opportunity to review this year's developments in global
financial markets, the world economy, and Japan's economy, talk about the background to
the current global financial crisis, and lastly explain the Bank of Japan's thinking on the
conduct of monetary policy.
I. Global financial markets and the world economy
I would like to start with developments in global financial markets and the world economy.
As you know, the turmoil in global financial markets since the summer of 2007 was caused
by declines in the prices of securitized products backed by subprime mortgages. It is not
appropriate to limit our understanding of this trouble as "the subprime mortgage problem" or
interpret it as "the financial sector's fault". In essence, it was caused by the bursting of a
global credit bubble - a phenomenon generated by a combination of the rise in asset prices
and the increase in credit and leverage. During the period of the credit bubble, firms in
general enjoyed the fruits of high growth in the world economy. The rise and bursting of the
credit bubble was observed to the greatest degree in the U.S. economy, but other economies
also experienced similar phenomena, albeit with some differences in degree. The turmoil in
financial markets surfaced as "liquidity constraints" when conduits and aggregators of
securitized products and financial institutions faced difficulties in raising funds. Losses
incurred by financial institutions eventually expanded due to declines in the prices of various
securitized products, and this in turn led to a tightening of credit standards.
As a result, there was downward pressure on economic activity, impairing financial
institutions' assets. As was the case in Japan after the bursting of the bubble, financial
conditions in the United States deteriorated with market participants' pessimism rising and
falling in a repetitive pattern. Needless to say, the situation deteriorated sharply since the
bankruptcy filing of Lehman Brothers in mid-September. Since then, market participants and
investors have been extremely sensitive to counterparty risk and have significantly increased
their risk aversion. Consequently, the volume of transactions in financial markets dropped
sharply and market liquidity declined not only in uncollateralized funds transactions, but also
in collateralized ones such as repo transactions, which are fund transactions with
collateralized bonds, and foreign exchange swaps. The situation deteriorated further, with a
widening of credit spreads on corporate bonds and a further decline in the prices of
securitized products. This is evidenced by the fact that the price level of securitized products
such as collateralized loan obligations (CLOs), which are products backed by corporate
loans, has dropped to around 20 percent of the level observed before the summer of 2007 in
the case of single A-rated products. In the United States, delinquency rates have risen not
only for mortgage loans but for commercial real estate loans and consumer loans as well,
reflecting the weaker U.S. economy. Reflecting this, the capital bases of financial institutions
have been further impaired, and their lending attitudes have become even tighter - the
emergence of a negative feedback loop between financial and economic activities.
To address the situation, which can be described as a "financial crisis," governments and
central banks have already taken decisive measures. Central banks have strived to stabilize
financial markets by aggressively providing liquidity in their own currencies. In addition, since
September major central banks including the Bank of Japan have been providing a massive
amount of liquidity in U.S. dollars in their respective markets under a coordinated framework.
Since the bankruptcy filing of Lehman Brothers, governments have undertaken such
measures as placing troubled financial institutions under government control and injecting
public funds, substantially expanding deposit insurance coverage, and providing guarantees
for financial institutions' debts.
Despite the numerous measures taken in each country, global financial markets as a whole
remain under great strains. In money markets, interest rates on comparatively short-term
instruments have recovered to the level before the bankruptcy filing of Lehman Brothers, due
partly to the decisive measures taken by governments and central banks to date. However,
interest rates on longer-term instruments remain elevated. Stock prices have fluctuated
widely against the backdrop of concerns over the outlook for the world economy. Credit
spreads on corporate bonds have been at a high level due to concerns about corporate
performance. The tightness of liquidity conditions among financial institutions has begun to
improve somewhat, but the crux of the problem has now shifted to the magnitude and
duration of adjustments in the world economy.
The slowdown in the world economy has gradually become marked in 2008. In particular, the
negative feedback loop operating between financial and economic activities is no longer
confined to the U.S. and European economies but has recently begun to be observed in
other economies, indicating that the conditions of the world economy have become more
severe.
At the beginning of December, the National Bureau of Economic Research (NBER), which
determines the business cycle of the U.S. economy, announced that the U.S. economy,
which had been expanding from November 2001, already entered a recession phase in
December 2007. The Federal Reserve has significantly reduced its target for the federal
funds rate since last fall. Nevertheless, due to the widening of credit spreads, the interest
rates applied to loans extended to financial institutions, firms, and households have been
rising so far. With regard to the housing market, which holds the key to the outlook for the
U.S. economy, adjustments are likely to continue. Given the tightening lending attitudes of
financial institutions, it is likely that fund-raising conditions will remain severe for firms and
households. The prevalent view regarding the timing of the recovery in the U.S. economy
seems to be the latter half of 2009, but I think that this view is backed by the expectation that
the current severe situation is likely to continue for some time, and not by some reasoning
indicating that the economy is likely to recover from that time. In any event, it is likely that the
current recession may become the longest in the postwar era, longer than the 16 months
recorded in the periods 1973 to 1975 and 1981 to 1982. Economic conditions in Europe have
also deteriorated. As in the U.S. economy, the lending attitudes of financial institutions have
tightened, and pressures acting to depress economic activity from the financial side have
intensified. In addition, the slowdown in emerging economies - for example, in Asia, Central
and Eastern Europe, and Latin America - where economic conditions have been favorable
until relatively recently, has become increasingly pronounced due not only to the decrease in
their exports reflecting the deterioration in economic conditions in the United States and
Europe but also to the adverse effects on domestic demand in emerging economies from the
turmoil in global financial markets.
Economic growth rates around the globe have been declining simultaneously and rapidly,
albeit with some differences in level, as the effects of the financial crises in the United States
and Europe have spread to other economies. Without a doubt, the distinctive features of the
current recession are "simultaneity" and "rapidity." At present, not only advanced economies
such as the United States, Europe, and Japan but also emerging economies are undergoing
either an economic slowdown or a recession simultaneously for the first time since the
formerly planned economies joined the world of the market economies. As for the rapidity, it
is obvious from the degree of downward revisions made to GDP growth rate forecasts since
World Economic Outlook
the beginning of this year. According to the released by the
International Monetary Funds (IMF), the growth of world output for 2009 was projected to be
4.4 percent in January, but was revised downward to 2.2 percent in November. The output of
advanced economies was also revised downward from 2.1 percent to minus 0.3 percent.
Why has the world economy simultaneously faced rapid economic deceleration? There are a
few likely hypotheses. First, the nature of economic downturn may have changed due to the
globalization of financial markets. It is no exaggeration to say that a negative feedback loop,
which I have just discussed with regard to the U.S. and European economies, is now
operating on a global basis. A typical example of this can be seen in the reduction of credit
extension to emerging economies by U.S. and European financial institutions. Second,
technical innovations in the field of information and communications, as represented by
supply chain management, may have had an impact. While supply chain management has
enabled efficient management of production and inventories, at the same time it may have
also facilitated rapid recognition of the decline in final demand, inducing sharp reductions in
production. Additionally, with today's easy access to diverse information via the Internet,
changes in the psychology of corporate management and consumers may have become
increasingly synchronized around the globe. Third, with the global economic deceleration
and turmoil in financial markets never experienced before, feelings of anxiety and defensive
behavior may have spread globally, further accelerating the downturn.
I am not sure which of these hypotheses on the simultaneity and rapidity of the economic
deceleration actually applies. Regardless, the background to the deceleration in world growth
boils down to the single fact that various "excesses" accumulated during the prolonged
period of high growth that continued until recently. Looking back, the world economy, until
recently, had been enjoying unprecedentedly favorable conditions. High growth rates of
around 5 percent continued from 2004 to 2007. On the other hand, prices, notwithstanding
high growth, remained stable on the whole until the recent past, due to an expansion of
production capacity resulting from the participation of emerging economies in the global
market economy. Although memory fades, there were hot discussions in 2004 on the risk of
deflation. "China exporting deflation" and "threat of deflation" were issues often addressed at
international conferences. Low interest rates continued for a prolonged period in an
environment of high growth and low inflation. In this continued benign environment of high
growth, stable prices, and low interest rates, various excessive activities, both economic and
financial, were undertaken and "excesses" accumulated. Investors and financial institutions
eased their credit standards, and a global credit bubble emerged. The substantial rise in
asset prices, the surge in commodity and energy prices, and the significant increase in
leverage by market participants were all indications of excessive financial and economic
activities. Looking calmly at the current deterioration in economic conditions around the
globe, it can be viewed basically as part of the process of correcting the "excesses" that
accumulated during the period of the credit bubble.
As you know, Japan experienced this adjustment process from the 1990s to the beginning of
the 2000s, following the bursting of the economic bubble. Japan's economy finally started to
return to a full-fledged recovery path with the resolution of the "three excesses" of production
capacity, employment, and debt. In the case of the U.S. economy, key factors for the
economy to recover will be how adjustments in the household sector progress and to what
extent financial institutions can write off their losses and enhance their capital bases. Future
developments in the world economy will be critical as well. Looking back, Japan's economic
recovery materialized with the support of high growth in overseas economies. However, the
current situation is difficult in that this time the outlook for the world economy is highly
uncertain.
II. Current situation and outlook for Japan's economy
Next, I would like to discuss the current situation of Japan's economy and the outlook for its
future, taking into account the developments in global financial markets and the world
economy that I have just described.
Japan's economy continued to enjoy a moderate but prolonged economic expansion from the
beginning of 2002, but since the middle of 2007 the economy has been hit by a series of
negative shocks, and become increasingly sluggish. Economic growth began to slow from
around the end of 2007, due mainly to a sharp decline in housing investment as the revised
Building Standard Law came into force. Growth in corporate profits and wages has been
subdued due to the deterioration in the terms of trade since this spring reflecting increases in
energy and materials prices, and as a result growth in business fixed investment and private
consumption has been slowing at a moderate pace. The slowdown in overseas economies
has become pronounced as strains in global financial markets and in the U.S. and European
financial systems have intensified since this summer, and reflecting this, growth in Japan's
exports turned negative. And since September, tightening in corporate financing, which I will
discuss later, has started to negatively influence economic activity. With these negative
effects accumulating, economic conditions have recently been deteriorating. The results of
the December Tankan (Short-Term Economic Survey of Enterprises in Japan) released last
week also indicated the severe situation of Japan's economy. Looking ahead, we judge that
economic conditions are likely to increase in severity for the immediate future. This is
because domestic private demand is likely to weaken further as corporate profits decline,
firms' funding conditions deteriorate, and the employment and income conditions in the
household sector worsen, and also because exports are expected to decrease sharply due to
the further slowdown in overseas economies and the appreciation of the yen.
As for prices, the year-on-year rate of change in the consumer price index (CPI) for all items
excluding fresh food had been around 0 percent from around 2003, but from around the end
of 2007 it rose at a rapid pace, especially in petroleum products and food, due to the surge in
commodity prices, and reached 2.4 percent this summer. Thereafter, it began to decline
reflecting the drop in commodity prices. Looking ahead, given that aggregate supply and
demand conditions will likely ease as growth in real GDP is expected to fall short of the
potential growth rate for the next several quarters, and that commodity prices have been
falling, the rate of change is expected to moderate further.
In sum, economic conditions have been deteriorating and are likely to become still more
severe in the immediate future. With regard to risk factors, much depends on the future
developments in the financial crises in the United States and Europe and their impact, and
on developments in overseas economies and financial conditions in Japan. Attention must be
paid to the further downside risks posed to economic activity. As for prices, there is a
possibility that the inflation rate will decline further if the downside risks to economic activity
materialize or commodity prices fall further.
Among the risk factors affecting the outlook for Japan's economy, I have already discussed
the situation of the world economy. Financial conditions in Japan have deteriorated sharply
on the whole. This can be seen in tighter funding conditions in the CP and corporate bond
markets as well as in an increasing number of small and even large firms which report that
their financial positions are weak and the lending attitudes of financial institutions are severe.
Should the severity in financial conditions such as the lending attitudes of financial
institutions and in the issuance of CP and corporate bonds increase, pressures acting to
depress economic activity from the financial side may intensify. With regard to bank loans,
which had been covering the decline in the issuance of CP and corporate bonds, the
December Tankan shows an increasing number of firms reporting that the lending attitudes
of financial institutions have tightened. The increase in the number of corporate bankruptcies
and the fall in stock prices observed recently may, through a rise in credit costs and an
increase in the risk associated with stockholdings, change financial institutions' risk-taking
behavior, thereby leading to a tightening of their lending attitudes. In this regard, the current
situation in Japan requires careful examination of a possible negative feedback loop
operating between financial and economic activities.
III. Conduct of monetary policy
Having discussed the current situation and the outlook for Japan's economy, I will now turn to
the Bank's conduct of monetary policy. Since September, when the turmoil in global financial
markets and in the U.S. and European financial systems increased in severity, the Bank has
promptly undertaken various measures. These can be categorized in three areas: reductions
in policy interest rates, measures to stabilize the market, and measures to support corporate
financing. I would now like to explain the thinking behind these policy measures, including
those decided last week.
First are the measures taken as interest rate policy. Since February last year, the Bank had
maintained the target of its policy interest rate, the uncollateralized overnight call rate, at 0.5
percent. At the end of this October, the Bank reduced the target to 0.3 percent, and it was
further reduced to 0.1 percent last week. The Federal Reserve, last week, also reduced its
target for the federal funds rate, and set the interest rates on required and excess reserve
balances at 0.25 percent. At the same time, the Federal Reserve announced that the
exceptionally low level of the federal funds rate will continue for some time. When interbank
overnight interest rates are lowered this far, meaningful policy in terms of stimulating demand
through interest rates shifts toward easing firms' accessibility of funds. This holds true in both
Japan and the United States.
In this sense, measures that will ensure stability in financial markets and maintain an
environment to extract maximal monetary easing effects are extremely important. In this
area, the Bank implemented U.S. dollar funds-supplying operations soon after the
bankruptcy filing of Lehman Brothers as a coordinated measure among the central banks in
major economies, and has been supplying sufficient dollar funds ever since. These
operations are currently being conducted without limitation on the amount, as long as it is
within the value of collateral. As a result, dollar funding rates have declined, mainly for
shorter terms, and these operations are supporting economic activity by relieving the funding
concerns of Japanese firms through reducing the dollar funding pressures among financial
institutions. With regard to yen funds, the complementary deposit facility has been introduced
to enable smooth and sufficient provision of funds, and funds for over the year-end have
been provided in larger amounts than a year before. Although the influence of intensified
tensions in the global financial markets is being felt in Japanese markets in the form of large
fluctuations in stock prices and a widening of credit spreads in the corporate bond market,
Japanese financial markets have still been relatively stable compared to U.S. and European
markets, in part because of the swift money market actions taken by the Bank. In addition, at
the Monetary Policy Meeting held last week, the amount of outright purchases of JGBs was
increased from 14.4 trillion yen per year to 16.8 trillion yen per year. This is to supply
longerterm funds and resolve the problem of having to conduct frequent short-term funds supplying
operations, thereby facilitating smooth money market operations.
Along with money market stabilizing measures, the Bank has introduced various measures to
support corporate financing with a view to extracting maximal monetary easing effects. In
advanced economies, the parties that extend credit directly to firms are private financial
institutions and investors, and the role of central banks is to indirectly support this credit
extension. Specifically, the role of central banks is to provide liquidity through money market
operations and to take corporate debt as eligible collateral for its credit extension to private
financial institutions. If central banks implement measures that take on the credit risks of
individual firms, this will inevitably take away the businesses of private financial institutions.
In addition, considering the increasing possibility of incurring losses, undertaking such credit
risks must be examined from various aspects such as role sharing with the government in a
broad sense, the financial health of the central bank, and confidence in the currency. In this
connection, when the Federal Reserve introduced its outright purchases of CP, it attached
various safety measures such as accepting only the most highly rated CP.
As I mentioned earlier, financial conditions in Japan are deteriorating sharply on the whole,
and the risk that low interest rates may not exert their intended impact on economic activity
has increased. Based on this recognition, since this September the Bank has introduced
various measures to reduce such risk through providing liquidity to financial institutions and
expanding the range of eligible corporate debt accepted as collateral. The Bank has already
been conducting purchases of CP under repurchase agreements, and these have been
significantly increased in terms of frequency and size to support the better functioning of the
CP market. In addition, with a view to facilitating corporate financing during the run-up to the
calendar and fiscal year-ends, the range of corporate bonds and loans on deeds accepted as
eligible collateral has been expanded and, as a temporary measure, BBB-rated corporate
bonds and loans on deeds have been included in eligible collateral. Furthermore, a decision
was made to introduce a special operation to facilitate corporate financing, which will be
implemented in early January. This special operation will enable financial institutions to
obtain funds over the fiscal year-end with no explicit ceiling on the total funds available,
although the maximum loans available to individual financial institutions will not exceed the
value of the corporate debt pledged as collateral. Also, the interest rate on these funds will
be set lower than corresponding market interest rates. With these measures, the Bank is
aiming to support, in terms of funds availability and costs, the lending activities of financial
institutions and transactions on the CP and corporate bond markets.
In addition, given that the tightness in corporate financing may increase further during the
run-up to the end of the fiscal year, the Bank decided, last week, to introduce outright
purchases of CP as a temporary measure, and to investigate how other corporate financing
instruments may be employed as a central bank. Since outright purchases of CP essentially
undertake the credit risks of individual firms, they constitute an exceptional step taken by the
central bank in light of the Bank's fundamental position that the main purpose of central bank
operations is to provide liquidity. Looking back on the history of central banks in leading
countries, the only cases where central banks have purchased corporate financing
instruments outright are the Bank of Japan's purchasing of ABCP, ABSs, and corporate
stocks in the first half of this decade and the Federal Reserve's purchasing of CP mentioned
earlier. Nevertheless, it becomes difficult to draw a clear line between measures to provide
liquidity and those that take on credit risk in crisis situations. Central banks are expected,
based on the current economic and financial situation, to fully recognize the importance of
their responsibilities in ensuring the stability of prices and of the financial system, and to
make judgments on specific and practical matters in view of appropriately assuming these
responsibilities. The Bank, in providing support to corporate financing, will examine the scope
of undertakings that are necessary and appropriate for a central bank, as well as appropriate
ways, including the involvement of the government, to ensure the Bank's financial health and
confidence in the currency.
Closing remarks
Today, I have discussed the conditions of global financial markets and the world economy,
the economic situation in Japan, and the conduct of monetary policy, and also presented
some outlook for the coming year. Currently, the world economy is in a severe situation
never experienced for many years that I may venture to call a crisis situation. The immediate
task is "fire-fighting" against this crisis, and we are doing our utmost. At the same time,
however, looking back on the developments in the world economy for the past two decades
or so, the phenomenon of the rise and bursting of bubbles seems to have increased in
frequency and become visible across a wider range of economies.
Considering the background to these experiences, it seems necessary to remember that
responding to crises with excessive policy actions may lead to larger crises later on. In the
current crisis, many issues have surfaced in central banking circles in areas such as the
basic ideas behind the conduct of monetary policy and the regulation and supervision of
financial institutions. I am sure that various issues are also being reconsidered in the field of
corporate management, given the progress of globalization in economic and financial
activities. The Bank, through exchanging views with you, will do its utmost as a central bank
to facilitate the return of Japan's economy to a sustainable growth path with price stability.
Thank you very much for your kind attention.