Masaaki Shirakawa: Recent economic and financial developments and
the conduct of monetary policy
Speech by Mr Masaaki Shirakawa, Governor of the Bank of Japan, at a meeting with
business leaders, Nagoya, 30 November 2009.
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Introduction
I am honored today to have an opportunity to speak and to exchange views with business
leaders from the Chubu region. I take this opportunity to express my deep gratitude for your
cooperation with the Bank of Japan's Nagoya Branch.
The last time I addressed you was in the beginning of September 2008. Immediately after
that in mid-September, Lehman Brothers failed and a financial crisis broke out in the United
States and Europe. Triggered by that event, the global economy deteriorated rapidly and
simultaneously and economic activity in Japan deteriorated substantially, but mainly as a
result of various policy measures by the governments and central banks around the world
and progress in inventory adjustments, the economies both at home and abroad have started
to pick up.
However, the outlook remains uncertain, and many challenges remain for the global
economy to shift to a sustainable growth path. Today, before exchanging views with you, I
will first explain the economic developments and outlook at home and abroad as well as the
thinking on the Bank of Japan's conduct of policy.
I. Developments in the global economy
I will start with the global economy. While many factors were pointed out to be in the back of
a sharp deterioration in the global economy since the autumn of last year, I summarize those
based on the following two factors.
First, the global accumulation of excesses up to the mid-2000s and balance-sheet
adjustments that occurred in the process of unwinding those excesses. Up to the mid-2000s,
the global economy had enjoyed, in retrospect, extremely benign conditions of high growth,
low inflation rates, and low interest rates for a long period. In such an environment, the
housing investment boom in the U.S. and European economies and the global increase in
demand for durable consumer goods occurred. On the financial front, a rapid expansion in
credit, as represented by the subprime mortgage problem, and a surge in leverage took
place. While various excesses in economic and financial activities piled up during such a
process, the excesses could not last for a long time. The essence of what we see now mainly
in the United States and Europe is the process of solving the problems such as households'
excess debts, firms' excess production capacity, and financial institutions' impaired assets.
That is, the process of restoring and adjusting balance sheets. During the process, economic
entities will restrain spending activity and downward pressure would be persistently exerted
on the global economy, especially the advanced economies.
Second, the panicked financial contraction triggered by the failure of Lehman Brothers and
the ensuing plunge in economic activity. The financial intermediary function deteriorated
significantly around the world and the funds necessary for economic activity were not
provided sufficiently, causing a rapid contraction of economic activity not only in the United
States and Europe, but also in the emerging countries.
Following such a severe economic downturn, the global economy started to level out around
this spring, but the developments thereafter vary among the regions. The projections of the
International Monetary Fund showed that the growth rate of the global economy would
increase by four percentage points, to 3.1 percent in 2010 from -1.1 percent in 2009.
Something striking is that the contribution of emerging economies to the growth of global
economy in 2010 became larger than that of advanced economies, with the advanced
economies accounting for 30 percent and emerging economies accounting for 70 percent.
In the United States and Europe, while the panicked contraction of economic and financial
activity settled down mainly due to the provision of ample liquidity by the central banks,
public capital injections to financial institutions, and large-scale fiscal expenditure, chronic
downward pressure on the economy is likely to continue in the form of balance-sheet
adjustments. Therefore, although the economies are picking up, the pace of recovery is
generally moderate.
In emerging and commodity-exporting economies, the underlying trend of domestic demand
in many of them is generally strong, reflecting the buoyant consumption associated with an
improvement in the standard of living and the need for improving social infrastructure.
Moreover, as emerging economies, unlike the U.S. and European economies, do not face
large-scale balance-sheet adjustments, the increase in fiscal expenditure has led to high
multiplier effects in stimulating domestic demand. In addition, the funds raised in advanced
economies, where interest rates have remained low, have been flowing into emerging
economies and has bolstered growth through, for example, an increase in bank lending and
a rise in asset prices. However, the developments in those countries and regions have not
been even. Careful monitoring is warranted according to the respective countries' specific
situations including the effects of the financial crisis to date, the developments in the outflow
and inflow of funds between advanced economies, and conduct of macroeconomic policy.
II. Current state of and outlook for Japan's economy
Based on the state of the global economy I have just mentioned, I will next explain the
current state of and the outlook for Japan's economy.
After the autumn of 2008, against a backdrop of the economic downturn in the United States
and Europe, Japan's exports and production plunged, and Japan's economy suffered an
unprecedented large fall. From the spring of 2009, Japan's exports and production have
been increasing due to the progress in inventory adjustments at home and abroad as well as
the effects of economic stimulus measures. Moreover, thanks to the increase in public
investment and recovery in private consumption, the flash estimate of Japan's real GDP in
the July-September quarter increased by an annualized quarter-on-quarter growth rate of
4.8 percent, which was an increase for the second consecutive quarter. The increase in
private demand was deemed being largely supported by various policy measures. Therefore,
the Bank of Japan judges that the momentum for self-sustaining recovery in private demand
remains weak while Japan's economy is picking up.
As for the outlook, the pace of improvement in Japan's economy is likely to remain moderate
until around the middle of fiscal 2010, as pressures for adjusting employment and wages are
likely to remain. It is always a difficult task in terms of communication to decide what words
are the most appropriate to express the current state and outlook for the economy in a short
phrase. The expression I have just mentioned, "moderate improvement," is used to also
convey cautious judgments that, while the economy has gotten out of a deteriorating phase,
the level of economic activity remains low and the pace of future recovery will not likely to be
smooth. In fact, it cannot be denied that there is a possibility that the momentum for Japan's
economic recovery will temporarily slow at around the spring of 2010, when the effects of
economic stimulus measures will wane at home and abroad.
Having said that, given that the advanced economies including Japan are firmly keeping a
stance to support the economy and the growth of emerging economies is robust, a possibility
that the momentum for economic recovery at home and abroad will stall seems not so
significant. Thereafter, in the second half of fiscal 2010 onward, it is likely that the
improvements in the corporate sector originating from exports will spill over to the household
sector and the growth rate of Japan's economy will start to rise gradually. While the outlook
for the global economy, which lies behind such a view, is basically similar with that of other
central banks in advanced economies and not the Bank's unique view, the Bank thoroughly
recognizes that the outlook is associated with considerable uncertainty. In that regard, the
Bank pays due attention to the effects of the recent rapid appreciation of the yen on business
sentiment of the firms that are on the road to recovery, as well as to the effects of
international financial developments since last week on the financial markets. It would be
important, above all, for a central bank to examine the economy without prejudgment.
Meanwhile, prices have been fluctuating substantially since 2008, like the United States and
Europe, due to the effects of the changes in the prices of petroleum products. The
year-onyear rate of change in the consumer price index (CPI) in Japan rose to 2.4 percent in the
summer of 2008, but it became negative from the spring of 2009, and registered the
largestever decline of minus 2.4 percent in August 2009. The year-on-year rate of decline in the CPI
somewhat moderated to minus 2.2 percent in October, and it is expected that the pace of
decline is likely to moderate to approximately minus one percent toward the beginning of
next year, as the effects of the previous year's surge in the crude oil prices abate. The
question is beyond that point. While it is expected that the pace of decline will gradually
moderate as the economic slack dissipates, it is likely that downward pressure on prices will
remain for an extended period reflecting a moderate improvement in the economy.
Therefore, in the Outlook for Economic Activity and Prices issued at the end of October, the
Bank released a grim outlook that the price decline will likely continue until fiscal 2011, albeit
the pace of decline gradually moderating. While the Government expressed recently its view
that the Japanese economy was in a mild deflationary phase in that the decline in prices was
continuing, the Bank's judgment on prices presented at the end of October is based on the
same recognition with such Government's view.
III. Conduct of monetary policy
Based on the recent economic and financial developments, let me explain next the Bank's
monetary policy management. In terms of monetary easing, the Bank had reduced the policy
interest rate to 0.1 percent toward the end of 2008, in order to steadily support economic
activity on the interest rate front. As a result, short-term interest rates in Japan are now at the
lowest levels in the world. While those low interest rates have power to support economic
activity of firms and households, the potential economic stimulus effects of low interest rates
tend to increase as the economic environment improves. In October this year, the Bank
expressed again its aim to maintain the extremely accommodative financial environment and
provide steady support for Japan's economy, and I will emphasize again today that the Bank
firmly maintains such a stance. The Bank will thoroughly check the future developments in
the economy and prices and take appropriate policy responses to bring Japan's economy
back to a sustainable growth path with price stability.
In terms of the effects of monetary easing, it is important to ensure the stability of financial
markets. To ensure the stability of the financial markets is a responsibility as a central bank,
and I will reemphasize that the Bank is always prepared to act promptly and decisively if
judged necessary to ensure the stability of financial markets.
IV. Responses to deflation
In relation to the policy management, I will now describe the basic thinking on coping with the
issue of deflation. As previously mentioned, the Bank has been doing its utmost as a central
bank to meet the challenge of getting out of the state of continued decline of prices, namely,
deflation, and put Japan's economy back to a sustainable growth path with price stability,
and made it clear to continue with such stance.
To begin with, at the root of a continued decline in prices, there is a fundamental factor that
demand is weak compared with the supply capacity of the economy as a whole. The starting
point of the current price decline was the rapid contraction of financial and economic
activities since the autumn of last year, and, as a result, the supply and demand balance
deteriorated significantly. In order to deal with such situation, it is necessary to prepare an
environment conducive to a sustainable expansion of final demand, such as business fixed
investment and private consumption. In other words, on a policy front, it becomes critical to
make households feel secure about their future and firms able to have expectations about
the future growth. At the same time, as long as there will be no recurrence of the excessive
booms in the United States and Europe, it will be essential also for firms to convert their
supply system into a new one that is in line with consumers' needs in a new era.
As such, steady efforts on the part of the policy authorities as well as the private economic
entities are necessary for coping with the issue of deflation, and such a process necessarily
takes some time. In the meantime, it is also important to avoid a situation in which the
decline in prices induces adverse effects on economic activity, which in turn leads to a further
decline in prices, namely, a vicious circle between economic activity and prices. History
shows that most of the cases, in which a decline in prices induced contraction of economic
activity and resulted in a vicious circle between economic activity and prices, took place
during the period when the financial system became extremely instable through bank failures
and others, namely, during the period of financial contraction. In such a situation, firms that
faced funding difficulties made fire-sales of their own products to meet day-to-day funding
needs or could not maintain employment. That in turn led to a decline in prices and wages,
resulting in further deterioration of the economy. While that might be an extreme case, a
valuable lesson in history is that it is critical to ensure the stability of the financial system in
preventing a vicious circle between the economy and prices.
As described, in coping with deflation, what becomes a key is first, to keep improving the
supply and demand balance of the economy as a whole, and second, to prevent a vicious
circle between economic activity and prices, especially to maintain the stability of the
financial system. Based on such thinking, the Bank will do its utmost to overcome deflation
both in terms of monetary easing and ensuring the stability of the financial markets.
V. Toward sustainable growth
I have been explaining the thinking on policy responses to deflation. Given that the essence
of the issue is the deterioration in the supply and demand balance of the economy as a
whole, efforts to overcome deflation overlap the efforts to strengthen the potential of Japan's
economy, namely, to strengthen the growth potential itself. To that end, I will next touch on
the challenges toward a sustainable growth of Japan's economy.
Sustainable growth of the economy is achieved through a sustained expansion in final
demand, and an associated expansion in the supply capacity. In the economic analysis,
economic growth viewed from the supply side is often analyzed by looking into three factors,
namely, growth in capital stock, growth in labor force, and growth in productivity. This is a
method referred to as growth accounting. By using the method, I will review the source of
growth during the period when Japan's economy was growing at a much higher rate than
now. Typical study in this regard is the analysis by Professor Masahiro Kuroda, the former
President of the Economic and Social Research Institute, Cabinet Office. According to the
analysis, in the 25 years between 1960 and 1985, Japan's annual growth rate was 6.8
percent on average, of which growth in capital stock, labor force, and productivity accounted
for 3.7 percent, 0.9 percent, and 2.2 percent, respectively. While both expansions in demand
and in supply capacity are of course necessary for achieving a sustainable economic growth,
in meeting such expansion from the supply side, growth in labor force accounts for a
surprisingly small degree, and an increase in capital stock and a rise in productivity are
significant. In that regard, the efforts to tackle the population decline and the associated
problems are without doubt important, and, similarly, we are left with two key factors. First,
where to expect a source of demand expansion. And second, how to achieve a rise in
productivity.
First, in terms of source of demand expansion, significant challenges are to foster
households' confidence about their future and prepare infrastructure conducive to expansion
of domestic demand, as well as, given a future decline in population, how to take in the
expanding demand of emerging and commodity-exporting economies. Having said that, I am
not insisting that Japan should increase its dependence on merchandise exports to emerging
economies. Various ways can be considered to take in demand. In fact, in the past five
years, the factors that account for Japan's current account surplus have been changing, and
more than 70 percent of Japan's current account surplus now comes from the receipt of
income from abroad associated with securities and direct investments. The important point
is, in addition to merchandise exports, the efforts to strengthen the relationship with emerging
economies in various forms, including vertical and horizontal specialization, are required.
The efforts to raise productivity from the supply side are also critical. Corporate managers
have been working on the establishment of global production bases and the development of
high-value-added products meeting the needs of consumers. Such moves will lead to
exploring new demand. As is the case with the changes in demographic composition, new
demand will surely be created as long as the economy and society consistently change. The
challenge for firms is to make potential needs into actual demand. While the output gap has
been often discussed in economic debates, the discussions have been done by comparing
demand for products based on the existing needs with the supplying capacity of products
that meet such needs. Given that the unprecedented global bubble has burst, it cannot be
expected that demand will be created to meet the supplying capacity of the same products in
the past. In that context, the oft-discussed output gap seems to have an aspect of an
indicator of the mismatch between supply and demand. What is important is the corporate
effort to make potential needs into actual demand. In addition, to support such firms' efforts,
the systems or mechanisms should be reviewed so as to ensure the flexibility of Japan's
economic structure according to the changes in society and in the global economy. For
example, the rate of establishment of new firms and the rate of closure of the existing firms in
Japan are less than half of those in the United States, suggesting that the metabolism of
Japan's economy is low.
While consideration from various angles would be necessary in order to improve such a
situation and prepare a mechanism through which production resources transfer smoothly to
areas with strong needs, from the standpoint of a central bank, I will emphasize the role of
financial markets, financial institutions, and institutional investors. The financial markets
facilitate an efficient fund allocation according to profitability and potential of firms as well as
risks, thereby play a role in enhancing the metabolism of the economy. In that regard, a more
efficient fund allocation will be possible if versatile markets exist and various fund providers
assess the profitability of firms and others. Therefore, to develop versatile and efficient
financial markets is likely to play an important role also in raising the productivity of the
economy as a whole.
Concluding remarks
Needless to say, economic growth is eventually achieved by the power of human will. In that
regard, in Nagoya, there are many firms that have taken various changes in the environment
as new opportunities and have achieved high growth by responding to the changes.
Recently, there have been moves to develop and expand the production of high-value-added
products including energy saving automobiles, which is reassuring. If such efforts are
stepped up, it would pave the way to a sustained growth path for Japan's economy. The
Bank will do its utmost to support your such efforts from the standpoint of a central bank.
Thank you.