Yoshihisa Morimoto: Economic activity and prices in Japan and
monetary policy
Speech by Mr Yoshihisa Morimoto, Member of the Policy Board of the Bank of Japan, at a
meeting with business leaders, Nagasaki, 23 June 2011.
* * *
I. The current situation of and outlook for the world economy
The Bank of Japan released its latest Outlook for Economic Activity and Prices (hereafter the
Outlook Report) on April 29. The report presents the scenario for Japan's economy
considered to be the most likely by the Bank. The Bank projects that the economy will return
to a moderate recovery path in the second half of fiscal 2011. Although supply-side
constraints - due to the damage to production facilities and the disruption of supply chains
for parts and components caused by the Great East Japan Earthquake in March - as well as
constraints on electric power supply are expected to weigh down the economy for a while,
these downward pressures are expected to gradually ease, paving the way for a moderate
recovery in production. Of course, this recovery in production will not be long-lived unless it is
accompanied by a rise in sales. A key element in this scenario of a return to a moderate
recovery, therefore, is the expectation that exports will increase based on an improvement in
overseas economies. Consequently, before talking about the domestic economy, let me take
a closer look at the world economy.
Following the recovery from the Lehman shock in the autumn of 2008, growth in the world
economy temporarily slowed in the summer of 2010. From the end of autumn, economic
growth then regained momentum, driven by strong growth in emerging and
commodityexporting economies. At present, the pace has slowed somewhat due partly to the effects of
soaring crude oil prices. As for the outlook, a number of issues require careful attention, but
basically it is expected that - fueled by rapid growth in emerging and commodity-exporting
economies - the pace of global growth will soon pick up again and the global economy will
continue to expand. The International Monetary Fund (IMF) in its World Economic Outlook
released in April 2011 forecasts that the global economy will grow by around 4.5 percent in
both 2011 and 2012.
A. Advanced economies
Looking at developments in the global economy in greater detail, it is useful to focus on
advanced economies and on emerging and commodity-exporting economies separately. Let
me start by considering advanced economies. In the United States, from the autumn of 2010
onward, various stimulus measures, such as monetary easing by the Federal Reserve and
the extension of tax cuts introduced by the Bush administration, led to optimism regarding
the U.S. economy. Caution, however, has returned as personal consumption has been
curtailed by higher prices for gasoline and other daily necessities, leading to a slight decline
in the growth rate of the economy overall. Moreover, job market data for May showed that
nonfarm payroll employment was well below market forecasts, indicating that the recovery in
the job market remains shaky. With balance-sheet adjustments continuing to be a burden
and the path for addressing the fiscal deficit unclear, the need to pay attention to downward
risks is increasing.
Even though upward momentum is currently weak, however, the Bank's main scenario,
which expects the U.S. economy to recover moderately, remains unchanged. While
developments up to the present are somewhat on the low side, they are within the range of
expectations. As for the outlook, exports - mainly to emerging and commodity-exporting
economies - are expected to follow an upward trend. Furthermore, the U.S. stock market,
which has been in an adjustment phase for the past few weeks, remains firm from a longer-
term perspective. In this environment, private consumption and business fixed investment
are unlikely to deteriorate to any serious extent. In short, we should be aware of the
downside risks without being unduly pessimistic.
Economic activity in the euro area is recovering moderately as a whole, although the contrast
has been increasing further between the strong performance of Germany and the
performance of peripheral countries with serious fiscal problems such as Greece and
Portugal. As for the outlook, the situation as a whole is likely to remain unchanged, with the
moderate recovery continuing. However, since around April 2011, doubts have emerged
regarding the credibility of Greece's plans for fiscal reconstruction and funds procurement,
leading to a surge in the yield on 10-year Greek government bonds to record levels of more
than 15 percent. The surge triggered a rise in the yields on government bonds issued by
other peripheral countries. Damage could spread from financial markets to economic activity.
Therefore, it is necessary to closely watch fiscal developments in Greece and other
peripheral countries, as well as the response of the European Union (EU) as a whole.
B. Emerging and commodity-exporting economies
Emerging and commodity-exporting economies are expanding steadily, led by firm domestic
demand. Moreover, although these economies are likely to continue tightening their
monetary policies in response to heightened concerns over inflation, they are expected to
maintain relatively high growth, albeit at a slightly reduced pace. In China, for instance,
consumer prices are rising at a rate of more than 5 percent and authorities are tightening
monetary policy. The Chinese economy is expected to continue showing high growth, though
at a somewhat slower pace, due to the continued increase in private consumption, housing
investment, and investment in various infrastructures, reflecting higher household incomes
and continuing urbanization. Economic activity in the NIEs and ASEAN countries is also
likely to follow a recovery trend. It has been suggested that production is being affected by
sluggish shipments of parts from Japan, but domestic demand - such as business fixed
investment and private consumption - is expected to remain firm, and exports are expected
to continue increasing. On the other hand, there is concern that growth in
commodityexporting economies may slow if international commodity prices drop. Any deceleration,
however, is unlikely to be prolonged.
II. The Japanese economy
Keeping in mind the present situation of and outlook for overseas economies I just outlined,
let me now talk about the Japanese economy and prices.
A. Economic activity
The pace of improvement in the economy slowed temporarily from the autumn of 2010, partly
due to the expiration of subsidies for purchases of environmentally friendly cars. Thereafter,
from the beginning of 2011, the economy started to gradually return to a moderate recovery
path. The devastating earthquake that struck northeastern Japan in March, however,
destroyed many production facilities, disrupted supply chains, and caused electric power
shortages. Production of cars and other products came to a standstill even though demand
was clearly present. The index of industrial production for March showed a decline of
15.5 percent from the previous month, the steepest fall ever for a single month since data
started to be compiled. The cause of the decline in production differed from that after the
collapse of Lehman Brothers, when demand simply evaporated. This meant that immediately
after the earthquake, the usual mechanism for economic recovery - in which a recovery is
preceded by an improvement in overseas economies that boosts Japanese exports and
production - was partially paralyzed.
Supply-side constraints are still in evidence and downward pressure on production will
remain for the time being, although there are also signs of recovery. Supply chains are likely
to be restored earlier than previously anticipated due to the close cooperation among firms,
especially in the car industry, and the wholehearted and coordinated efforts of workers on the
ground. Another bright factor is that electricity demand in the Kanto and Tohoku regions this
summer is expected to be lower than forecast earlier, although of course much depends on
the weather. Initially, it was expected that supply constraints would ease from the beginning
of autumn 2011, but now it appears that production will return to pre-earthquake levels in the
July-September quarter and that supply constraints will be largely resolved by early autumn.
From a somewhat longer-term perspective, uncertainties persist with regard to the supply of
electricity. However, as the supply constraints ease, Japan's economy should continue to
recover, driven by the increase in exports and production that the expected improvement in
the global economy should bring with it. Moreover, by that time, restoration and rebuilding of
infrastructure, buildings, and other facilities damaged by the earthquake should be in full
swing, pushing the economy forward.
Looking at each demand component, exports, particularly of cars and car parts, declined as
a result of supply chain disruptions. However, overseas demand in general is expected to
continue to expand. Furthermore, exporters, particularly automobile makers, are working
hard to resume shipments as quickly as possible. Therefore, although much depends on
developments in the foreign exchange market, it looks increasingly likely that shipments will
return to pre-earthquake levels sometime in the July-September quarter, which is earlier
than previously expected. Exports are expected to follow an upward trend thereafter.
Business fixed investment bottomed out and started to recover moderately during the second
half of fiscal 2009, reflecting increased production and a recovery in corporate profits.
Although business sentiment deteriorated due to the impact of the earthquake, various
indicators suggest that business fixed investment has remained surprisingly resilient. This
shows that firms' growth expectations have remained stable. On this basis, business fixed
investment, despite some fluctuations, is likely to remain firm against the backdrop of strong
profits in fiscal 2010. It is likely to start to clearly turn upward from around the autumn of
2011, supported by the expected recovery in exports and production as well as rebuilding
efforts in areas hit by the earthquake.
Turning to private consumption, the mood of restraint seen immediately after the devastation
resulting from the earthquake has gradually eased, with department stores and retailers of
electrical appliances voicing, albeit cautiously, the view that consumption is returning to more
normal levels. Furthermore, various indicators point to a slight improvement in consumer
sentiment. Therefore, private consumption is expected to head toward a gradual recovery.
Needless to say, it is important to keep an eye on the effect, particularly in the service sector,
of the supply and demand balance of electricity during the summer. In addition, consumer
sentiment is likely to be dampened by the ongoing problems at the nuclear power plant and
awareness of the need to save electricity. What is more, the employment and income
situation, particularly the wage situation, is becoming more severe. The expected recovery in
consumption is, therefore, bound to be modest.
B. Prices
The three key factors likely to shape the direction of prices for the time being are (1) the
aggregate supply and demand balance; (2) medium- to long-term inflation expectations; and
(3) international commodity prices. In the short term, the net impact on the aggregate supply
and demand balance is unclear, since on the one hand supply capacity has declined as a
result of the earthquake, while on the other demand has also fallen due to a deterioration in
consumer sentiment. Nevertheless, in the longer run, the supply and demand balance is
likely to follow an improving trend as the economy returns to a moderate recovery path.
According to various surveys, medium- to long-term inflation expectations have been stable
at around 1 percent in recent years. Prices of international commodities, such as crude oil,
have been undergoing adjustments recently. However, there has been little change in the
factors that have fueled the rise in commodity prices so far, such as the strong growth of
emerging economies and the increased "financialization" of primary commodities.
Under these circumstances, with the aggregate supply and demand balance remaining on an
improving trend in the longer run, and assuming that international commodity prices will
increase moderately, domestic corporate goods prices are expected to rise. For the same
reasons, the rate of increase in the consumer price index (CPI; excluding fresh food) is
expected to remain slightly positive. The CPI, however, is very likely to be revised downward
somewhat as a result of the planned change in August of the CPI base year to 2010.
III. Risks to the outlook
I would now like to turn to risks affecting the outlook for economic activity and prices.
A. Risks to economic activity
In the April 2011 Outlook Report, the Bank listed the following as risk factors concerning the
outlook for economic activity: (1) uncertainty about the possible effects of the earthquake
disaster on Japan's economy; (2) firms' and households' medium- to long-term growth
expectations; (3) developments in overseas economies; and (4) the effects brought about by
a possible further rise in international commodity prices.
As for the first risk factor, there is great uncertainty regarding the timing when supply-side
constraints will be resolved, the timing and scale of the restoration of damaged capital stock,
and the impact on the economy of possible changes in consumer and business sentiment
caused by the disaster. The degree of the impact varies depending on future developments
in the situation at the nuclear power plant, as well as on the outlook for corporate profits and
the compensation of employees. In addition, if concern about the growth potential of the
economy increases due to the effects of the disaster, and firms' and households' medium- to
long-term growth expectations decline as a result, this could depress firms' and households'
appetite for spending and act to reduce economic activity for a protracted period. On the
other hand, medium- to long-term growth expectations by firms and households could rise if
firms take the disaster as an opportunity to bolster efforts to implement growth strategies.
Risk factors regarding overseas economies, as I explained earlier, are increasing to some
degree. In emerging economies, there are upside risks due to economic expansion, and
although monetary tightening has continued in these economies, this has not sufficiently
calmed concern over overheating or inflation. Therefore, there is concern that from a
longerterm perspective sustainable growth may be undermined due to increased fluctuations in
economic activity. In addition, if international commodity prices rise further, this could lead to
a decline in the purchasing power of households and a deterioration in corporate profits,
which could depress private domestic demand in Japan.
I believe that all of these risk factors are equally important. Although there is a possibility that
the economy will grow faster than expected if supply-side constraints ease earlier than
anticipated, it seems to me that the downside risks stemming from uncertainties regarding
the effects of the disaster require the most attention, simply because the disaster involved an
unprecedented tsunami and a nuclear power plant accident. Moreover, firms, particularly
small firms, are concerned about whether the shift to overseas production will accelerate and
the hollowing out of domestic industry will continue. This is an issue that I also feel requires
attention.
B. Risks to prices
Next, turning to the risks to prices, these involve the materialization of the risks to economic
activity that I have just described. Developments in the aggregate supply and demand
balance play an important role in determining the outlook for prices, but because of the
impact of the earthquake, these developments in the short term are not yet clear. Even if
supply-side constraints cause supply shortages, firms will avoid making hasty decisions
- such as raising prices of their products - that may result in losing customers, if firms judge
the supply shortages to be temporary. On the other hand, if downside risks to the economy
materialize, leading to a prolonged economic downturn, prices will be affected accordingly.
Other risk factors to prices include firms' and households' medium- to long-term inflation
expectations, as well as developments in import prices, which are affected by fluctuations in
international commodity prices and foreign exchange rates.
IV. Monetary policy
A. The bank's thinking behind the conduct of monetary policy
So far, I have talked about economic activity and prices in Japan. I would now like to turn to
the Bank's conduct of monetary policy. The Bank recognizes that Japan's economy is faced
with the extremely important challenge of emerging from deflation and returning to a
sustainable growth path with price stability. Based on this recognition, the Bank has been
doing - and is determined to continue to do - its utmost as the central bank, using a
threepronged approach consisting of (1) pursuing powerful monetary easing under the
comprehensive monetary easing policy, (2) ensuring stability in financial markets, and
(3) providing support to strengthen the foundations for economic growth. Furthermore, with a
view to ensuring stability in financial markets, the Bank introduced a number of measures in
the wake of the earthquake to address its impact on the economy and associated risks.
1. Pursuing powerful monetary easing under the comprehensive monetary easing
policy
"Comprehensive monetary easing" is a policy package that the Bank introduced in
October 2010, consisting of three measures. First, the Bank lowered its policy interest rate,
that is, the target for the uncollateralized overnight call rate - the shortest interbank rate - to
"at 0 to 0.1 percent", thereby indicating that it was pursuing a virtually zero interest rate
policy. Second, the Bank clarified its commitment regarding the time horizon based on the
"understanding of medium- to long-term price stability" (hereafter the "understanding"). The
"understanding" is the level of inflation that each Policy Board member understands as being
consistent with price stability over the medium to long term. The "understanding" at present
falls in a positive range of 2 percent or lower, and the midpoints of most Policy Board
members' understanding are around 1 percent. The Bank has made clear that it will maintain
the virtually zero interest rate policy until it judges, on the basis of the "understanding", that
price stability is in sight, on condition that no problem is identified in examining risk factors,
including the accumulation of financial imbalances. And third, the Bank decided to establish
the Asset Purchase Program. The Bank decided on this temporary easing measure to
conduct outright purchases of various financial assets, such as Japanese government bonds
(JGBs), and risk assets such as CP, corporate bonds, exchange-traded funds (ETFs), and
Japan real estate investment trusts (J-REITs). The Bank has been steadily conducting
outright purchases of such financial assets, which are registered on its balance sheet,
through the Asset Purchase Program.
2. Providing support to strengthen the foundations for economic growth
The fund-provisioning measure to support strengthening the foundations for economic
growth supplies long-term funds at a low interest rate to private financial institutions in
accordance with their efforts in terms of lending and investment to strengthen the
foundations for economic growth. The Bank has provided 18 examples, including
"environment and energy business", "medical, nursing care, and other health-related
business", and "tourism business", as areas for which financial institutions' lending or
investment would be funded by the measure, and in addition to these areas, a large amount
of funds has been invested in the area categorized as "others", such as lending or
investment to support local industries. The Bank decided to implement this measure based
on the recognition that the decline in the economic growth trend since the 1990s has been
the fundamental cause of deflation and that it was important to support various growth areas
to overcome deflation. In other words, it is important not only for Japan's economy to achieve
a cyclical recovery, but also to make efforts to raise Japan's economic growth in the long
term. While the government, for its part, also has been implementing measures to support
economic growth, such as its "New Growth Strategy" aimed at achieving renewed economic
vigor, I believe that the Bank's measure to support the economy from the financial side - that
is, to provide funds to support strengthening the foundations for economic growth - not only
produces effects through the provision of funds, but also sends a strong message and raises
awareness about the issues faced by Japan's economy.
The fund-provisioning measure to support strengthening the foundations for economic
growth was decided at the Monetary Policy Meeting (MPM) held on June 14 and 15, 2010.
On June 8, 2011, the Bank carried out the fourth loan disbursement under the measure, and
the total amount of loans disbursed has reached nearly 3 trillion yen - the amount set as the
ceiling for the measure. Therefore, given that the maximum amount of loans had almost
been disbursed, Policy Board members at the MPM held on June 13 and 14, 2011 discussed
how to proceed with the measure. If we assess the loan disbursements carried out so far, it
could be said the measure has played its intended role as a catalyst in prompting financial
institutions to develop their own initiatives to strengthen the foundations for economic growth.
A wide range of financial institutions have been actively making a number of efforts targeting
their specific customer base or the region they serve, such as establishing new dedicated
funds that will support economic growth, so that the amount of lending and investment
greatly exceeds the amount of loans disbursed by the Bank. However, the effects of the
measure on equity investment and in terms of encouraging financial institutions to cultivate
new business models have been insufficient, and it has been pointed out that a side effect of
the measure is to intensify competition among financial institutions to lower lending rates.
Against this background, my view with regard to the future of this scheme was that it should
continue to firmly support as broadly as possible the efforts of private financial institutions to
build on their specific experience and expertise and devise their own ways to meet demand
in the areas and regions they serve. This view was shared by other members of the Policy
Board, and at the MPM held on June 13 and 14, 2011 the Bank decided that it would firmly
maintain its stance of supporting financial institutions' efforts to strengthen the foundations
for economic growth and take measures that would focus on boosting Japan's growth
potential even further. Specifically, the Bank decided to establish a new line of credit for
equity investments and asset-backed lending (ABL) aimed at encouraging smooth financing
of firms that lack sufficient collateral or equity investment, and/or who so far have received
very little financing from the existing fund-provisioning measure. In introducing this measure,
the Bank decided to set long loan periods to make them easier for financial institutions to
administer, and to lower the minimum amount per investment or loan to meet even small
requests and sow the seeds for growth in even the smallest "nooks and crannies."
B. The bank's responses after the earthquake
Since immediately after the earthquake disaster, the Bank has been taking a range of
measures in a timely manner, from three main perspectives: (1) maintaining the functioning
of financial and settlement systems; (2) ensuring the stability of financial markets; and
(3) supporting the economy. I would now like to discuss the Bank's response to the disaster.
1. Maintaining the functioning of financial and settlement systems and ensuring the
stability of financial markets
In terms of maintaining the functioning of the financial and settlement systems, the Bank has
been taking all possible measures to provide cash to the disaster areas and to operate
Japan's major payment and settlement systems as usual, including the Bank of Japan
Financial Network System, or BOJ-NET - the core settlement system for funds and
Japanese government securities. In addition, to respond to the increase in precautionary
demand for funds, the Bank provided ample funds to sufficiently meet market demand. More
specifically, on Monday, March 14, the first business day after the disaster, the Bank
provided a total of 21.8 trillion yen in funds, almost three times the largest daily funds
provision during the financial crisis after the failure of Lehman Brothers. Thereafter, the Bank
continued its ample provision of funds. As a result, the outstanding balance of financial
institutions' current accounts at the Bank marked a historical high of 42.6 trillion yen as of
March 24. Comparing this amount to the level before the earthquake of around 17 trillion yen
illustrates well the amount of funds provided by the Bank after the disaster. Due to these
measures taken by the Bank, financial markets remained stable following the earthquake.
2. Further enhancing monetary easing by increasing the amount of the Asset Purchase
Program
At the MPM held immediately after the earthquake, on March 14, 2011, the Bank decided to
take measures to further enhance monetary easing, with a view to preempting a deterioration
in business sentiment and an increase in risk aversion in financial markets from adversely
affecting economic activity. Specifically, the Bank decided to double the amount of asset
purchases - mainly of risk assets, such as CP, corporate bonds, and ETFs - through the
Bank's Asset Purchase Program from about 5 trillion yen to about 10 trillion yen. I also
shared the view that it was extremely important for the Bank to decide on drastic further
monetary easing to fully reassure market participants. I believe that the measure was
effective in reassuring market participants in that it prevented a deterioration in business
sentiment and an increase in risk aversion in financial markets: for example, issuance
spreads on CP, which had expanded immediately after the earthquake, declined to more or
less the same level as prior to the earthquake and issuing conditions for CP continue to be
favorable. I should note, however, that there are signs that since the earthquake small firms
have been facing some difficulties in obtaining funding, and I will pay close attention to this
issue when assessing the financial environment.
3. Supporting financial institutions in disaster areas
In addition to the measures mentioned thus far, the Bank decided to conduct long-term
funds-supplying operations to financially support initial response efforts by financial
institutions in the disaster areas even before demand for the purpose of rebuilding and
revival becomes full-fledged. Furthermore, with a view to securing sufficient financing
capacity of financial institutions in disaster areas, the Bank decided to broaden the range of
eligible collateral for money market operations.
I believe the Bank's bold measures, including the decision to quickly provide long-term funds
to financial institutions in disaster areas to support firms in distress - particularly small and
medium-sized firms - were timely and most appropriate. The damage caused by the recent
earthquake has been much larger than that of the Great Hanshin-Awaji Earthquake in 1995,
but the Bank has taken full advantage of the lessons learned at the time.
The first funds-supplying operation to support financial institutions in disaster areas took
place in May, and the second such operation took place on June 21. The amount disbursed
so far totals some 200 billion yen at a rate of 0.1 percent. In principle, the operations, whose
expected maximum amount is 1 trillion yen in total, will continue every month until October
this year.
These measures were put in place as an initial response to meet the demand for funds
expected to emerge for rebuilding and revival. The Bank will continue to study further
measures to help disaster areas recover, reconstruct, and move forward as quickly as
possible.