Kikuo Iwata: Japan's economy and monetary policy
Speech by Mr Kikuo Iwata, Deputy Governor of the Bank of Japan, at a meeting with
business leaders, Sapporo, 27 May 2015.
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Accompanying charts can be found at the end of the speech.
Introduction
It is my pleasure to have the opportunity today to exchange views with administrative,
financial, and business leaders in this region. I would like to take this chance to express my
sincerest gratitude for your cooperation with the activities of the Bank of Japan, particularly of
the Sapporo Branch and the local office in Asahikawa.
Today, I would like to have your views on the actual situation of the local economy as well as
your candid opinions about the Bank's policies and activities.
Before exchanging views with you, I will briefly explain the recent economic developments at
home and abroad, and then touch on some points regarding the conduct of monetary policy.
I. The current situation of and outlook for Japan's economy
Japan's economy has continued to recover moderately in a situation where a virtuous cycle
from income to spending has been operating in both the corporate and household sectors. In
the following, I would like to elaborate on the background to this assessment and on the
outlook for Japan's economy in terms of the corporate sector - including exports and
production - and then in terms of the household sector - such as the employment and
income situation and private consumption.
A. Corporate sector
Exports have been picking up recently owing to the recovery in overseas economies and
support from the effects of the depreciation of the yen (Chart 1). In particular, exports to the
United States have continued to see a marked increase since capital goods and parts have
increased, reflecting the recovery in business fixed investment in the United States, and
since motor vehicles and their related goods have picked up.
The global economy, which is the key to projecting the outlook for exports, is expected to
moderately increase its growth rate as advanced economies continue to see firm recovery
and its positive effects gradually spread to emerging economies. According to the April 2015
World Economic Outlook (WEO) released by the International Monetary Fund (IMF) last
month, global economic growth is projected to accelerate moderately on the whole: after
registering 3.4 percent in 2014, it is projected to be 3.5 percent in 2015 and 3.8 percent in
2016 (Chart 2).
Looking specifically at the developments by region, in the United States, which is expected to
be the driving force of global growth, the real GDP growth rate for the January-March quarter
has decelerated considerably, due in part to effects of adverse weather conditions.
Nevertheless, the economy continued its robust recovery trend supported by household
spending - as seen in private consumption rebounding from a fall in winter - against the
background of the favorable employment and income situation in particular. The U.S.
economy is expected to continue to see growth led mainly by private demand, starting from
firm household spending. In addition, the European economy, in which the momentum for
recovery had been weak, has recently been seeing a clear increase in private consumption,
reflecting the effects of the decline in crude oil prices and of a rise in stock prices. It also has
been seeing a pick-up in business sentiment and production activity resulting from an
improvement in exports and corporate results due to the depreciation of the euro. Going
forward, the European economy is expected to continue to see moderate recovery with the
permeation of the effects of depreciation of the euro and those of the monetary easing
measures by the European Central Bank (ECB). Meanwhile, turning to emerging economies,
the growth momentum of the Chinese economy has been sluggish against the backdrop of
the deceleration in fixed asset investment and continued inventory adjustments.
Nevertheless, it is likely to follow a generally stable growth path as there are likely to be
effects of the authorities' policy measures to support economic activity, although the pace of
growth is expected to be somewhat reduced. Other emerging economies and
commodityexporting economies have continued to lack momentum on the whole, but are expected to
gradually increase their growth rates, mainly as the recovery in advanced economies
spreads to them.
In sum, the global economy - mainly advanced economies - is expected to continue
recovering moderately, and against this backdrop, Japan's exports are expected to increase
moderately. Of course, various uncertainties - including the pace of growth in the U.S.
economy, the prospects regarding the European debt problem, including developments in
Greece, developments in the emerging and commodity-exporting economies, and
geopolitical risks - continue to call for close attention.
In a situation where exports have been picking up and, as I will explain later, private
consumption has been resilient, production has been picking up. Corporate profits have
increased to historical highs and business sentiment has generally stayed at a favorable
level (Chart 3). Under these circumstances, with regard to firms' business plans for fiscal
2015, shown in the March Tankan (Short-Term Economic Survey of Enterprises in Japan),
corporate profits as a whole are projected to continue improving and a positive stance on
business fixed investment has been maintained for this time of year. In this way, a virtuous
cycle in the corporate sector - in which business fixed investment will continue its moderate
increasing trend amid a continued improvement in corporate profits - is expected to operate
going forward.
B. Household sector
Next, turning to the household sector, positive developments in the corporate sector have led
to a tightening in labor market conditions and to an improvement in the employment and
income situation in accordance with that tightening. The unemployment rate has declined to
around 3.5 percent, and judging from firms' view on employment, the labor shortage is
growing further (Chart 4). Reflecting this tightening in labor market conditions, nominal
wages have increased moderately, albeit with fluctuations. In this way, since nominal wages
have been rising and the number of employees has been increasing, employee income has
been increasing moderately.
An improving trend in private consumption is becoming evident gradually amid steady
improvement in the employment and income situation, although some areas had been
sluggish. Such firmness in private consumption was also confirmed by the GDP statistics
released last week, which showed that private consumption has increased for three
consecutive quarters. In addition, a pick-up in consumer sentiment is becoming evident. As
for the outlook, the employment and income situation is likely to continue to see steady
improvement as many firms will increase wages, including base pay, which will be raised to a
larger extent than last year in the annual labor-management wage negotiations in spring
2015; in this situation, private consumption is expected to remain resilient.
As I have explained, a virtuous cycle from income to spending is likely to continue operating
in both the corporate and household sectors, since domestic demand is likely to be resilient
and exports are expected to increase moderately. Against this backdrop, Japan's economy is
likely to continue growing at a pace above its potential from fiscal 2015 through fiscal 2016.
Thereafter, through fiscal 2017, the economy is projected to maintain its positive growth,
although with a slowing in its pace to around a level somewhat below the potential growth
rate. The slowdown is due mainly to (1) the effects of a front-loaded increase and
subsequent decline in demand prior to and after the consumption tax hike planned in April
2017 and (2) cyclical deceleration. In the Bank's April 2015 Outlook for Economic Activity
and Prices (hereafter the Outlook Report), the Policy Board members' forecasts of the real
GDP growth rate were around 2 percent for fiscal 2015, around 1.5 percent for fiscal 2016,
and in the range of 0.0-0.5 percent for fiscal 2017 (Chart 5).
II. Conduct of monetary policy and price developments in Japan
Next, I would like to touch on the conduct of monetary policy and price developments in
Japan.
A. Change in policy regime
The Bank is pursuing policy measures that aim at converting people's deflationary mindset,
which has been formed firmly amid the prolonged period of deflation, to one that expects
moderate inflation. That is, preparing a platform on which people can act on the assumption
that prices continue to rise moderately.
To begin with, in January 2013, the Bank set the price stability target of 2 percent in terms of
the year-on-year rate of change in the CPI; in other words, the introduction of "inflation
targeting."
With a view to achieving this price stability target, the Bank has been implementing an
aggressive monetary easing measure called quantitative and qualitative monetary easing
(QQE) since April 2013, and expanded the measure in October 2014 (Chart 6).
By implementing such bold policy measures, the Bank has intended to clearly indicate to the
public that the basic thinking behind its monetary policy - that is, the policy regime - has
changed, and also to encourage them to change their behavior in view of such change. In
other words, this is the Bank's declaration that "the rules of the game have been changed."
B. Commitment to achieving the price stability target at the earliest possible time
Before the introduction of QQE, the Bank had pursued various monetary easing measures
that were considered unconventional, such as the introduction of the zero interest rate policy
and quantitative easing, and this made the Bank a forerunner in monetary policy history.
Although each of the measures on their own could have been a quite powerful policy tool, it
turned out that they were not effective enough to overcome deflation.
While a variety of analyses attempted to explain why the Bank was not successful in
overcoming deflation, a major reason, in my view, was that the Bank's faith that "deflation
can be overcome through monetary policy" was not strong enough, and that its commitment
to achieving this aim was insufficient; in other words, the policy regime was not changed
considerably. Thus, the mindset of private economic entities such as households, firms, and
financial institutions was not converted.
Based on this bitter experience, when QQE was introduced in April 2013, the Bank entered a
new phase of monetary easing by adopting a large-scale measure and made clear the time
frame for achieving the target - namely, that it will achieve the price stability target of
2 percent at the earliest possible time, with a time horizon of about two years. The Bank
showed its commitment to achieving the price stability target at the earliest possible time in a
stronger manner than ever, by stating that it was putting forth a specific time horizon of about
two years, rather than simply adopting a stance of achieving it at the earliest possible time.
As I will discuss later, the Bank currently expects that the CPI inflation rate is likely to reach
around 2 percent around the first half of fiscal 2016. This timing is somewhat delayed from
the previous projection. However, the underlying trend in inflation itself has been rising
steadily with the mechanism of QQE working as envisaged, and at this moment the Bank has
no intention of changing its commitment to achieving the price stability target at the earliest
possible time.
C. Why has the CPI inflation not reached 2 percent yet?
Looking at developments in the year-on-year rate of change in the CPI (all items less fresh
food), or the core inflation rate in Japan, it had hit a bottom of minus 0.5 percent immediately
before the introduction of QQE, and thereafter, excluding the direct effects of the
consumption tax hike, followed a steady rising trend until it reached 1.5 percent in April 2014.
This means that QQE had pushed up the core inflation rate by 2.0 percentage points in about
one year. During this period, the effects of QQE were clearly confirmed on the price front.
Nevertheless, the price stability target of 2 percent has not been achieved yet. The core
inflation rate peaked in April 2014, and then followed a gradual declining trend. It has
recently been about 0 percent (Chart 7). In my view, there are two major factors behind the
decline in the inflation rate.
1. Consumption tax hike
The first factor is negative effects on demand of the consumption tax hike in April 2014.
Although the decline in demand following the front-loaded increase prior to the consumption
tax hike had been expected, the degree of the decline had not been projected to be as large
as the decline associated with the April 1997 hike, when the consumption tax rate rose from
3 percent to 5 percent.
However, the actual negative effects exceeded most of the projections, and were protracted.
There are various reasons for this, but here I would like to point out an increase in
lowincome households due to the protracted sluggish employment situation as well as an
increase in the number of pensioners reflecting the aging of the population as part of the
background.
That being said, as I have explained, with the steady improvement in the employment and
income situation and in corporate profits continuing, a virtuous cycle from income to
spending has been operating firmly in both corporate and household sectors. Against this
backdrop, the downward pressure on demand exerted by the consumption tax hike has been
dissipating.
2. Decline in crude oil prices
The other factor behind the recent decline in inflation rates is a rapid and substantial fall in
crude oil prices that has occurred since last summer.
It should be noted that the effects of falling crude oil prices may be assessed differently
depending on the time horizon that you have in mind. To be more specific, the decline in
crude oil prices will result in lower costs for various economic activities, and thereby exert
wide-ranging positive effects on the real economy. From a longer-term perspective, it will
push up prices as the aggregate demand increases. However, from a short-term perspective,
until effects of an increase in the aggregate demand are manifested on the price front, the
direct effects of falling energy prices exceed those of an increase in demand. Thus, there is
temporary downward pressure on prices.
The short-term effects of the decline in crude oil prices are expected to dissipate gradually
from the second half of fiscal 2015, assuming that crude oil prices will rise moderately from
around the recent level, though the timing of this depends on developments in crude oil
prices.
D. Underlying trend in inflation
The year-on-year rate of increase in the CPI is projected to be about 0 percent for the time
being, with negative contributions of energy-related items offsetting positive contributions of
other items.
However, as I have explained, the underlying trend in inflation is likely to rise steadily, and
the inflation rate is projected to accelerate toward the target level of 2 percent as the effects
of the decline in crude oil prices dissipate.
In assessing the underlying trend in inflation, it is necessary to take into account factors such
as the following: (1) the output gap that is the difference between the aggregate demand and
the supply capacity of the economy as a whole; (2) medium- to long-term inflation
expectations; and (3) the extent to which a future increase in prices will be taken into account
in wage and price settings.
To begin with, let me discuss the first factor, the output gap. Private consumption is expected
to remain resilient with the improvement in the income situation against the background of
tightening in labor market conditions, together with manifestation of positive effects of the
decline in energy prices on real income. Business fixed investment is projected to continue a
moderate increasing trend as corporate profits improve. Exports, which have been picking up
recently, are expected to increase moderately against the background of the recovery in
overseas economies and of underpinning effects of the depreciation of the yen. As such, the
improving trend in the output gap will continue with the aggregate demand in the economy as
a whole expanding, and upward pressure on prices is expected to increase gradually.
Let me turn to the second factor, inflation expectations. Judging from indicators that are
observable in the market and analyses of various survey results, medium- to long-term
inflation expectations appear to be rising on the whole, despite the recent decline in the
inflation rate. Going forward, the observed inflation rate is likely to accelerate. That will bring
about a rise in inflation expectations, and such expectations are expected to remain firm.
Moreover, as I have mentioned earlier, as a result of the annual labor-management wage
negotiations in spring 2015, many firms will increase wages, including base pay, which will
be raised to a larger extent than last year. The business model of firms seems to be in a
process of transformation from one of the deflationary type - that is, one in which firms adopt
a lower price-setting strategy through cutting expenses mainly in labor costs - to one of the
innovative type - that is, one in which firms do not resort to lower prices but devote their
efforts to developing new products and services that can enhance customer satisfaction. In
this situation, some firms have been shifting their price-setting strategy to one of raising sales
prices while increasing value-added.
In this way, the mechanism of inflation accelerating moderately accompanied by wage
increases has continued to operate, and the underlying trend in inflation has steadily
improved. In the April 2015 Outlook Report, the Policy Board members' forecasts of the
yearon-year rate of increase in the CPI (all items less fresh food) were 0.8 percent for fiscal 2015,
2.0 percent for fiscal 2016, and 1.9 percent for fiscal 2017 (Chart 5). Although the timing of
reaching around 2 percent depends on developments in crude oil prices, it is projected to be
around the first half of fiscal 2016, assuming that crude oil prices will rise moderately from
the recent level. Thereafter, the year-on-year rate of increase in the CPI is likely to be around
2 percent on average.
Concluding remarks
In conclusion, let me touch on the economy of Hokkaido Prefecture.
The economy has been recovering moderately, although some weakness has been
observed in some aspects, such as the public construction sector, which largely affects small
firms. Turning to final demand, there are somewhat weak developments in terms of the
decline in public investment, but a marked increase in the number of foreign visitors to Japan
has been underpinning demand. Moreover, over the period of more than a year since the
consumption tax hike, even durable consumer goods and housing investment have started to
level off. Meanwhile, as seen in the steady improvement in the employment and income
situation, a virtuous cycle from income to spending has been operating in the region in the
same way as in Japan as a whole.
In Hokkaido Prefecture, there are plenty of topics associated with encouraging tourism. For
example, Yoichi city became the setting for Massan, a morning drama serial by Japan
Broadcasting Corporation (Nippon Hoso Kyokai, NHK). In addition, the Hokkaido shinkansen
will commence its operation by March 2016, and it is scheduled to be extended to Sapporo
city. These topics show that Hokkaido Prefecture will receive further attention going forward.
Moreover, Sapporo city has announced its intention to bid for the 2026 Winter Olympics, and
this will increase the opportunity for Hokkaido Prefecture to display to the world its appeal.
Other than tourism, Hokkaido Prefecture has strength in the food industry on the back of its
abundant agricultural and fishery resources. I have heard that Hokkaido Prefecture now
faces problems such as lower production of raw milk resulting from increasing abandonment
of farming as well as slack in unloading in the fishing industry, but I expect that production of
higher value-added goods will be promoted through efforts such as Healthy-Do, which is the
certification system of functional food that the Hokkaido government is making efforts to
popularize.
Other initiatives include promoting Hokkaido Prefecture as a back-up base for the
metropolitan area and Honshu - the main island of Japan - since Hokkaido Prefecture faces
less natural disasters. This initiative has actually led to attracting firms to Hokkaido
Prefecture, and I have heard that even some export-related manufacturers, such as those in
transportation equipment, in which Hokkaido Prefecture had been facing a disadvantage,
have been lured. I believe this will largely contribute to reinforcing Hokkaido Prefecture's
industrial infrastructure.
As common issues across the country, the population decline as well as declining birth rate
and an aging population have been pointed out, and in this region these issues have
progressed faster than in Japan as a whole. Therefore, I expect that, with cooperation among
industry, academia, the government, and finance, the region will overcome this problem by
promoting vitalization of the local economy ahead of other regions in Japan and developing
business models that would apply for Japan as a whole. The Bank's Sapporo Branch will
conduct analyses of the regional economy so as to contribute to such efforts as much as
possible.
In closing, I wish all the best for the further development of the regional economy.
Thank you.
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