Mr Matsushita comments on recent monetary and economic conditions in
Japan Speech given by the Governor of the Bank of Japan, Mr Yasuo Matsushita, at the Keizai
Club in Tokio on 4/2/97.
I. Introduction
I truly appreciate this opportunity to address this distinguished audience at the
invitation of the Keizai Club.
Over the past several years, the Japanese economy has had to overcome the
aftereffects of the bursting of the economic "bubble" while facing the weighty challenge of
establishing an economic structure suitable for the new era. Although there were concerns about
a deflationary spiral at one time, the economy has been recovering moderately since the
beginning of 1996 partly due to strong monetary and fiscal support. Recently, this economic
recovery has gradually firmed, offering signs that progress has been made toward establishing
this suitable economic structure.
However, since the beginning of the year, stock prices have fallen significantly,
suggesting that market participants remain cautious about the economic outlook. With this in
mind, I would like to discuss the Bank of Japan's thinking on the recent economic developments
and monetary policy management, together with the Bank's views on the uncertain factors
regarding the economic outlook.
II. Domestic Economic Condition
With regard to the domestic economic condition, the Bank of Japan's judgment is
that a moderate economic recovery continues, and that the economic recovery is gradually
becoming firmer.
When considering the strength of an economic recovery, the Bank pays attention
to the positive interactions between production and private demand. Specifically, attention is
given to whether the increase in production is leading to an expansion of business fixed
investment through improved corporate profits, and whether this increased production is
followed by a recovery in personal consumption through increased income.
Looking back on the economic developments in Japan over the past year from a
viewpoint of determining the strength of the recovery, the growth of aggregate demand,
including public and housing investments, accelerated in the first half of 1996, and accordingly,
market expectations of an economic recovery strengthened and long- term interest rates showed
a temporary rise. However, no significant improvement was seen in production, as the increase
in final demand was partly offset by inventory adjustment and by an increase in imports. As a
result, a virtuous circle of demand, production, and income was not confirmed.
This situation, however, appears to have changed somewhat in the latter half of
1996. Firstly, the decline in external demand, which had been a constraining factor of the
economic recovery, halted in autumn 1996, mainly due to the increase in exports that followed a
depreciation of the yen. Recently, there has been an upward trend in external demand. In
addition, inventory adjustment in some raw materials and semiconductor industries was almost
completed. As a result, production, which had remained sluggish in the first half of 1996, started
to grow at an accelerating pace, reflecting fully the increase in final demand.
Notably, the firm recovery in production is now generating a recovery in private
demand, including business fixed investment and personal consumption. Reflecting
improvements in corporate sales and profits, the recovery in business fixed investment is
spreading to a wider range of industries and to smaller firms than previously observed. Indeed,
according to the results of the November 1996 "TANKAN -- Short-Term Economic Survey of
Enterprises in Japan," business fixed investment for the smaller firms, which had been slow to
improve, is expected to show a year-to-year increase in fiscal 1996 for the first time in five
years.
Growth of personal consumption, the other mainstay of private demand, leveled
off at one time in summer 1996, but resumed later in autumn, especially in consumer durables
such as automobiles. The contributing factor to the moderate but steady recovery in personal
consumption has been the improved income reflecting the favorable changes in employment
conditions and wages that followed the increase in production.
It must be borne in mind that the increase in demand ahead of the rise in the
consumption tax rate scheduled for fiscal 1997 is contributing to the improvement in economic
indicators, as in housing investment, and therefore these improvements need to be seen in this
light. There has, however, recently been a notable change in economic developments compared
to the first half of 1996. Despite a gradual decrease in public-sector investment from the latter
half of 1996, the virtuous circle -- in which increased production leads to increased private
demand through improved corporate profits and employment income -- has clearly begun to
operate.
III. Uncertain Factors Regarding the Economic Outlook
A. Views of Financial Market Participants
Turning from the Bank of Japan's views on the current domestic economy, the
issue of concern now is the future development of the economy. Revitalization of economic
activity usually brings about increases in corporate profits and employment income, which lead
to improvements in business fixed investment and personal consumption. These improvements
in turn lead to a further expansion in economic activity.
However, developments in financial markets, such as stock prices and long- term
interest rates, suggest that despite the increasing strength of the economic recovery, market
participants remain cautious about the economic outlook. Various causes are cited for the
significant fall in stock prices since the beginning of the year: renewed concern about the
nonperforming-loan problem; uncertainty over the social and economic systems in Japan as a
whole; and pressures to decrease the differential between domestic and international stock prices
in terms of various measures of evaluation, such as the price/earnings ratio. It is extremely
difficult to assess each factor and to specify the cause of the uncertainty. Still, the overall trend
in the financial markets over the past several months clearly indicates that market participants
have a cautious outlook on the economy, as shown by the slowdown in growth or even a decline
in stock prices since autumn 1996, and by the concurrent decline in long-term interest rates.
Cautiousness on the part of the market participants reflects the fact that they are
strongly aware of the following three issues: (1) effects of the anticipated fiscal tightening in the
next fiscal year; (2) structural adjustment pressures facing Japanese industry; and
(3) balance-sheet adjustment of firms and the nonperforming- loan problem of financial
institutions, both of which are burdens created by the economic "bubble" and its burst.
Before explaining the Bank of Japan's views on these issues, I would like to
emphasize that my talk today is not intended to draw specific conclusions or to assess the levels
of stock prices and interest rates. This requires careful analysis and is an issue on which a central
bank governor should refrain from comment. Rather, I would like to give you an idea of how the
Bank examines these issues.
B. Effects of Fiscal Tightening
The first issue that I would like to discuss is the influence of fiscal tightening
-such as reduction in public-sector investment, rise in the consumption tax rate, and termination
of special tax reduction -- on the economy for the next fiscal year.
Public-sector investment began to decline in autumn 1996, after having continued
to expand until mid-1996 as a result of the economic measures introduced in autumn 1995.
Although there may be a slight temporary increase in public-sector investment reflecting the
implementation of the supplementary budget for the current fiscal year, the declining trend is
expected to continue for some time. In addition, an increase in the consumption tax rate and the
termination of the special tax reduction is scheduled for fiscal 1997.
It is important to mention here that the influence of fiscal tightening on the
economy may vary significantly depending on the prevailing economic conditions, such as
corporate profits and employment income development, as well as on the confidence that the
corporate and household sectors have in the economy. Furthermore, this influence can differ
substantially depending on how the public's expectations of the future economy change in
response to reduced fiscal expenditures and tax increases, and how market interest rates respond
to any reduction in the budget deficit.
The effects on the economy of a reduction of public-sector investment or a budget
deficit have been debated by academics. The simplest Keynesian view is that reduced
public-sector investment cumulatively acts to restrain private demand through multiplier effects.
Some argue that a decrease in the budget deficit will lower interest rates and the yen's foreign
exchange value, thus offsetting the negative effects on the economy. Some even hold that
because the public behave rationally with anticipation of future tax increases or reductions,
neither a decrease nor an increase in the budget deficit will have any effect on the economy.
The influence of a reduced budget deficit on the economy may thus be complex
and diverse, once the movement of market interest rates, foreign exchange rates, and the public's
expectations are taken into account. It is natural to assume that in reality, the impact of reduced
fiscal expenditures on the economy cannot be denied, although the influence is unlikely to reach
the extent estimated by simply multiplying the nominal value of the reduction by a multiplier.
To underline the argument I just made, the economic mechanism does not work
on the basis of simple addition and subtraction, but rather involves dynamic interactions of many
factors which incorporates the public's expectations. After all, the effects of fiscal tightening are
an empirical issue for which conclusions cannot be reached in advance, and therefore, it is very
difficult to accurately predict future developments at this stage. Bearing this in mind, it is
necessary to view carefully the effects of fiscal tightening on the economy as a whole.
C. Progress in the Structural Adjustment of Industries
Let me now turn to the next issue of the structural adjustment of industries, which
is a medium- to long-term issue for the Japanese economy.
One of the changes in the environment surrounding the Japanese economy in the
past several years has been that a wider range of industries have come to face severe
international competition due to the increasing supply capacity of other East Asian countries.
The weakening of international competitiveness made it difficult for some industries and firms
to continue domestic production of some of their conventional products. This forced them to
relocate their production bases overseas while shifting their domestic production to new products
for which they have a comparative advantage.
This is not the first time that the Japanese economy has faced structural
adjustment pressures. In fact, it successfully confronted the challenge several times in the past.
However, the adjustment this time has inevitably involved greater pains than in the past, due to
the after-effects of the bursting of the economic "bubble."
Furthermore, as relocation overseas took place prior to a shift to new products,
structural adjustment significantly constrained domestic production and, as a result, investment
and employment were also limited. The negative impact was particularly substantial for the
smaller firms, as many of them manufactured labor-intensive products and were subcontractors
to the large firms which relocated their production bases overseas.
The key factors we should keep in mind in projecting future developments in the
Japanese economy are therefore the progress in the structural adjustment of industries, that is,
the emergence of new products or industries that will promote future economic growth.
A careful look at individual industries reveals some positive signs. In production,
for example, an increasing number of firms and industries are shifting to goods with
international competitiveness. More specifically, the production of producer goods and capital
goods that are capital-intensive and technology-intensive has been increasing while the
production of labor-intensive consumer goods has been declining. These changes are also
reflected in imports and exports of goods. Recently, exports of consumer goods, mainly
household electric appliances such as television sets and radios, have been decreasing while their
imports have been increasing, and exports of capital goods and parts such as electronic
machinery and automobile parts have been increasing significantly.
Notable as these changes may be, one cannot simply add up these microeconomic
developments to obtain a comprehensive evaluation of how successfully the Japanese economy
as a whole is undergoing the structural adjustment of industries. Rather, the progress in
structural adjustment should be reflected most evidently in the revitalization of forward-looking
business activity. If this were the case, the stance taken by firms toward fixed investment and
employment should provide a measure of the progress in macroeconomic structural adjustment.
In this respect, business fixed investment by large firms began to recover in fiscal
1995 well ahead of small and medium-sized firms. Investment by smaller firms, which had been
more susceptible to structural adjustment pressures, has also finally begun to show a recovery.
Although the recovery is extremely moderate, this resumption of investment by smaller firms, an
activity that lays the foundation for the future, may be considered as evidence of progress in
structural adjustment as it indicates that these firms are starting to have a clear idea about the
new direction of their business.
Progress is also reflected in the business fixed investment of various industries.
Namely, investment has been increasing in capital- and production-goods related sectors, where
high growth in production has been recorded. There has also been a rapid expansion of
investment in a new industry of mobile telecommunications. Business fixed investment for
development of new products and new businesses also seems to be increasing gradually.
With regard to employment, structural adjustment pressures are persistent in some
indicators such as the high unemployment rate. However, based on the most recent changes in
employment indicators and the microeconomic information on firms, labor market conditions
are seen to be improving gradually, indicating steady progress in industrial restructuring.
For example, recent numbers of new job offers are significantly higher than those
in the previous year. Business surveys indicate that an increasing number of firms plan, for the
first time in many years, to increase the number of new graduates hired in the next fiscal year.
Results of the November TANKAN also indicate that more than half of the smaller firms
surveyed feel that they are shorthanded. Furthermore, labor market conditions in each sector
indicate that employment has decreased significantly in sectors where imports have been making
inroads -- such as the electrical machinery and textiles industries -- while employment has
increased in new sectors such as telecommunications. These changes indicate a gradual shift of
labor between sectors.
In sum, although pressures for the structural adjustment of industries remain, it
can be said that structural adjustment has progressed significantly as reflected in the recent
recovery in business fixed investment and employment.
D. Balance-Sheet Adjustment
The third issue to be discussed is that of balance-sheet adjustment. There are two
aspects to this issue: the improvement of the financial condition of firms and the disposal of
nonperforming loans of financial institutions.
With regard to the balance-sheet adjustment of Japanese firms, there have been
serious efforts by firms to reduce their liabilities since the bursting of the economic "bubble."
Despite these efforts, the mismatch between assets and liabilities expanded in many sectors until
1994 or 1995 due to the continued decline in real estate prices. While the decline in asset prices
has slowed since 1995, liabilities have decreased owing to the recovery in corporate profits
which followed firms' restructuring efforts and lower interest rates.
Several indicators, such as the ratio of long-term debts to assets at market value,
reveal that balance-sheet adjustment pressures are persistent. In particular, small and
medium-sized firms still need to make substantial efforts to complete their adjustment. As I have
just mentioned, however, the improvement of firms' balance sheets has doubtlessly been making
moderate but steady progress in general, and thus, constraints imposed by the adjustment
pressures on economic recovery should continue to be gradually alleviated.
Regarding the nonperforming-loan problem of financial institutions, the total
amount of nonperforming loans of the financial institutions was approximately 29 trillion yen as
of the end of September 1996, according to the data published by the Ministry of Finance. Of
this total, the estimated amount of problem loans to be disposed of, not including those already
covered by collateral and provisions, is estimated at approximately 7 trillion yen. Both of these
figures have decreased by approximately 10 trillion yen from the previous year, and thus, in
general, it can be said that steady progress has been made in solving this particular problem.
The amount of nonperforming loans that need to be disposed of, however,
remains large. The Bank of Japan will continue to strongly encourage financial institutions to
dispose of the remaining nonperforming loans expeditiously and to exert themselves to the
utmost to (1) restore their capital bases which have been impaired in the process of disposing of
nonperforming loans; (2) strengthen their profitability through restructuring; and (3) enhance
their internal risk management.
In relation to the economy, an issue of concern is whether the decline in the
intermediary functions of those financial institutions burdened with nonperforming loans is
constraining economic recovery. While it may certainly be true that financial institutions have
imposed stricter screening criteria for lending following the experiences of the economic
"bubble" period, most financial institutions now maintain a policy of actively increasing loans of
reliable quality while, or rather for the purpose of, disposing of nonperforming loans. In fact, the
lending attitude of financial institutions, as seen from the point of view of the firms, has become
less severe and lending rates have stayed at a historically low level. It is, therefore, difficult to
assume that the severer lending attitude of the financial institutions is hampering the recovery in
business fixed investment.
IV. Economic Outlook and Monetary Policy Management
A. Economic Outlook
I have so far discussed such issues as the effects of fiscal tightening and the
current situation of structural adjustment, both considered to be the major factors contributing to
the cautious economic outlook in financial markets. Among these, developments of structural
adjustment may be summarized as follows: (1) both the structural adjustment of industries and
balance-sheet adjustment are still in progress and therefore the pace of economic recovery is
likely to remain moderate for some time; (2) however, as industrial restructuring and
balancesheet adjustment are making steady progress, albeit moderate, its constraining effects on
economic recovery are likely to gradually ease.
Therefore, the most important issue in considering the economic outlook is
whether the increase in private demand can overcome the downward pressures from fiscal
tightening and whether it is possible, as a result, to lead the economy on to a path of
selfsustained recovery.
As I mentioned earlier, economic recovery has been recently gaining strength. If
this recovery is analyzed in terms of the level of economic activity, namely the output gap, it can
be noted that capacity utilization has been rising steadily reflecting the recent recovery in
production, and has recovered to the same level as that of four years ago. Furthermore, the
results of the November TANKAN indicated that the excessive production capacity and
employment perceived by surveyed firms have gradually fallen to the same level as in 1987, at
which time the economy was recovering from the recession caused by the appreciation of the
yen. While the profit-to-sales ratio of smaller firms has not yet recovered to the average level of
the past, the ratio of large firms has already reached a relatively high level. Judging overall, it
can be said that the current level of economic activity in Japan is approaching the same point
where the strength of the recovery began to firm in past business cycles.
This level of economic activity will provide a basis for the virtuous circle of the
economy, one that is led by expanded private demand, to gain further strength. In other words, if
the recent economic recovery continues for some time, increased production will further
improve corporate profits and employment income, which in turn are likely to lead to increases
in business fixed investment and personal consumption. If this virtuous circle gains stronger
momentum, there will be a higher possibility of the strengthened virtuous circle absorbing the
downward pressures from prospective fiscal tightening.
A temporary slowdown in economic recovery seems inevitable as downward
pressures from fiscal tightening will be strong during the first half of fiscal 1997 and as a
reaction to the increase in demand ahead of the rise in the consumption tax rate scheduled for
April 1997 is expected. However, the recovery trend of the economy is likely to be sustained on
account of the strengthening recovery in private demand.
I indicated earlier, however, that it is necessary to consider the effects of fiscal
tightening carefully. Business sentiment and consumer confidence are also becoming important
factors for a further increase in private demand. The corporate and household sectors will plan
their activities and put them into action in the form of production, investment, and consumption,
taking into account the fiscal 1997 budget and the actual placement of public work orders.
Therefore, in predicting future economic developments, it is important to closely examine
various macro- and micro-economic data and not only the economic indicators that will be
released in the future, but also firms' business plans and signals sent by financial markets.
Meanwhile, it is expected that prices will cease to decline due firstly to the rise in
import prices reflecting the yen's depreciation and higher crude oil prices, and secondly to the
improvement in domestic supply and demand conditions. However, when considering the fact
that the improvement in supply and demand conditions is expected to be moderate for now and
that the pressures of global competition will persist, there is only a limited possibility that
domestic prices will follow a clear upward trend. Yet, as foreign exchange rates have recently
shown rather rapid movements, it is necessary to cautiously monitor the effects of such a
development on the domestic economy.
While refraining from making any comments on the recent foreign exchange rate
levels and movements, the Bank's fundamental thinking is that it is desirable for exchange rates
to be stable and determined in accordance with the real economic conditions of each country.
Based on this thinking, the Bank of Japan will continue to carefully monitor foreign exchange
rate developments and their effects on the Japanese economy.
B. Monetary Policy Management
In the management of current monetary policy, the Bank of Japan will continue to
monitor economic developments closely, placing emphasis on further strengthening the
foundation of an economic recovery.
In April 1997, the consumption tax rate will be raised from 3 percent to 5 percent.
Therefore, I would also like to discuss how the Bank of Japan views the possible effects of this
tax rate rise on prices, in the context of managing monetary policy. Specifically, the issue here is
what monetary policy measures should be taken in light of the price hikes due to the rise in the
tax rate.
I would first like to point out that the price hikes caused by the rise in the
consumption tax rate is different in nature from the ordinary rise in prices, that is inflation.
Generally, inflation is generated in the mechanism of economic cycles as a result of, for
example, tightening of supply and demand conditions for labor or products, or excessive supply
of money. In turn, inflation affects economic activity in various ways.
In contrast, price hikes due to a rise in the consumption tax rate are equivalent to
a once only rewriting of all the old price tags on April 1. There are no relevant changes in
economic activity, such as a tightening of supply and demand conditions, an increase in wages,
or excessive money supply. Therefore, it would not be appropriate to formulate monetary policy
against such superficial changes in prices.
Although this represents the fundamental thinking of the Bank, it does not mean
that the central bank is indifferent to the rise in the consumption tax rate. If the rise triggers price
hikes taking advantage of the tax rate rise, or if overall inflationary expectations are heightened,
then the risk of a genuine inflation will arise. In particular, this risk cannot be disregarded when
the supply and demand conditions for products are fairly tight. Therefore, it is necessary to pay
attention to the inflationary expectations and possible over-reactions caused by the rise in the
consumption tax rate rather than paying attention to the previously-mentioned superficial hikes
in prices.
In summary, in order to promote a smooth structural adjustment, to bring about a
strengthening of the economic recovery, and to encourage the renewed development of the
Japanese economy, the implementation of a drastic structural reform, including effective
deregulation, is indispensable. In this respect, I hope that the government will continue to
exercise strong leadership and earnest efforts will continue to be made by various parties.
V. Financial System Reform and Revision of the Bank of Japan Law
A. Financial System Reform
I would like to use the remaining time to discuss financial system reform and the
revision of the Bank of Japan Law.
The important challenge for Japan today is to vigorously promote structural
reform as discussed above, and this also applies to the reform of the financial markets and of the
financial system.
Financial markets worldwide have experienced significant changes in recent years
amid rapid financial and economic globalization and technological innovation. New financial
instruments such as derivatives and securitized products have been developed in succession to
provide firms and households with diverse means of risk-hedging, investment, and financing. At
the same time, profit opportunities for financial institutions have expanded in various fields.
It seems that it is now time for the market participants to select the market, rather
than the markets selecting the participants. Countries are vying with each other to reform their
financial markets, based on a growing worldwide perception that the financial services sector
will show rapid growth and create numerous employment opportunities into the twenty-first
century. Each country is thus striving to make their own markets attractive to participants.
Japan, too, has engaged in the review of regulations and systems to promote
financial deregulation. However, reform has been gradual and financial institutions have tended
to deal with it cautiously due to the severe challenge they have had to face after the bursting of
the economic "bubble." As a result, the Tokyo market has fallen far behind the New York and
London markets in terms of its ability to develop financial instruments that incorporate new
techniques.
In recognition of this, Prime Minister Hashimoto proposed the "Big Bang"
deregulation package for Japan. I understand that the purpose of this financial reform package is
to revitalize the Tokyo market as a free and active global market. The Bank believes that the
aims of this reform package are most appropriate and as a central bank, intends to contribute to
the achievement of its goals.
In carrying out the reform, it is especially important that the three basic principles
of freedom, fairness, and globalization are strictly followed, and that the pace of the reform is
not relaxed. The "Big Bang" package aims to realize and complete all reforms by the year 2001,
immediately implementing any measures on which study has been concluded. However, this
should not mean that the process of market reform become unduly gradual or slow, as this may
jeopardize the consistency of the reform, or result in only an easier part of the reform being
implemented.
For example, one deregulation measure included in the "Big Bang" package and
highly valued by the Bank is the fundamental revision of the Foreign Exchange Control Law. If
deregulation in other areas proceeds too slowly, the effects of the new Foreign Exchange
Control Law might encourage financial transactions to shift to overseas markets and might then
lead to the hollowing-out of the Tokyo market. In order to avoid such a turn of events, it is most
important to bring about concrete measures within the shortest possible time to maintain the
coherence of the deregulation as a whole.
B. Revision of the Bank of Japan Law
Lastly, I would like to discuss the revision of the Bank of Japan Law.
The revision of the Bank of Japan Law is now in the final stage of deliberation by
the Financial System Research Council, an advisory committee to the Minister of Finance,
following discussions last year by the Central Bank Study Group, an advisory panel to the Prime
Minister.
The Bank has made public its views on the Bank of Japan Law revision at a press
conference held at the end of 1996 and on other occasions. To summarize, (1) the Bank holds
that the basic views stated by the Central Bank Study Group -- that is, ensuring central bank
independence and enhancing transparency -- should be clearly stated in the law; and (2) the
Bank believes that further deliberations should be conducted on several issues regarding the
relationship between the government and the central bank, on which the Central Bank Study
Group was unable to reach conclusions, so as to duly reflect the two concepts of independence
and transparency.
Fortunately, the Bank's views appear to be adequately shared by the members of
the Financial System Research Council. I would therefore like to discuss today the significance
of the revision of the Bank of Japan Law to the Japanese economy as a whole.
First, this revision of the central bank system is a response to the global trend of
changes, including financial and economic globalization and marketization, which have been
driven by progress in financial innovation.
On various occasions in the past, I have discussed how in the new financial
environment, markets around the world respond instantaneously to various information and they
also respond to changes in the expectations of market participants as the participants process
such information. The "Big Bang" package is likely to promote this tendency through increased
efficiency and globalization of the markets. Under such circumstances, if the role and
responsibility of the central bank in charge of monetary policy management are not made clear,
or if both domestic and overseas understanding of the central bank's monetary policy
management is insufficient, a country's monetary policy intentions may not permeate
sufficiently throughout the market. In addition, irrelevant information may disrupt the markets.
The idea of entrusting the responsibility of ensuring price stability with the central
bank, an establishment detached from short-term interests, is a wisdom acquired from the history
of battles against inflation. The recent strengthening of central bank independence and the
growing demand for transparency of monetary policy management around the world reflect the
stronger emphasis on the status and responsibility of central banks to meet the new challenges
present