Hirohide Yamaguchi: Recent financial and economic developments and
challenge of revitalizing Japan's economy
Speech by Mr Hirohide Yamaguchi, Deputy Governor of the Bank of Japan, at the JCIF (Japan
Center for International Finance) International Finance Seminar, Tokyo, 22 November 2011.
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Introduction
Thank you for having me at the JCIF International Finance Seminar. Today, I will talk about
the financial and economic developments at home and abroad, followed by my thoughts,
from a medium- to long-term perspective, against the background of a declining trend in the
growth potential of Japan's economy and challenges toward the future.
I. Developments in the global economy
Current situation and future of the global economy
Let me start with the developments in the global economy. Looking back, the global economy
continued to mark a high growth rate in the recovery process from the Lehman shock, led by
emerging and commodity-exporting economies. The pace of growth has been slowing,
mainly in advanced economies, since this spring.
In the United States, which was the epicenter of the Lehman shock, balance sheet
adjustment, mainly in households, has been weighing on the economy, and the pace of
recovery remains quite moderate. In Europe, the economies were recovering moderately
after the Lehman shock, but their growth rates have recently been clearly decelerating as the
sovereign debt problem, which started from peripheral countries including Greece, have
aggravated.
The pace of growth in emerging and commodity-exporting economies, which have been
achieving high growth, is somewhat slowing. That is because real purchasing power has
declined due to a rise in energy and food prices, and monetary tightening, which was
implemented to contain the overheating of the economies, have shown effects. In addition,
there are the effects of the slowdown in advanced economies. While the slowdown in the
pace of growth itself in emerging and commodity-exporting economies, which have been
somewhat overheating, is desirable in achieving sustainable growth with price stability,
inflationary pressure in those economies is yet to be contained.
For the time being, the pace of growth in the global economy will remain decelerated, mainly
in the advanced economies, amid lingering strains in international financial and capital
markets. Thereafter, the growth rate of the global economy will rise again led by emerging
and commodity-exporting economies, which have high growth potential. Such outlook is
associated with great uncertainties. In particular, the consequences of the sovereign debt
problem in Europe remain unforeseen.
So I will now talk about the sovereign debt problem in Europe.
European sovereign debt problem and accumulation of financial and economic
imbalance
The origin of the sovereign debt problem was Greece's massive fiscal deficits that surfaced
toward the end of 2009. In the spring of 2010, Greece faced difficulty in raising funds in the
market and was driven into a corner which was said to be a Greek crisis. As a result, Greece
received financial support by euro area countries and the International Monetary Fund. The
Greek government subsequently announced various fiscal structural reforms including a
reduction in public servants' salaries and revisions in the tax system. However, amid
negative economic growth, a fiscal deficit reduction was not achieved in a pace initially
envisaged, and Greece faced a second round of crisis toward this summer.
In the meantime, a decline in market confidence in fiscal sustainability, which started from
Greece, has spilled over to peripheral countries including Ireland and Portugal, which was in
a tough fiscal situation, as well as bigger economies such as Spain and Italy.
The yields of government bonds in those countries have risen substantially and market
prices have declined significantly. European financial institutions, mainly those which held a
large amount of such government bonds, have faced deterioration in their balance sheets
and difficulty in raising funds in the markets. They have started to strive to reduce the size of
balance sheets through measures including tightening their lending stance. As a result, firms'
and households' sentiment has deteriorated and economic activity has been slowing.
At present, in Europe, a rapid adverse feedback loop seen during the Lehman shock has not
been generated, but the adverse feedback loop of the fiscal situation, the financial system,
and economic activity seems to have started to act.
On the back of the sovereign debt problem in Europe, there are factors that are essentially
common to the Lehman shock. Namely, against a backdrop of accommodative financial
conditions in the mid-2000s, a rise in asset prices, and optimistic growth expectations,
financial and economic imbalances have been accumulated.
In the United States, on the back of "technological innovation in finance" as seen in an
expansion of securitized products, financial institutions' and investors' risk awareness
concerning financial products including subprime loans became lenient. That, together with
accommodative financial conditions and a rise in housing prices, has led to a significant
increase in home loans and an accumulation of imbalances, mainly in the household sector,
and consequently induced the Lehman shock.
In European peripheral and other countries, due to the ease of fiscal funding on the back of
confidence in "a single currency euro" and excessive expectations for economic growth
potential and an increase in tax revenue, fiscal discipline has tend to become loose. Of
course, a major player in the expansion of imbalances in such a case is the government
sector, but also in the private sector, there have been inefficient investment and excessive
employment supported by accommodative financial conditions, and productivity and external
competitiveness have declined.
Intrinsically, the government sector and the private sector, just because the countries are the
members of the Euro, cannot continue to raise funds at low interest rates, which are beyond
those sectors' real strength, and continue to increase spending. Once the funding
environment for the governments and the private sector becomes severe, due to a decline in
confidence in fiscal conditions and a surge in government bond yields, economic activity will
decline and a reverse whirl will start.
Toward problem resolution
A quick fix for the problem unfortunately does not exist. The accumulation of imbalances is
like a chronic disease induced by the neglect of health for many years. For a cure, it takes
time to improve physical health. Namely, the road to normalization is, by restoring fiscal
discipline and raising economic growth potential, to repay debt and not to accumulate debt
again in the future. While it is important to take responses including funding support and debt
restructuring, those are, so to speak, policy measures to "buy time" and, in order to gain
market confidence, it becomes necessary to show the market that countries have the
capability to repay debt in the future.
If the road toward the resolution of the sovereign debt problem in Europe is understood as
just described, economic activity and financial systems in Europe are likely to be unstable for
the time being.
In addition, while I do not go into detail today, it should be noted that the United States is
faced with a similar problem in that it suffers from the legacy of the accumulation of financial
and economic imbalances.
II. Developments in Japan's economy
Japan's economy after the great earthquake disaster
I will next talk about Japan's economy. In the wake of the Great East Japan Earthquake on
March 11, economic activity plunged. Because of the damage to production facilities and a
severe power shortage, the nationwide and worldwide supply chains were cut off, and
production and exports declined substantially. Households' and firms' sentiment slumped
and spending declined. Looking at the developments thereafter, supply-side constraints were
removed at a pace faster than expected and, around the summer, economic activity almost
recovered to the pre-quake level.
Together with the restoration of damaged facilities, firms made various efforts and attempts,
including producing in alternative facilities at home and abroad as well as ensuring parts
procurement from alternative sources. As for a power shortage in the summer, severe
constraints on economic activity were avoided due to the efforts to save electricity and to
level electricity usage. In those ways, "strength in the field", or genbaryoku, of Japan's
economy has been fully exerted in the experience of the recent earthquake disaster
Outlook and risk factors for Japan's economy
Japan's economy is in a situation in which supply-side constraints were almost removed and
economic activity will be determined by demand-side developments. For the time being, the
economy will be affected by a slowdown in overseas economies and the appreciation of the
yen as well as flood damage in Thailand. After that, Japan's economy is expected to return to
the moderate recovery path because the pace of recovery in overseas economies will
subsequently increase led by emerging and commodity-exporting economies and because
demand related to reconstruction after the earthquake will gradually grow.
According to the projection in the Outlook for Economic Activity and Prices (Outlook Report)
that the Bank released recently, the real GDP growth rate is projected to remain relatively
low in fiscal 2011 due in part to the effects of the disaster. The growth rate is projected to rise
in fiscal 2012, partly because of an increase in reconstruction-related demand, and continue
to register somewhat high growth in fiscal 2013. Turning to prices, the year-on-year rate of
change in the CPI will remain at around 0 percent for the time being, and is projected to be
around 0.5 percent toward fiscal 2013 on the back of an improvement in the supply-demand
balance.
Such an outlook is accompanied by high uncertainties. First, the source of the utmost
uncertainty is the consequences of the aforementioned sovereign debt problem in Europe.
Fortunately, as Japanese firms have been performing vigorous management since the burst
of a bubble, they have sufficient management vitality at present. Japanese financial
institutions have also been restoring soundness in their assets and striving to reinforce their
capital. The robustness of the financial system has been maintained. Therefore, despite
continued strains in European financial and capital markets, financial conditions in Japan
remain accommodative, supporting economic activity from the financial side.
As the US economy is not in its best condition, suffering the aftereffects of the Lehman
shock, due vigilance is necessary against a possibility that a shock initiated in Europe will
lead to intensify global investors' risk aversion or to a lower-than expected growth in the
global economy as a whole. In those cases, downward pressure could also be exerted on
Japan's economy through the financial channel of the appreciation of the yen and a plunge in
stock prices, the real economic channel including a decline in exports, and the channel of
sentiment of economic entities, including firms.
Second, uncertainty about demand related to reconstruction after the earthquake disaster. In
the disaster-stricken areas, various activities toward reconstruction that include the
reconstruction of disaster-affected facilities have already been underway. Demand for
reconstruction in the worst-hit areas, including the Tohoku coast areas, is likely to gradually
gain momentum as reconstruction plans that include the overall picture of urban
development become specific. However, full-scale reconstruction demand, including private
investment, should be seen with a certain margin of error in terms of size and pace of
implementation.
Third, uncertainty about firms' and households' growth expectations. After the earthquake
disaster, Japan's economy is faced with new difficulties, including the problems of electricity
supply, in addition to the problem of the downtrend in economic growth rate due to the
demographic vortex. Depending on responses to those problems, firms' and households'
growth expectations could change and induce unexpected effects on future developments in
economic activity. In what follows, I will talk somewhat in detail about those problems, which
relate to the topic of today's seminar "Strategy for Revitalization of Japan's Economy".
III. Japan's medium- to long-term challenges and toward their resolution
Downtrend in growth rates
After the burst of a bubble, Japan's economy has often been referred to as a "lost decade" or
"lost twenty years". Recently, in the United States and Europe, in which prolonged economic
stagnation has started to be worried about, the phrase "Japanization" has also been used.
Looking at Japan's real GDP growth rate, the average growth rate was relatively high at
above 4 percent in the 1980s, but fell substantially to around 1.5 percent in the 1990s and
further to less than 1 percent in the 2000s. Given such downtrend in the economic growth
rate, it is likely that the growth potential of Japan's economy has recently been structurally
weakening.
The reasons for the weakening growth potential are complicated. Broadly speaking, it seems
that the system and the business practice which were formed in the past higher growth
period as well as firms' behavioral principle could not sufficiently adapt to two large changes
going on since the 1990s. The two changes in the business environment were the
intensification of global competition and the domestic demographic vortex.
The first change, global competition, accelerated in the 1990s. Globalization enabled various
and quick combinations of advanced economies' capital and technology and emerging
economies' labor force, and opened the door to emerging economies to high growth.
Potential business opportunities expanded beyond borders, and, in that regard, globalization
was a change that brought new growth opportunities for Japanese firms and, eventually,
Japan's economy. At the same time, globalization ushered in a "mega competition" era.
Japanese firms were strongly required to gain strength to promote differentiation from many
overseas rivals and become among the first to tap potential demand. While it is a fact that
Japanese firms have been going in that direction, the speed has not necessarily fast enough,
compared with the speed of changes in the business environment.
The second change, the demographic vortex has also progressed markedly since the 1990s.
The population of workers, namely, the working-age population, defined as the population
between 15 and 65 years old, started to decline since the mid-1990s and the pace of decline
has been accelerating.
Such change in the demographic composition could induce a shortage of labor and becomes
a factor in reducing growth potential from the supply side. At the same time, on the demand
side, the change will prompt structural changes of the demand content because necessary
goods and services will differ, according to each stage of life. Mass consumption markets,
including housing and consumer durables, will shrink, while demand for various goods and
services that raise the quality of life, such as medical and nursing care services, will
increase, at least potentially. If changes on the supply side cannot catch up with the
substantial changes in the demand structure, potential needs will not lead to actual spending
and remain untapped, while excess supply will continue in markets for existing goods and
services and economic activity will be under downward pressure. In Japan's economy since
the 1990s, it is likely that a supply and demand mismatch has chronically remained and
continued to act as one of the reasons for inducing low economic growth.
Background of delayed responses to changes in the business environment
Why Japan's economy failed to adapt to changes including globalization and the
demographic vortex? I would like to point out the following three. First, external
exclusiveness. Second, rigidity in resource allocation. Third, a lack of the financial function
that supports firms' challenges to new businesses. Let me elaborate on those.
First, external exclusiveness. Japan's economy has basically been maintaining high export
competitiveness even since the 1990s. The share of exports in the nominal GDP or the sheer
size of trade, which is the sum of exports and imports, is by no means large. In addition,
while Japanese firms have been actively expanding overseas, if the ratio of foreign direct
investment to the nominal GDP is compared with that in other major countries, Japan is at
quite a low level. What is more pronounced is a small number of foreign firms' advancement
to Japan, namely, a low level of inward direct investment. Also in terms of people, the
acceptance of foreign workers is overwhelmingly small and the number of foreign tourists
who visit Japan is at a low level.
As described, if one looks at the extent of internationalization in terms of people, goods, and
capital, Japan is not necessarily a country opened externally. Since the 1990s, even though
business opportunities across borders have substantially expanded, Japan's economy has
lacked openness to utilize such chances.
Second, rigidity in resource allocation. In Japan's economic system that was established
before the 1980s, long-term stability was valued in the relationship between management
and labor, firms and firms, and firms and financial institutions. Such system, which used to be
beneficial, has become a factor in hampering economic growth recently, when globalization
and the demographic vortex have progressed and speedy metabolism and business model
conversion have been called for. In that regard, an old-style safety net also has an aspect of
constraining the effectiveness of resource allocation in the economy as a whole.
Third, a lack of the financial function that supports firms' challenges to new businesses.
Enhancing competitiveness by improving production efficiency and cost reduction has been
techniques of Japanese firms since the high growth era, and I believe it is still the case even
now. Since the 1990s, as emerging economies with low production costs have come to the
forefront, it is not possible any more for Japanese firms to earn sufficient profits just by
improving production efficiency. Firms' strategies to open people's eyes to new values and
create new markets should be strengthened. The problem is that such efforts do not always
work. If so, the supply of risk money that supports such efforts will become critical. In that
regard, restructuring of the financial function that will replace the traditional main-bank
system and mortgage-backed loans is only half done.
Direction for strengthening growth potential
Looking at the medium- to long-term future of Japan's economy, the pace of decline in the
working-age population is projected to further accelerate.
The economic growth rate can be divided into the growth rate of workers and the rate of
productivity growth per worker. The acceleration of a decline in the working-age population in
the future implies that there will be greater declining pressure on the number of workers. To
avoid a downtrend in the growth rate in such situation, it is necessary to stave off a decline in
the number of workers. Given that an increase in population and immigration is difficult in the
short run, realistically, it is necessary to make efforts to encourage the employment of
potential labor force. In particular, it is critical to solve the so-called "M-shaped curve"
problem that women's labor participation rate declines after marriage and childbirth, and
raise woman's labor participation rate. It is also necessary to increase opportunities for
healthy elderly people to work.
Those measures alone have their limitations. Without an increase in productivity, a decline in
the growth rate cannot be staved off. To raise women's and elderly people's labor
participation rates, some measures, including the expansion of part-time workers and men's
childcare leave, which will rather result in reducing productivity per worker, will become
necessary. To overcome such adversities and clearly increase the rate of productivity growth
is no easy matter.
To begin with, now that Japan is trying to fight against a headwind of a continued decline in
population over several decades and aging, we need to have resolution to convert our sense
of value and reconstructing an economic society. Those are daunting tasks, but, as I have
explained, the directions of the tasks have become clear to some extent. Let me summarize
again.
First, in order to benefit from the positive effects of globalization, open our country as much
as possible. We need to increase not only trade but also the inbound and outbound traffic of
capital and people. In addition to tourism and medical care, it is important to enhance the
openness in various areas including education, culture, arts, and research and development.
Attracting people from overseas could stimulate economic activity in terms of demand and
innovation.
Second, enhance the latitude and flexibility of the economy as a whole through regulatory
reform and improvement in flexibility in the labor market. In the aging society, there are
areas, including medical and nursing care services, in which potential demand will indeed
increase. Of course, public support will be essential for medical and nursing care services,
through which the public should fairly enjoy the benefits. There is room for encouraging
market-based growth through deregulation and other measures. In addition, the employment
system need to be reconstructed into a further flexible system so that transferring of job,
learning of new skills, and various ways of working could be chosen more freely.
Third, the supply of risk money that nurtures entrepreneurship. For firms to venture into new
markets and generate profits and employment, the role of finance that shoulders such risk
will be inevitable. In that regard, financial institutions are required to refine their own
knowledge, find firms' business opportunities, and create demand for funds by themselves.
In addition, without relying on mortgage collateral or borrowers' guarantee capability, it is
also effective to diversify the form of lending, including the utilization of asset based lending,
through being heavily involved in the process of firms' cash flow generation. Furthermore, the
activation of equity capital through funds is a critical element in supporting venture firms and
speedy business strategy.
IV. Needs for fiscal restructuring
While I have so far talked about the direction for strengthening growth potential of Japan's
economy, an important challenge that also relates to that is fiscal consolidation. Japan's
government debt outstanding is at an extremely high level, compared with other advanced
countries. So far it has not yet led to a situation in which financial and capital markets are
severely affected. As one can see from the sovereign debt problem in Europe, the market's
view on a country's fiscal condition will change suddenly. It is not too much to say that there
is always a risk that government bonds, which used to be regarded as "safe assets", might
change discontinuously to "risky assets". Therefore, it is particularly a period like this when
the markets are stable, when Japan needs to take steady steps toward fiscal consolidation.
To raise the growth potential of Japan's economy through the aforementioned efforts will
lead to a decline in fiscal deficit through an increase in tax revenue. In addition, if Japan's tax
system and social security system change to sustainable ones, corresponding to the
demographic vortex, it is likely to support the self-sustaining recovery power of the economy
through reducing households' future uncertainty, and lead to a rise in the medium- to
longterm growth rate. It is critical to pursue the strengthening of growth potential and fiscal
consolidation concurrently, and let a positive feedback loop work.
V. Conduct of monetary policy
Finally, let me talk about the Bank of Japan's monetary policy. The Bank has been pursuing
powerful monetary easing in the framework of comprehensive monetary easing.
First, the Bank sets the policy rate at 0 to 0.1 percent, which can be deemed a virtually zero
interest rate. Second, the Bank is publicly committed to continuing this virtually zero interest
rate policy until it judges that price stability is in sight. And third, it purchases from the
markets not only long- and short-term government bonds but also risk assets such as CP,
corporate bonds, and exchange-traded funds (ETFs) and Japan real estate investment trusts
(J-REITs). The program for purchasing financial assets, called the Asset Purchase Program,
started at 35 trillion yen in October 2010, but has been repeatedly expanded in size on a
significant scale to about 55 billion yen. Those measures aimed at encouraging a decline in
longer-term risk-free interest rates and narrowing of various risk premiums.
Such pursuit of powerful monetary easing has become one of the factors responsible for
stability in the financial environment in Japan, despite continued strains in the U.S. and
European financial markets.
Apart from those measures, the Bank started in June 2010 the new lending framework of the
Fund-Provisioning Measure to Support Strengthening the Foundations for Economic Growth.
It is a measure through which the Bank supplies long-term and low interest rate funds to
private financial institutions that lend or invest in the promising areas. The ceiling of the
measure was initially set at 3 trillion yen and, taking it into account that the funds actually
provided have come close to the ceiling, the Bank established a new line of credit of
500 billion yen to provide funds to financial institutions that undertake equity investments or
asset-based lending.
As I have talked today, strengthening medium- to long-term growth potential is a critical
challenge Japan's economy is faced with, and if that challenge is met, it could lead to
overcoming deflation through raising firms' and households' growth expectations. Based on
that recognition, the aforementioned measure aimed at supporting private financial
institutions' efforts from the financial front.
The Bank will consistently make contributions as a central bank so that Japan's economy will
emerge from deflation and return to the sustainable growth path with price stability.
Concluding remarks
I have today talked such issues as medium- to long-term challenges to Japan's economy. I
strongly hope that Japan will meet those challenges in the near future and restore its luster.
At that time, I believe that the word "Japanization" would be used in an exact opposite
meaning.