Masaaki Shirakawa: Toward sustainable growth with price stability
Speech by Mr Masaaki Shirakawa, Governor of the Bank of Japan, at the Kisaragi-kai
Meeting, Tokyo, 12 November 2012.
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Introduction
It is a great honor to have the opportunity to address you today.
As you are well aware, the Bank of Japan undertook further aggressive monetary easing for
two months in a row, in September and October 2012. Today, I will begin by explaining these
policy measures while outlining our assessment of the underlying economic activity and
prices. I will then discuss various issues regarding deflation and monetary policy conduct and
explain our thinking behind these issues.
I. Developments in overseas economies
Let me start with developments in overseas economies. Overseas economies entered a
deceleration phase in the second half of 2011. Recently, many countries and regions - in
particular, their manufacturing sectors - have moved deeper into that phase. As forecasts by
international organizations and economists in the private sector show, the outlook for the
global economy has been downwardly revised rapidly since this summer (Chart 1). There are
two factors behind this.
First, the effects of the European debt problem have been spreading. Since the second half
of 2011, concern about government debt stemming from Greece has spread to Spain and
Italy. As a result, the negative feedback loop among fiscal balances, the financial system,
and the real economy is in effect. Since the beginning of 2012, such negative effects have
spread to core countries such as Germany. The real GDP growth of the euro area remained
negative for three consecutive quarters, from October-December 2011 through April-June
2012, and it is believed that negative growth cannot be avoided for the July-September
quarter. As such, the effects of the economic recession in Europe have been exerting
downward pressure on the global economy not only through a decline in trade activities - a
direct channel - but also through cautious business activities resulting from heightening
uncertainty.
Second, the deceleration in the Chinese economy has been more prolonged than expected.
In China, exports to Europe have declined and private real estate investment has slowed.
Against the backdrop of such weakening of demand at home and abroad, inventory
adjustment has been prolonged, especially in materials industries with excess production
capacity. While the annualized real GDP growth rate is still somewhat high, it has been
declining for seven consecutive quarters through this past July-September. In response,
authorities have carried out economic stimulus measures on the monetary and fiscal fronts.
So far, however, they appear to maintain a cautious policy stance toward achieving
sustainable growth even when they are at the crossroads of changing their policy stance
toward easing, partly based on past experience - namely, the large-scale policy measures
following the Lehman shock that in the end brought about an excess in capacity and
overheating in the real estate market.
At the G-20 meeting that I attended last week, it was noted that economic activities in some
regions have reportedly stopped deteriorating and started to show signs of stabilization. On
the whole, however, my impression is that momentum for recovery in the global economy
following the Lehman shock has been weak. Looking back at where we came from, strong
growth in the United States and Europe toward the mid-2000s owes much to the credit
bubble, which had reached an unprecedented level, and the amount of debt in the private
sector has increased markedly (Chart 2). At present, the United States and Europe are in the
process of adjusting excess debt, and until such adjustment is completed, these economies
will suffer from a low growth rate, based on our experience from the aftermath of the bubble
bursting. Indeed, from the perspective of the recovery in real GDP after the bursting of
bubbles, economic performance in the United States and Europe has been worse to date in
those economies than that of Japan after its bursting of the bubble, notwithstanding the
aggressive monetary policies of central banks, including the Federal Reserve (Chart 3).
Based on such recognition, overseas economies are likely to remain in a deceleration phase
for the time being, but will gradually emerge from that phase and turn toward a moderate
recovery thereafter. Factors behind this scenario include an improving trend in U.S. housing
investment, reflecting the bottoming-out of house prices, and monetary easing effects
underpinning momentum for recovery. As for the European debt problem, a safety net has
been put in place, which includes such moves as the European Central Bank (ECB)'s
decision to launch a new government bond purchasing program and the establishment of the
European Stability Mechanism (ESM). Against this background, a number of policy
measures for economic and fiscal reform are expected to make progress gradually, which
would improve business and household sentiment. In China, the effects of economic policy
measures as well as continued inventory adjustment are expected to materialize. In fact, in
its projections for global economic growth released last month, the International Monetary
Fund (IMF) has forecasted that the global economy will gradually post higher growth, from
3.3 percent in 2012 to 3.6 percent in 2013, and further to 4.1 percent in 2014.
I fully recognize, however, that such projections regarding overseas economies rest on
considerable uncertainties, including future developments in the European debt problem, the
outcome of the problem surrounding the "fiscal cliff" in the United States, and the likelihood of
economic deceleration in China being prolonged further. The Bank will closely monitor these
developments.
II. Developments in Japan's economy
Next, I will outline the current situation of and the outlook for Japan's economy, taking into
account the developments in overseas economies I have touched upon.
As for recent developments, exports have shown a marked decline in the July-September
quarter of 2012 following a rapid increase in April-June, and industrial production has
decreased for two consecutive quarters, as overseas economies have moved deeper into the
deceleration phase. Looking at exports by destination, those to the European Union (EU)
have been declining for four consecutive quarters and those to China have recently shown a
notable decline (Chart 4). The implications of the relations between Japan and China have
begun to affect Japan's economy, reflected in areas such as trade activities and tourism.
Whether the implications of Japan's relations with China will expand any further requires
close attention.
In contrast, domestic demand had been relatively firm on the whole until recently, mainly
against the background of an increase in demand related to reconstruction following the
Great East Japan Earthquake. Effects of the weakness in exports have gradually appeared
in the employment situation, however, as seen in the fact that the number of new job offers in
the manufacturing sector has been negative on a year-on-year basis since June. Private
consumption has also lost some of its momentum compared with the period leading up to
early summer, partly due to the ending of subsidies for the purchase of environmentally
friendly cars. As for business fixed investment, firms' investment plans for fiscal 2012 in the
September Tankan (Short-Term Economic Survey of Enterprises in Japan) have posted
relatively high growth for that time of year. Nevertheless, attention needs to be paid to
whether firms might abandon their business fixed investment plans. Taking this situation into
account, the Bank has continued to revise downward its assessment of Japan's economy as
a whole, and assessed at the Monetary Policy Meeting on October 30 that the economy has
been "weakening somewhat."
Going forward, developments in Japan's economy will basically depend on those in overseas
economies. Using the outlook for overseas economies I mentioned earlier as an assumption
basis, Japanese economic activity is expected to be more or less flat for the time being.
Exports and production are likely to remain relatively weak for the time being, and domestic
demand as a whole is unlikely to increase at a pace that will outperform the weakness in
exports.
Under such circumstances, the Bank decided to undertake further aggressive monetary
easing at the Monetary Policy Meeting on October 30. As for the outlook for economic
activity after incorporating the effects of such monetary easing and those of the government's
efforts to invigorate the growth potential, the economy, which will be more or less flat for the
time being, is expected to return to a moderate recovery path in due course. Expressing this
in numerical terms, the median of the Bank's nine Policy Board members' forecasts for the
annualized growth rate is 1.5 percent, 1.6 percent, and 0.6 percent for fiscal 2012, 2013, and
2014, respectively (Chart 5). Reflected in these figures, however, are the effects of the
front-loaded increase and subsequent decline in demand prior to the consumption tax hike,
and adjustment of such effects brings the median of the forecasts to 1.0-1.5 percent for both
fiscal 2013 and 2014. The output gap is therefore expected to improve steadily, given that
these forecast figures exceed the potential growth rate, which appears to be around
0.5 percent.
This naturally affects price developments as well. The year-on-year rate of change in the
consumer price index (CPI) for all items less fresh food is currently around 0 percent. It is
expected to hover around that level for the time being, but will start rising gradually thereafter
as the output gap that I just mentioned narrows. In terms of the median of the Policy Board
members' forecasts, figures for fiscal 2012 and 2013 are -0.1 percent and 0.4 percent,
respectively, and 0.8 percent for fiscal 2014 excluding the effects of the consumption tax hike
(Chart 6). The Bank publishes, in a numerical form, "the price stability goal in the medium to
long term," which is the inflation rate that it aims to achieve in conducting monetary policy. In
concrete terms, the Bank judges "the price stability goal in the medium to long term" to be in
a positive range of 2 percent or lower in terms of the year-on-year rate of change in the CPI,
and has set a goal of 1 percent for the time being.1 The Bank is determined that it will
continue with the current powerful easing until it judges the 1 percent goal to be in sight, but
on the condition that it identifies no significant risk to the sustainability of economic growth,
such as from the accumulation of financial imbalances. The forecast that I have provided
suggests that, in fiscal 2014, it appears likely that the rate will move steadily closer toward
this goal of 1 percent. At the same time, we have not reached a stage where the 1 percent
goal is in sight.
Such an outlook is attended by considerable uncertainties - in particular, the future
developments in overseas economies described earlier - that could deviate either upward or
downward from the projection, and relatively closer attention should be paid to the downside
risk for the time being.
III. Bank of Japan's conduct of monetary policy
I will now move on to the Bank's conduct of monetary policy. The Bank's implementation of
further aggressive monetary easing on October 30 marks the fourth time this has been done,
counting from the beginning of this year - in February, April, September, and October. At its
Monetary Policy Meeting on October 30, the Bank made the following two decisions. First, it
decided to increase the size of the Asset Purchase Program (hereafter, the Program) by
about 11 trillion yen, from about 80 trillion yen to about 91 trillion yen. Second, it established
a new lending facility called the "Stimulating Bank Lending Facility."
In the following, while I will mainly discuss our monetary policy decision on October 30, in
order to facilitate a better understanding of the aim and content of such a decision, I will start
by concisely explaining how a monetary easing policy permeates the economy and prices.
The monetary transmission mechanism can be divided into two stages. The first stage is the
transmission of monetary easing effects from the realm of monetary policy to the financial
environment, where firms and households can achieve necessary financing from financial
markets and financial institutions at low costs. The second stage is the transmission of
effects from the financial conditions to economic activity and prices; in other words, the
extent to which firms and households can take advantage of the accommodative financial
conditions to increase their investment and spending.
Increase in the size of the Asset Purchase Program: stimulating the first stage of the
Monetary Transmission Mechanism
Among the decisions at the Monetary Policy Meeting on October 30, the increase in the size
of the Program is aimed at stimulating the first stage of the transmission mechanism more
forcefully (Chart 7). The Program was introduced in October 2010 in order to generate further
easing effects in a situation where the overnight call rate - that is, the Bank's target rate -
had already been at virtually zero percent. Through the Program, the Bank purchases not
only Japanese government bonds (JGBs) and T-Bills but also various types of risk assets,
including CP, corporate bonds, exchange-traded funds (ETFs), and Japan real estate
investment trusts (J-REITs). Such purchases of risk assets are unprecedented for a central
bank (Chart 8). The aim of the Program is to encourage a decline in longer-term market
interest rates and a reduction in risk premiums.
Since the introduction of the Program, longer-term market interest rates have been declining
steadily (Chart 9). Government bond yields up to three years have declined to an extremely
low level of 0.1 percent. The 5-year bond yields have come to nearly 0.2 percent. Reflecting
such developments in the market rates, bank lending rates have also been declining.
Recently, these rates, both in the short term and long term, have hit 1.0 percent - an
unprecedented level. The lending attitudes of financial institutions as perceived by firms have
also improved clearly, and have reached a level that exceeds the average since the 2000s.
The issuing conditions for CP and corporate bonds are also accommodative on the whole.
The Bank decided to increase the size of the Program with additional purchases of a wide
range of assets that comprise not only JGBs but also risk assets including ETFs. Through
such measures, the Bank intends to firmly maintain extremely accommodative financial
conditions, even after entering next year, and support Japan's economy forcefully from the
financial side.
Establishment of the Stimulating Bank Lending Facility: stimulating the second stage
of the Monetary Transmission Mechanism
On top of this, the extent to which the private sector can make use of such accommodative
financial conditions - in other words, the second stage of the transmission mechanism
- becomes crucial. On this issue, while firms' profitability relative to total assets - i.e., ROA -
has recovered to 3-3.5 percent, the average interest rate paid by firms declined to nearly
1.5 percent, and the gap between these two indicators has become large (Chart 10).
Why is it the case that business activity has not necessarily been invigorated even though it
is profitable for firms to raise funds and make business outlays? Among several reasons that
I can think of, the first reason owes to the difference in profitability between existing and new
investments. The ROA that I just mentioned indicates the profitability of past investment. If
the profitability of new investment is lower than that in the past, firms are unlikely to invest.
The second reason is that, as a result of prolonged periods of low growth, business
sentiment has become cautious and there is not enough risk-taking activity in the corporate
sector. As for the third reason, it is far more profitable to invest overseas than at home
(Chart 11).
The Bank hears from many corporate managers that there are only a few attractive
investment opportunities at home. Unless we somehow manage to change this view, it will
be difficult to stimulate business investment. The flipside is that investment will increase if we
are able to change this view. While the first stage of the monetary transmission channel is
the process of encouraging a further decline in market interest rates, we also need efforts to
raise "natural interest rates," if I may use an economist's jargon.
In order to encourage the second stage of the transmission mechanism, it is vital that a wide
range of economic entities, including firms, financial institutions, and the government, play
their respective roles with a view to invigorating the growth potential of the economy.
However, the Bank also strongly asserts that we will also do our best, making every possible
effort from the perspective of monetary policy. This assertion led to the introduction back in
2010 of the Growth-Supporting Funding Facility, which is now generating some positive
outcomes. Moreover, the Bank decided to establish the "Stimulating Bank Lending Facility" in
October in order to promote the proactive lending activity of financial institutions and help
stimulate the credit demand of firms and households (Chart 12).
Under this facility, the Bank will provide yen-denominated funds - up to an amount
equivalent to the net increase in lending - to financial institutions, at their request. The total
amount of funds provided by the Bank will be "unlimited" - that is, there shall be no upper
limit. In calculating net increases in loans, only those extended to the non-financial private
sector will be counted, and this can take the form of either yen-denominated lending or
foreign currency-denominated lending. This is because firms' overseas activities and
financial institutions' encouragement of such activities through lending have important
implications for the development of Japan's economy in the midst of globalization. Loans with
a duration of up to three years can be chosen by the banks, and loans can be rolled over up
to four years at the request of these banks. Furthermore, the interest rate charged by the
Bank will be 0.1 percent per annum for now. Thus, financial institutions can borrow funds at a
long-term fixed rate equivalent to the Bank's target for the uncollateralized overnight call rate.
The size of this facility will be determined by the voluntary efforts of depository institutions to
increase lending. According to data for the 12 months up through August 2012, the amount
of loans increased by a total of approximately 15 trillion yen for financial institutions that saw
a rise in their lending. Of this, 11 trillion yen constitutes loans that originated at domestic
branches and 4 trillion yen at overseas branches (Chart 13). Going forward, if these
institutions manage to increase their lending more aggressively, the amount of funds that can
be provided by the Bank will rise accordingly. At present, the Bank is in the process of
making the necessary arrangements. We plan to release the details of this facility before the
end of the year and start its operation as soon as possible.
The Bank decided to call the combination of the Stimulating Bank Lending Facility and the
aforementioned Growth-Supporting Funding Facility the "Loan Support Program." The aim of
this program is to vigorously push forward use of the accommodative financial conditions by
the private sector. In doing so, the importance of the Growth-Supporting Funding Facility will
not be undermined at all. Under this facility, the Bank - irrespective of whether or not lending
has increased - continues to encourage financial institutions to carry out lending or
investment in support of invigorating the foundations for Japan's economic growth, and to
ensure that the public is well aware of the need to raise the growth potential.
IV. Issues concerning the overcoming of deflation
Next, in order to facilitate a better understanding of the Bank of Japan's conduct of monetary
policy, I wish to go "back to basics" and describe what it really means to overcome deflation,
and what is necessary to accomplish this goal, by referring to several issues.
Relationship between overcoming deflation and the rate of price rises
The first issue is the relationship between overcoming deflation and the rate of price rises. In
general, the term "deflation" is used to describe a continued decline in prices. Thus, to
overcome deflation means to achieve a state in which such a drop in prices comes to a halt
or in which prices start rising at a very moderate pace, if one looks at the definition of
deflation from the opposite angle. According to the Bank's forecasts that I touched upon
earlier, prices are expected to rise moderately from fiscal 2013 toward fiscal 2014. Given that
its price stability goal of 1 percent for the time being has not come in sight, the Bank is
committed to continuing with aggressive monetary easing. In any case, when we say that
overcoming deflation is an important challenge, we are not simply looking for a pick-up in the
price index. On this point, we can derive important implications from the Opinion Survey on
the General Public's Views and Behavior that the Bank conducts, based on the responses
collected from individuals (Chart 14). Among the respondents who felt that prices had gone
up, more than 80 percent viewed the price rise as "rather unfavorable." In contrast, among
those who felt that prices had gone down, about one third deemed the price decline as
"rather favorable." The results of the survey may seem odd at first sight, considering the
broadly shared goal of the Japanese population to overcome deflation. On second thought,
however, they may not come as a surprise at all. Respondents in the former group may have
chosen "unfavorable" when they were asked solely about prices; they had to base their
response on a situation where prices rose without the associated increase in wages.
Our goal is to overcome deflation and have Japan's economy return to sustainable growth
with price stability. In other words, in overcoming deflation we are not merely aiming to
achieve a state in which prices simply rise, but one where better economic conditions are
realized on the whole by increasing corporate profits, employment, and wages. There may
also be a state in which the economy is overheating but the inflation rate is low. The bubble
period in the second half of the 1980s is a typical example. The rate of change in the CPI
remained below 1 percent for three years starting from 1986, but nobody refers to that period
as one in which Japan was in a state of deflation (Chart 15). In short, what is necessary is to
check economic activity, prices, and the financial environment in a balanced manner from the
perspective of realizing sustainable growth.
Reality of inflation expectations
The second issue regarding the overcoming of deflation concerns inflation expectations.
Counter to the view that economic growth is necessary to overcome deflation, we hear the
argument that the priority should be to lift inflation expectations in order to improve the
economy, and that this is exactly what a central bank should do. The mechanism underlying
this argument is that lifting inflation expectations in the private sector will lead to a decline in
the real interest rate, which is derived by subtracting the inflation expectation rate from the
nominal rate, which will in turn stimulate the economy.
Nonetheless, in an environment where neither prices nor wages have risen for a number of
years, it is not realistic to believe that the general public's inflation expectations will go up all
of a sudden, or that we can manage to lift these expectations somehow. We can think of a
situation where inflation expectations alone go up - for example, when the economy is hit by
oil shocks - but this is not exactly the same as the overcoming of deflation that we seek.
According to the opinion survey that I have just mentioned, the fact that most of the
respondents viewed the price rise as "rather unfavorable" suggests that there is a possibility
of wide acceptance in the public realm that it is normal for prices not to rise, or that price
rises cannot be tolerated. In fact, looking at detailed consumer price data for the last
15 years or so, in the United States, those items for which prices pick up at the rate of
2.5-3.0 percent have the largest weight, whereas in Japan, those items for which prices pick
up at the rate of 0-0.5 percent have the largest weight (Chart 16). On the whole, the CPI is
slightly less than 0 percent, but this is due in part to the fact that, compared to the United
States, there are a few items - such as televisions and personal computers - for which, for
the purpose of statistics, prices are deemed to be declining significantly in reflection of their
improved qualities.
The general public's common understanding on prices - or its perception regarding prices -
has been formulated on the basis of such conditions, and this is the reality of the abstract
notion of "inflation expectations" in economic theory. Consumers, with the perception that
prices should not rise, are unlikely to accept price hikes by firms, who in return reduce costs
including wages; hence, it will take longer for the economy to overcome deflation. After all, it
is more important to generate material changes in the economy, including strengthening the
economy's growth potential and achieving higher wages. I will come back to this point
shortly.
Meaning of the output gap
The third issue regarding overcoming deflation concerns the meaning of the output gap.
According to the Cabinet Office's estimation, the output gap amounts to about 2 percent of
GDP or approximately 10 trillion yen on an annual basis, in line with the Bank of Japan's
estimation. Given that it was about 40 trillion yen right after the Lehman shock, the output
gap has narrowed substantially, though it still exists. Because the output gap is generally
recognized as a shortage of demand, one can argue that, if a fiscal measure equivalent to
the amount of the gap is taken, the gap will be wiped out and this will put an end to deflation.
Surely, if such a shortage is temporary in nature, this argument may hold. Nevertheless, one
has to bear in mind that the output gap assumes only the present supply-side structure and
merely captures the shortage of demand corresponding to that structure. Society and the
economy keep changing all the time, and in Japan new demand is being created constantly
on the back of the aging population, women's entry into the labor market, and increasingly
diverse preferences. In the medical and nursing business, one often hears that services
sufficient to meet demand are not being provided, mainly due to various regulations and
labor shortages at worksites, even though there is rapidly expanding potential demand
resulting from the aging population. Moreover, with regard to the elderly's spending - which
has received considerable attention lately - there is a big difference among the elderly in
terms of income, health conditions, and taste. Therefore, unlike the consumption by younger
members of the population, the elderly's spending pattern is increasingly granular, and
depending on the creativity of the supply side, there is considerable room left to expand the
elderly's spending. The cause of this inability to meet potential demand - namely, the
shortage of supply in growing business areas - is not measured in the output gap. Put
differently, in a rapidly changing economy, the output gap only captures the shortage of
demand in terms of the current supply of goods and services, and does not capture the
shortage of supply against new potential demand. In this sense, the notion of the output gap
is asymmetric. Put differently, what should essentially be recognized as the mismatch
between supply and demand is instead perceived in the form of the shortage of demand.
In order to improve the output gap in a sustainable manner, it is necessary to restructure the
supply side according to economic changes, which enables potential demand to materialize.
The newly created demand is based on what people willingly want; hence, this is likely to
create a virtuous circle of increasing expenditure, revenue, and income. As such, not only
short-term macroeconomic policies but also initiatives to change the economic structure in
which new businesses are more likely to emerge, such as enhancing the metabolism of the
economy, play an important role in achieving improvement in the output gap.
Importance of invigorating the growth potential
Last, but not least, is the importance of invigorating the growth potential. This is the issue
that provides an overall summary of what I have been talking about.
The Bank has been emphasizing repeatedly that Japan's economy faces the critical
challenge of overcoming deflation and returning to a sustainable growth path with price
stability, and that this challenge can only be met if efforts by a wide range of economic
agents to strengthen growth potential and support from the financial side proceed hand in
hand. Growth potential is ultimately the ability to differentiate from the existing goods and
services and to cultivate new demand swiftly at home and abroad. If one succeeds in
providing attractive goods and services that consumers can acknowledge as having worth,
one can maintain the ability to control prices while preserving value-added. Such
value-added will initially generate an increase in corporate profits. If this is eventually
distributed in a balanced manner to the household sector in the form of a rise in employment
and higher wages, it will result in a broad-based increase in purchasing power. Furthermore,
this will lay out the foundation for the economy where cultivating new demand is likely to be
successful. Once the virtuous circle in which rising wages leads to an increase in expenditure
and income starts to work through, the general public will begin to willingly accept the idea of
moderately rising prices. This is the avenue that the change in price perception - that is, a
rise in inflation expectations - will take in line with the economic reality, and this is the
fundamental mechanism for overcoming deflation. After the Lehman shock, wages have
been relatively firm compared with the immediately preceding recovery phase, and we will
monitor carefully how they feed into prices in the future (Chart 17).
The ability to cultivate new demand derives from firms' spirit of challenge. At the same time,
however, financial institutions need to support the funding of firms that exhibit risk-taking
behavior arising from this spirit, and the government should lay out foundations such as
expanding, through decisive deregulation, business areas for firms; such efforts play pivotal
roles in helping firms take on challenges. This recognition is shared by the government. At
the Monetary Policy Meeting held on October 30, in addition to the aggressive monetary
easing, the Bank decided to release the "Measures Aimed at Overcoming Deflation" jointly
with the government in order to state clearly their shared understanding. In this "shared
understanding," the government showed a clear recognition that, in order to overcome
deflation, it is essential to reform an economic structure that is predisposed to deflation, as
well as conduct appropriate macroeconomic policy management. The Bank strongly expects
the government to vigorously promote measures for strengthening Japan's growth potential.
Of course, the Bank will make its utmost efforts from the financial side. Once various efforts
by a wide range of economic entities come into play, I am confident that sustainable growth
with price stability can be achieved.
V. Issues concerning the Bank of Japan's conduct of monetary policy
In the following, I will introduce issues concerning the conduct of the Bank's monetary policy,
bearing in mind questions that are often raised.
Is monetary easing enough or not?
We have heard the opinion that, with a view to overcoming deflation as early as possible, the
Bank's policy stance is not enough. By contrast, there is another opinion arguing that
financial conditions are already accommodative enough and asking if there is anything
meaningful to be gained by further enhancement of monetary