Haruhiko Kuroda: Challenges to achieving the price stability target of 2
percent
Speech by Mr Haruhiko Kuroda, Governor of the Bank of Japan, at a meeting, held by the
Naigai Josei Chosa Kai (Research Institute of Japan), Tokyo, 6 November 2015.
* * *
Introduction
It is my great honor to have the opportunity to address you today at the Naigai Josei Chosa
Kai.
At the Monetary Policy Meeting held on October 30, the Bank of Japan produced the Outlook
for Economic Activity and Prices (Outlook Report) and published its projections for Japan's
economic activity and prices through fiscal 2017.
Looking at the recent economic developments, Japan's exports and production have been
sluggish, reflecting the slowdown in emerging economies, particularly China. On the price
front, the year-on-year rate of change in the consumer price index (CPI, all items less fresh
food) has declined and reverted to about 0 percent, due mainly to the effects of the
substantial decline in crude oil prices.
However, as I will explain, the fundamentals of Japan's economy are sound and the
environment surrounding firms and households has significantly improved compared to some
years ago. Moreover, the underlying trend in inflation has been improving steadily.
Quantitative and qualitative monetary easing (QQE), which the Bank introduced in April
2013, has been exerting its intended effects toward overcoming deflation.
The Bank will continue to steadily pursue QQE and solidly maintain accommodative financial
conditions. In this circumstance, firms and households are expected to be more proactive in
economic activity, Japan's economy is likely to continue growing at a pace above its
potential, and the price stability target of 2 percent certainly would be achieved. Today, I
would like to explain the Bank's view on the outlook for economic activity and prices, as well
as on its monetary policy while touching on the Outlook Report. I would first like to elaborate
on the Bank's baseline scenario regarding the outlook for economic activity and prices, which
is considered most probable, and then touch on risks to the baseline scenario.
I. Current situation of Japan's economic activity and its outlook
Corporate profits at high levels and firms' positive investment stance
Let me start by discussing the current situation of Japan's economic activity and its outlook.
As many of you must be aware, the slowdown in emerging economies, particularly China,
has become marked recently, and this has affected Japan's exports and production. In the
April-June quarter of 2015, private consumption was somewhat weak, reflecting in part bad
weather. Against this backdrop, the projected real economic growth rate for fiscal 2015 was
revised downward to 1.2 percent in the Outlook Report compared with the projection of
1.7 percent in the July 2015 interim assessment (Chart 1).
Nevertheless, corporate profits have been seeing record highs, and improvements in the
employment and income situation have continued. A virtuous cycle from income to spending
has been operating steadily in both the corporate and household sectors, and it is judged
that Japan's economy has continued to recover moderately.
A situation in which corporate profits continue increasing despite the flattening of exports and
industrial production was not commonly observed in Japan's past economic recoveries. Let
me point out two reasons why this time is different. The first is firmness in domestic demand.
In the past economic recoveries, the general course of events was an increase in exports
leading to rises in corporate profits and business fixed investment in the manufacturing
sector; this time, the nonmanufacturing sector has shown a strong recovery on the back of
resilience in domestic demand. This can be observed in a clear improvement in the diffusion
index for business conditions and corporate profits of the nonmanufacturing sector compared
to the manufacturing sector, as shown in the Tankan (Short-Term Economic Survey of
Enterprises in Japan) (Chart 2). As the current economic recovery has been driven by
domestic demand, even though Japan's exports have become more or less flat due to the
slowdown in overseas economies, the tolerance of Japan's economy for this slowdown
seems to be relatively high compared to the recoveries in the past. Second, the decline in
commodity prices, mainly crude oil prices, affected in part by the slowdown in emerging
economies, has pushed up profits through an improvement in the terms of trade. Put
differently, a sort of automatic adjustment has been working in which the negative impact
from a decline in quantity has been offset by positive effects in terms of prices. In addition,
the rise in repatriated income from overseas business through dividends and interest, which
has accelerated partly as a result of the depreciation of the yen, has contributed to the recent
improvement in corporate profits.
Under this favorable situation in corporate profits, firms' fixed investment stance has become
positive. According to business plans for fiscal 2015 released in the September Tankan, the
year-on-year rate of growth of fixed investment plans for all enterprises and industries was
revised upward from the June Tankan, from 3.4 percent to 6.4 percent.
Turning to overseas economies, as shown in the October 2015 World Economic Outlook
(WEO) published by the IMF, global growth for this year is projected to decline compared to
2014, but to accelerate toward 2016 (Chart 3). Advanced economies have continued to see a
firm recovery trend, mainly in the United States. Emerging economies are likely to continue
their slowdown for the time being. Since the Chinese authorities, having relatively large room
for monetary and fiscal policy, have proactively been carrying out economic stimulus
measures, the Chinese economy is expected to follow a generally stable growth path, albeit
at a somewhat reduced pace. Emerging economies other than China are also likely to move
out of their deceleration phase on the back of the robust growth in advanced economies.
Based on these projections of overseas economies, the favorable developments seen in
Japan's corporate sector are likely to continue.
Improvement in the employment and income situation, and resilient private
consumption
I would next like to explain developments in the household sector. Needless to say, the
employment and income situation is a key factor in deciding household spending. On this
point, the tightening trend in labor market conditions has continued. Namely, the active job
openings-to-applicants ratio is currently 1.24 times, a high level last seen in 1992, and the
unemployment rate has declined to 3.4 percent, a low level last seen in 1997 (Chart 4). What
is worth noting is that the labor market has continued to tighten despite the flattening of
exports and production. In fact, as seen in the diffusion index for employment conditions
released in the September Tankan, a perception of labor shortage has heightened further
among firms, and the labor market can be regarded as being in a situation of "full
employment."
As corporate profits have increased to their highest level historically and tightening in labor
market conditions has continued, there has been upward pressure on wages. Based on the
Monthly Labour Survey, scheduled cash earnings have increased, reflecting in part a rise in
base pay, which was seen for two consecutive years (Chart 5). According to various survey
results, summer bonuses this year were raised in many sectors and firms. As a result, the
employment and income situation has been improving steadily, and consumer sentiment,
which deteriorated after the consumption tax hike in 2014, has been on an improving trend
on the whole (Chart 6). Private consumption for the April-June quarter was somewhat weak
due to lackluster sales of small cars and the effects of bad weather, but results of various
sales statistics suggest that private consumption has turned to an increase since around July
in many categories, and can be judged as being resilient on the whole.
With a virtuous cycle from income to spending in both the corporate and household sectors,
Japan's economy through fiscal 2016 is likely to continue growing at a pace above its
potential, which is currently estimated to be around 0.5 percent or lower. Thereafter, through
fiscal 2017, the economy is projected to maintain its positive growth, although with a slowing
in its pace to around a level somewhat below the potential growth rate. The slowdown is due
mainly to (1) the effects of a front-loaded increase and subsequent decline in demand prior to
and after the consumption tax hike planned in April 2017 and (2) cyclical deceleration.
II. Price developments and the path toward achieving the price stability target of
2 percent
Current state of and outlook for prices
Let me turn to price developments. The year-on-year rate of change in the CPI for all items
less fresh food, which was minus 0.5 percent just before the introduction of QQE, increased
to as high as 1.5 percent in April 2014, excluding the effects of the consumption tax hike.
However, as somewhat weak developments in private consumption continued after the
consumption tax hike and crude oil prices declined substantially from the summer of 2014,
annual CPI inflation declined and has been about 0 percent in recent months (Chart 7).
Nevertheless, the underlying trend in inflation has steadily improved, excluding the effects of
the decline in energy prices. For example, the year-on-year rate of change in the CPI for all
items less fresh food and energy has been positive for 24 consecutive months since October
2013, increasing to 1.2 percent this September. This was the first time since the late 1990s,
when Japan's economy fell into deflation, that a continued price increase was seen.
Meanwhile, the rate of increase in the daily or weekly price indices, such as for food and
daily necessities, has followed an accelerating trend since this April. Firms' price-hiking has
become widespread and sustained, as seen in the fact that the share of items in the CPI for
which prices have risen has been outweighing that for which prices have declined by an
increasing margin (Chart 8).
Monthly data for the CPI are susceptible to various factors, such as developments in import
prices that reflect changes in energy prices and fluctuations in foreign exchange rates. On
the other hand, the underlying trend in inflation is determined mainly by the output gap and
medium- to long-term inflation expectations. From this perspective, significant changes that
have not been seen in recent years are taking place. I will elaborate on these two aspects as
follows.
Developments in the output gap
The output gap indicates the supply and demand balance of Japan's economy as a whole;
that is, the extent to which capital and labor are utilized. Although capacity utilization has
continued its increasing trend as the economy continues to recover moderately, the effects of
the flattening of exports, reflecting the slowdown in emerging economies, have been
observed recently (Chart 9). Meanwhile, labor market conditions have continued to tighten.
This is partly because, reflecting firmness in domestic demand, the current economic
recovery has been largely attributable to the nonmanufacturing sector, which is more
laborintensive than the manufacturing sector. Therefore, the output gap has steadily followed its
improving trend, mainly on the labor side (Chart 10). Looking ahead, with the economy
expected to continue growing at a pace above its potential, capital and labor utilization is
likely to rise further and thereby the output gap is expected to continue improving further.
Thus, upward pressure on prices stemming from the output gap is likely to increase steadily.
Developments in medium- to long-term inflation expectations
Let me move on to inflation expectations. Medium- to long-term inflation expectations appear
to have been rising on the whole from a somewhat long-term perspective. Inflation
expectations can be assessed from various market indicators and survey results. Although
there are some indicators or results showing that inflation expectations have been somewhat
weak, they have been flat on the whole recently, despite the significant decline in crude oil
prices (Chart 11). In addition, it is important to analyze firms' and households' views on
prices upon which they engage in economic activities. Since the turn of the fiscal year, firms'
price-hiking behavior has been increasingly conspicuous. At the same time, households have
come to accept price increases as well, against the backdrop of actual and prospective
increases in their income. The increases reflect rises in wages, including base pay, which
took place at many firms. This makes a striking contrast with the episode that occurred last
April, when many firms attempted to raise their sales prices, only to back off rather quickly as
demands faltered, perhaps because this move coincided with the consumption tax hike. As
firms' and households' views on prices have changed clearly, especially since the turn of the
fiscal year, a positive feedback between the increase in wages and the moderate rise in
inflation is now firmly in place on the back of record profits.
Relationship between wage increases and inflation
I would like to elaborate on the relationship between wage increases and inflation of goods
and services. Our experience shows that wage increases have been moving almost in
parallel with inflation of goods and services (Chart 12). It often is said that, if wages do not
match up with inflation, real income will decrease, thereby exerting negative effects on
consumption. However, such developments, if they occur at all, will not last for long, at least
in the economy as a whole. This is because, if they were to occur, consumption will
decrease, making it difficult for firms to keep raising prices. In turn, if wages increase, firms
will be urged to raise their sales prices in order to secure their profit margins, leading to
higher inflation. Thus, there are only two scenarios in reality: either both wages and prices
increase or neither wages nor prices increase. Wage increases and price rises are two sides
of the coin, so to speak. QQE, which the Bank has been pursuing, is not intended to
engineer increases merely in prices by any means. But rather, it is designed, in accordance
with the mechanism of the economy, to realize a moderate inflation being accompanied with
wage increases.
Looking ahead, as the Bank pursues QQE and the observed inflation rate rises, medium- to
long-term inflation expectations are also likely to follow an increasing trend and gradually
converge to around 2 percent - the price stability target. Accordingly, firms' wage- and
pricesetting behavior is expected to be more proactive, and inflation rates are likely to gradually
rise accompanied by wage increases.
The year-on-year rate of change in the CPI for all items less fresh food is likely to be about
0 percent for the time being, due to the effects of the decline in energy prices and, as the
underlying trend in inflation steadily rises and the effects of the decline in crude oil prices
dissipate, the rate of increase is expected to accelerate toward 2 percent - the price stability
target. Although the timing of reaching around 2 percent depends on developments in crude
oil prices, it is projected to be around the second half of fiscal 2016, assuming that crude oil
prices will rise moderately from the recent level. As shown in the October 2015 Outlook
Report, the projected rates of increase in the CPI for fiscal 2015, 2016, and 2017 are
0.1 percent, 1.4 percent, and, excluding the direct effects of the scheduled consumption tax
hike, 1.8 percent, respectively (Chart 1). Compared to the projections in the July 2015 interim
assessment, the projected rates of increase in the CPI for fiscal 2015 and 2016 are lower
due mainly to the effects of the decline in crude oil prices, but the projection for fiscal 2017 is
more or less unchanged.
III. Risk factors regarding the outlook for economic activity and prices
I have so far explained the baseline scenario regarding the outlook for economic activity and
prices. However, there are various uncertainties surrounding the economy, and I would like
to touch on the risk factors that can affect the outlook for economic activity and prices.
The most important risk factor with regard to the outlook for economic activity is the
slowdown in emerging economies, particularly in China. The Chinese economy is currently in
the transition process from investment-driven high growth to consumption-driven stable
growth. The industrial structure is also shifting from one centered on manufacturing to one on
nonmanufacturing. It is in this context that economic activity in manufacturing has been
sluggish recently, whereas that in nonmanufacturing maintains its robustness (Chart 13).
With regard to short-term developments, the pace of increase in spending by local
governments, whose deceleration was one of the sources of sluggishness in the Chinese
economy in the first half of this year, has accelerated recently, due partly to instructions by
the central government and the measures taken to facilitate the financing of local
governments (Chart 14). It therefore is expected that the growth rate in China will accelerate
toward next year.
That said, we have to bear in mind the risk that the structural problems, such as excess
capacity in steel, automobiles, and other industries, will be protracted in the transition
process toward stable economic growth. There is also an uncertainty about the impact of
fiscal stimulus, depending on its composition, on boosting the economy. Even if the growth
rate in China picks up, its impact on other economies in East Asia should be carefully
assessed (Chart 15). In China, the relative weight of nonmanufacturing has been on the rise,
and even within the manufacturing sector, domestic production of manufactured parts and
products with high value-added, which were mostly imported previously, has been
increasing. Against this background, the effects of the economic growth in China stimulating
exports of other countries in East Asia via a trade channel have been getting smaller. Taking
this into account, there remains uncertainty about the impact of the positive spillover from the
recovery of the Chinese economy on other economies in East Asia.
As I described earlier, the slowdown in emerging economies already has been exerting
downward pressure on Japan's exports and production, which already is incorporated in the
baseline scenario. If the slowdown in emerging economies is within the range of our
assumption, notwithstanding its negative impact, Japan's economy is expected to continue to
grow, reflecting the steady increase in domestic demand and the positive impact of the
decline in energy prices on real income. However, if the slowdown in emerging economies
becomes much deeper than expected or prolonged, the negative impact on Japan's
economy accordingly will be larger. What matters most is the impact on the business
confidence of Japanese firms. If firms start to downsize their fixed investment plans or wage
increases against the backdrop of increasing concerns over the developments in emerging
economies, this will have a negative impact on the steady increase in domestic demand.
Although this is currently one of the risk factors rather than a probable scenario, we are
mindful of it.
When it comes to the impact on prices, the focal point is the developments in wage increases
toward next fiscal year. As I described earlier, the rates of increase in wages and in prices
move almost in parallel in the long run, and the underlying trend in inflation already has
shown a clear improving trend. In order to maintain the real wages and income of
households, it is important for the underlying trend in inflation to be reflected in wage
increases, notwithstanding the recent seeming decline in the rate of change in inflation. In
the baseline scenario, wage increases that are consistent with the trend inflation are
expected. We are mindful of a downside risk, however, of firms becoming more cautious with
regard to wage increases against the backdrop of uncertainties regarding developments in
overseas economies, particularly emerging economies. There is also a downside risk that, in
the case of insufficient wage increases, consumers will become more resistant to price
increases on goods and services, pushing down the pace of inflation.
IV. Challenges toward overcoming deflation
Japan's economy has been improving steadily toward achieving the price stability target of
2 percent, but it is only halfway through and due attention needs to be paid to risk factors
including developments in emerging economies. In my concluding remarks, I would like to
touch on the challenges toward overcoming deflation and achieving the price stability target
of 2 percent, particularly those of firms' behavior and monetary policy.
As I described earlier, firms are now enjoying record profits and the labor market can be
considered to be in a situation of full employment. In light of the mechanism of the economy,
under such favorable circumstances, firms are expected to increase business fixed
investment for their future growth, and to raise wages to secure the labor force needed for
the further expansion of business and production. Indeed, they continue to show a positive
stance toward fixed investment, and wages have been rising moderately, including base pay
increases. At the same time, however, the data to date give us an impression that the pace
of increase in fixed investment and wages is not at a high enough level in light of record
profits. The fact that firms are still restrained from spending amid a high level of profits is also
evidenced from the ample cash they hoard, which has accumulated to an even higher level
(Chart 16).
One of the reasons behind such restrained behavior of firms - exemplified by record profits
mostly being used just to build up already ample cash rather than being used for fixed
investment and wages - is that the deflationary mindset of firms still has not necessarily
been removed. From a different perspective, firms tend to see the current high level of profits
as windfall profits, being only transitorily helped by the current benign circumstances, and
thus they restrain from taking advantage of them.
Given that Japan's economy has been mired in deflation for a long period of time, it is never
easy to get out of such a situation and dramatically change firms' persistent mindset. But the
direction is clear. Firms should be strongly encouraged to devise a new strategy that fits with
the post-deflation era based on the prospect of Japan's economy overcoming deflation. In
light of this prospect, firms' forward-looking actions, which were not sufficiently rewarded in
the deflationary period, look quite promising. Firms should recognize that, without such
actions, it will be difficult to generate profits in the future and to increase firms' value. Not all
firms need to change at the same time. The more firms start to act in view of such a
prospect, the more vibrant the economy will become. Some forward-looking firms have
started to act already, and they will be rewarded in the end if such actions become
widespread.
The Bank of Japan will definitely and decisively play its role to make this happen. For these
past two and half years, the Bank has strongly committed to achieving the price stability
target of 2 percent and has been pursuing QQE. Japan's economy has been improving
steadily toward achieving the target. The Bank will continue the unprecedented large-scale
monetary easing to achieve the target. As I explained, the Bank currently is of the view that
the price stability target of 2 percent can be achieved through continuation of the current
policy. At the same time, the Bank will continue to carefully assess economic activity and
prices, recognizing downside risks to them, including the effects of the slowdown in emerging
economies. The Bank will make the most appropriate policy decisions by scrutinizing the
current situation of economic activity and prices and their outlook, various risk factors, and
developments in financial and capital markets at every Monetary Policy Meeting. Let me
reiterate that the Bank will make adjustments without hesitation if judged as necessary to
achieve the price stability target of 2 percent at the earliest possible time.
Thank you.
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