Masaaki Shirakawa: Japan's economy and monetary policy
Speech by Mr Masaaki Shirakawa, Governor of the Bank of Japan, at the Kisaragi-kai
meeting, Tokyo, 4 November 2010.
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Introduction
I am privileged to have an opportunity to speak before such a large audience. Having said
that, the timing of today's speech has become somewhat uneasy for me. The Policy Board of
the Bank of Japan has decided last week to bring forward the next Monetary Policy Meeting
to today and tomorrow to discuss and decide the principal terms and conditions for
purchases of exchange-traded funds (ETFs) and Japan real estate investment trusts
(J-REITs) with a view to starting such purchases promptly. Therefore, in my speech today,
based on the Outlook for Economic Activity and Prices released last week, I will talk about
the developments in the global economy, and then mainly about Japan's economic and price
developments and the Bank's "comprehensive monetary easing." While I make clear at the
beginning that there will be no information that implies the decision to be made at tomorrow's
Monetary Policy Meeting, I hope that my speech today will be of any use in enhancing your
understanding on economies at home and abroad, as well as on the Bank's monetary policy.
I. Developments in the global economy
The developments in the global economy since the failure of Lehman Brothers
I will start with the developments in the global economy.
The global economy plunged after the failure of Lehman Brothers in September 2008.
Behind that economic downturn were two factors. The first factor was a panicky contraction
of economic and financial activity due to the financial crisis triggered by the failure of Lehman
Brothers. That brought about acute effects on the economy. The second factor, which could
be said as more fundamental, was the unwinding of various excesses that had been
accumulated globally up to the mid-2000s mainly in the United States and Europe. That was
a disposal process of excesses such as excess debt in the household sector, excess
production capacity in firms, and impaired assets of financial institutions. Namely, the
process of repairing and adjusting balance sheets. During the repair and adjustment process,
spending activity of each economic entity will be restrained. Consequently, chronic
downward pressure will be exerted on the economy for a protracted period.
The global economy leveled out in the spring of 2009 and started to pick up, and that was
mainly because the first-mentioned acute symptom settled. Thanks to liquidity provision by
central banks and measures such as capital injections into financial institutions by the
governments, the panicky contraction of economic and financial activity calmed down. With
the settling of the acute symptom, the demand-boosting measures taken in each country in
response to the financial crisis became further effective and firms' moves toward inventory
restocking progressed. As a result, the global economy has been growing at an annual rate
close to 5 percent since the second half of 2009.
However, the recovery pace of the global economy has recently been slowing. As firms'
inventory restocking, which has been leading the recovery, has run its course, in advanced
economies, the effects of various demand-boosting measures have been waning. For
example, after the expiration of the homebuyer tax credits in June, the U.S. home sales have
been sluggish. In Japan, new passenger-car registration in October declined by about
30 percent, on a year-on-year basis, following the last-minute significant increase in demand
ahead of the expiration of subsidies for purchasing energy efficient cars. Emerging
economies have been still growing at a high rate, but the pace of growth has started to slow
somewhat. That slowdown in the pace of growth is partly attributable to the fact that, in
response to the increased upward pressure on general prices and residential house prices in
accordance with rapid economic growth, emerging economies have been making
adjustments to their accommodative monetary conditions. However, measures to restrain
overheating are necessary policy responses from the perspectives of restraining overheating
in economic activity and asset prices and ensuring sustainability of economic expansion. The
Bank judges that if sustainable growth in emerging economies is to be secured by those
measures, it will have favorable effects on the global economy in the long run.
Future of the global economy
While the pace of economic recovery has been somewhat slowing since the mid-year, the
Bank judges that the recovery trend in the global economy will be maintained. That view is
widely shared in many of the forecasts of international organizations and the private
institutions. For example, according to the world economic outlook by the International
Monetary Fund (IMF), the global economy is projected to grow at a relatively high pace of
more than 4 percent from 2011.
In that regard, it is, above all, emerging economies that are expected to play the role of
leading the global economy. There are several major reasons why a continued high growth in
emerging economies is expected. First, it can be pointed out that there has been strong
domestic demand from the beginning such as activation of consumption activity in
accordance with the improvement in living standards and the needs for establishment of
social infrastructure. A typical example is China. Urbanization has been rapidly progressing
in China, and the urban population in China has rapidly increased from 200 million to
600 million in the past 30 years. The number of the so-called "million cities" in Japan, a
country considered to have a high population concentration, was five in 1955, when the
highgrowth period began, or twelve at present. In China, the number already reached 190 cities
in 2008 and is expected to increase further in the future. Progress in urbanization generates
massive housing constructions as well as demand for establishing utilities including
electricity, gas, and water. The fact that expressways, which correspond to the total road
length of Japan's expressways, have been built almost annually since 2005 is also a typical
example showing the great demand for infrastructure in China. Therefore, emerging
economies have, potentially, a capacity to achieve a relatively high growth rate. Second, it
can be pointed out that the large-scale accommodative monetary policies in advanced
economies have led to an increase in capital inflows to emerging economies, thereby
accelerated the economic expansion in emerging economies.
Meanwhile, in advanced economies, the pace of recovery is likely to remain moderate for the
time being, since those economies are burdened by the balance sheet adjustments.
According to the IMF's world economic outlook, the contribution to the global growth was
60 percent by advanced economies and around 30 to 40 percent by emerging and
commodity-exporting economies until the 1980s and 1990s. The relationship between
advanced and emerging and commodity-exporting economies was reversed and became
30 percent by advanced economies and 70 percent by the others in the 2000s, and the
difference between the two groups of economies further widens in the projections for 2010
and 2011. Since such marked difference in the pace of future economic recovery between
advanced economies and emerging and commodity-exporting economies will have a
significant implication from a viewpoint of achieving sustainable growth of the global
economy, I will explain again later.
Uncertainty about the future of the global economy
As I have just explained, a baseline scenario shared by, for example, the Bank and
international organizations, is that the global economy is likely to maintain the recovery trend,
led mainly by emerging economies, and follow the sustainable growth path, but such
projection is associated with some uncertainties. Here, taking also into account the focus of
interest at recent international meetings, I will explain two points I think particularly important.
One is the uncertainty about the outlook for advanced economies and the other is, amid the
difference in the pace of recovery between advanced and emerging economies, the effects
accommodative monetary policies in advanced economies will have on the global economy
through capital flows.
Let me explain the first point.
As I mentioned at the beginning of the speech, from the second half of 2009 to early spring
2010, when the acute symptom after the failure of Lehman Brothers settled and the economy
was recovering rapidly, there were, from our point of view, somewhat optimistic views about
the future of the economy dominant in the United States and European countries. The
forecasts by international organizations and private institutions were constantly revised
upward and U.S. and European stock prices were on an uptrend. When looking at the yield
curve of interest rates in the U.S. dollar markets, up to early spring 2010, it factored in a
possibility that the Federal Reserve will raise the federal funds target rate by the end of 2010.
However, since the summer of 2010, triggered by a standstill in improvement in many
indicators of the U.S. economy, such as employment- and housing-related ones, a
pessimistic view spread that the balance sheet adjustments in the households and financial
institutions might continue for a considerable period and thus might substantially slacken the
pace of recovery in the U.S. and European economies.
The fact that resolving the balance sheet problems takes time is exactly what Japan has
experienced since the 1990s. Therefore, many in Japan including the Bank have seemed to
consider that the pace of economic growth in the United States and Europe, which were
burdened by balance sheet adjustments, might remain moderate. On the other hand, the
dominant view in the United States has appeared to be more optimistic about the effects of
the balance sheet adjustments compared with the views in Japan. Putting aside whether
such recognition was correct or not, a feeling that prompt and effective policy responses
have been implemented taking into account Japan's experience might also have been
behind such view. However, after looking at the ensuing sluggish developments in economic
activity, concern whether the economy might tumble into deflation or protracted stagnation
has started to be felt.1
Let me next explain the second factor that has induced uncertainty about the future of the
global economy, namely, amid the stark difference in the pace of recovery between
advanced and emerging economies, the effects of accommodative monetary policies in
advanced economies on the global economy through, for example, capital flows and foreign
exchange rates.
In many advanced economies, the pace of economic recovery has been sluggish and
inflation rates are projected to be lower than what is considered desirable. As a result, those
countries have been conducting accommodative policies. However, as advanced economies
at present are in the virtually zero interest rate environment while being burdened by balance
sheet adjustments, aggressive monetary easing will not lead to an increase in bank lending
and thus, in that regard, stimulus effects on the domestic economy will be unlikely. As a
result, it has been pointed out that accommodative monetary conditions in advanced
economies have probably induced an excessive capital inflow to emerging economies and
brought about risk-taking in those economies, and thus have become one of the reasons for
the overheating in those economies. It has also been pointed out by emerging economies
about a difficulty that, if they raise interest rates while advanced economies are continuing
with accommodative monetary policies, capital inflows to emerging economies will further
increase against the background of the interest rate differential, thereby offsetting the effects
of measures taken to restrain overheating of the economy.
There have also been various discussions concerning the policy conduct of emerging
countries. For example, if an emerging country's foreign exchange system lacks sufficient
flexibility and its foreign exchange rate is maintained at low levels compared with economic
fundamentals, that could, together with the effects of capital inflows from advanced
economies, excessively stimulate economic activity in that emerging country, thereby
resulting in generating economic and financial excesses and their unwinding over time. In
such a case, both emerging and advanced economies would be affected in the form of
destabilization in the economy. In addition, the issue of correcting unsustainable current
account imbalances has been discussed as a global challenge. In the situation where the
foreign exchange rates, which should serve as one of the adjusting valves to cope with such
imbalances, lack flexibility, it could become a factor in delaying the necessary adjustments.
At the G20 meeting of Finance Ministers and Central Bank Governors held in October at
Gyeongju, Republic of Korea, it was confirmed that, for the global economy, with an uneven
pace of recovery among countries, to achieve a sustainable and balanced growth, not only
efforts in macroeconomic policy but also those in regulation and structural reform would be
necessary. The policy authorities in each country are required to carefully examine economic
and price developments in each country or region and take necessary measures to achieve
their stability. While it may seem to stating the obvious, I emphasize two points about its
implications. One is, the policy authorities in each country have, after all, responsibility for the
stability of their own economy. The other is, due to the advancements in the globalisation of
the economy and financial markets, the extent to which each country's economic and
financial conditions as well as policy conduct affect each other has increased. Thus, policies
that are supposed to be carried out to maintain the stability of domestic economic activity and
prices need to be implemented by recognizing the path in which such policies affect the
global economy and international financial markets and, in turn, affect again the domestic
economy. It seems to be becoming more important for both advanced economies and
emerging economies to consider the stability of their own economies in carrying out policies
while taking account of mutual spillover effects of their policies.
II. Japan's economic activity and prices
Taking into account the developments in the global economy, let me turn to Japan's
economic activity and prices.
Current state of the economy
On the back of an increase in exports and production due to the recovery in overseas
economies and the boost from policy measures targeted at durable consumer goods,
Japan's economy has been improving. Given the sharp drop after the failure of Lehman
Brothers, the pace of recovery has been considerably faster, compared with that in the
United States and Europe.
However, Japan's exports and production, which have been leading the improvement in the
economy, have recently been slowing. Exports were increasing at a pace of more than
40 percent, on an annual basis, since the spring of 2009, but the pace of increase became
moderate since the middle of 2010 due partly to the slowdown in overseas economies and
an inventory adjustment in information-related goods, and exports have become more or less
unchanged in the July-September quarter. The Bank judges that the current state of Japan's
economy is in the process of a gradual recovery following the rapid pickup since the spring of
2009, but, as I have just explained, the signs of improvement have been weakening due
partly to the slowdown in the pace of increase in exports and production.
Outlook for economic activity and prices, and associating risk factors
What is important here is how we can view the future of economic activity that once slowed.
The Bank released last week the Outlook for Economic Activity and Prices, the so-called
"Outlook Report." To put the conclusion of the Report first, the Bank views that, in the second
half of fiscal 2010, the pace of Japan's economic recovery is likely to slow temporarily due to
the factors such as the slowdown in overseas economies and the ending of the boost from
policy measures targeted at durable consumer goods, as well as the recent appreciation of
the yen. After entering fiscal 2011, albeit with some lingering effects of the yen's
appreciation, the economy is expected to return to the moderate recovery path, given that
exports are projected to continue increasing as the growth rate of overseas economies is
likely to rise again, and that firms' sense of excessive capital stock and labor is likely to be
dispelled gradually. Thereafter, in fiscal 2012, Japan's economy is expected to continue
growing at a pace above that in fiscal 2011, as the transmission mechanism by which the
strength in exports and production feeds through to income and spending, will likely operate
more effectively due to a continued relatively high growth in overseas economies, especially
emerging and commodity-exporting economies. Showing that in term of the midpoints of
Policy Board members' projection, Japan's economy is projected to grow annually at
2.1 percent in fiscal 2010, 1.8 percent in fiscal 2011, and 2.1 percent in fiscal 2012.
The key to the outlook for prices is not only the outlook for economic activity but also
developments in people's inflation expectations in the medium to long term. On this point,
judging from various surveys, no significant change has been observed and such inflation
expectations seem to have been stable. On that basis, the Bank considers that the
year-onyear pace of decline in the CPI excluding fresh food is expected to continue slowing as the
aggregate supply and demand balance improves gradually. However, given that the drop in
demand after the financial crisis was considerable and the pace of economic recovery has
been moderate, the pace of improvement in the supply and demand balance is likely to
remain moderate, and the timing of the year-on-year rate of change in the CPI entering the
positive territory is likely to be sometime in fiscal 2011. As the rate of growth for the fiscal
year, following 0.1 percent in fiscal 2011, the pace of growth is expected to increase to
0.6 percent in fiscal 2012. While taking some more time, Japan's economy is expected to
steadily move toward the sustainable growth path with price stability.
The outlook for economic activity and prices is associated with various risk factors. In
particular, in the area of economic activity, there are some upside risks including faster
growth in emerging and commodity-exporting economies. However, amid continued
heightened uncertainty about the future, especially for the U.S. economy, attention should
also be paid to downside risks to Japan's economy. Regarding the outlook for prices, there is
a possibility that inflation will rise more than expected mainly due to an increase in
commodity prices brought about by high growth rates in emerging and commodity-exporting
economies, while there is also a risk that the rate of inflation will fall due, for example, to a
decline in medium- to long-term inflation expectations. The Bank will carefully check,
including those factors, whether Japan's economy is steadily making strides to the
sustainable growth path with price stability.
III. Conduct of monetary policy
Let me turn to the Bank's conduct of monetary policy, taking into account the developments
in economic activity and prices at home and abroad.
The Bank recognizes that Japan's economy is faced with an extremely important challenge
of emerging from deflation and returning to the sustainable growth path with price stability.
Based on that recognition, the Bank has been making utmost contributions as a central bank
through vigorous policy responses based on the three-pronged approach of pursuing
powerful monetary easing, ensuring stability in financial markets, and providing support in
strengthening the foundations for economic growth.
In terms of pursuing powerful monetary easing, the Bank has lowered twice the policy rate,
which was at the lowest level in the world at 0.5 percent even before the failure of Lehman
Brothers. In addition, by increasing longer-term funds provision to financial institutions, the
Bank has been influencing directly the interest rates of longer terms of 3-month and 6-month.
As a result, Japan's interest rates have been stable at extremely low levels, compared with
those in the United States and Europe, and firms' funding costs have still been declining. In
terms of ensuring stability in financial markets, the Bank has been endeavoring to spread a
sense of security on the funding front in financial markets through, for example, providing a
large amount of liquidity. Moreover, from a viewpoint of strengthening the foundations for
economic growth, and to support voluntary efforts by firms and financial institutions toward
raising Japan's productivity, the Bank prepared a framework for providing funds up to four
years at a low interest rate equivalent to the policy interest rate, and has already been
implementing it.
Having said that, as I explained earlier, the signs of improvement in Japan's economy are
likely to wane and the situation in which the pace of economic improvement remains slow is
expected to continue for the time being. Uncertainty about the future, especially about the
U.S. economy, has also been high. In those circumstances, the Bank judged that it has
become more likely that the timing of Japan's economy emerging from deflation and
returning to the sustainable growth path with price stability will be delayed, and at the
beginning of October implemented "comprehensive monetary easing" to further enhance
monetary easing in a front-loaded manner. In order to pursue further accommodative effects
by means of monetary policy under the situation in which there is little room for further
lowering short-term interest rates, there is no way but to step into a new territory beyond that
of traditional monetary policy and to employ a wide range of policy measures in the Bank's
policy toolkit, thereby enhancing policy effects. On the basis of such thinking, the Bank has
decided to encourage a decline in longer-term market interest rates and a reduction in risk
premiums and at the same time to implement the following three measures as a package.
Change in the guideline for money market operations
As the first measure, the Bank changed the guideline to encourage the uncollateralized
overnight call rate from the previously set "at around 0.1 percent" to "at around 0 to
0.1 percent." In the future, if further ample liquidity is provided through the implementation of
the asset purchase program that I will explain later, there might be days when the
uncollateralized overnight call rate becomes substantially lower than 0.1 percent. To meet
the purpose of lowering longer-term market interest rates and reducing risk premiums
through comprehensive monetary easing, the Bank considered it effective to explicitly allow
such swings in the overnight call rate. Moreover, it will also serve to show further clearly that
the Bank has been adopting the virtually zero interest rate policy.
From a viewpoint of achieving monetary easing effects, it should be noted that an excessive
decline in the overnight rate could have adverse effects of inducing a decline in yield rates on
investments of financial institutions and investors and a decline in margins on interest rates,
thereby hampering the financial intermediation function. What the Bank is aiming at after all
is to prepare an environment in which the effects of monetary easing will be exerted to a
maximum extent.
By taking into account such viewpoints, the Bank judges that the current combination of
"around 0-0.1 percent" for the guideline for the uncollateralized overnight call rate and
0.1 percent for a complementary deposit facility is the most appropriate. Such combination of
the target interest rate and interest rate on reserves has also been introduced overseas. In
the United States, the Federal Reserve has adopted the combination of 0 to 0.25 percent for
the target range for the federal funds rate and 0.25 percent interest rate for financial
institutions' reserves.
Clarification of the policy time horizon based on the "understanding of medium- to
long-term price stability"
As the second measure, the Bank clearly stated that it will continue the virtually zero interest
rate policy until it judges that price stability is in sight.
Longer-term interest rates are affected substantially by the market's expectations concerning
how short-term interest rates will evolve in the future. The measure taken this time aims at
encouraging a decline in longer-term interest rates by influencing the market expectations on
short-term interest rates developments through clarifying the Bank's ideas of policy conduct,
which has significant effects on the formulation of short-term interest rates.
At the same time, the Bank also clarified that it will use the "understanding of medium- to
long-term price stability" (hereafter "understanding") as a criterion for judging whether price
stability is in sight. The "understanding" is the level of inflation rate that each of the nine
Policy Board members understands as being consistent with price stability over the medium
to long term, and is now illustrated as "on the basis of a year-on-year rate of change in the
CPI, it falls in a positive range of 2 percent or lower, and the midpoints of most Policy Board
members' understanding are around 1 percent."
Two effects can be expected from the second measure. First, by explicitly showing the
medium- to long-term inflation rate that the Bank has in mind in conducting its policy, there
would be effects of giving the people an indication about the future inflation rate and of
stabilizing medium- to long-term inflation expectations - an anchoring effect. Second, by
linking explicitly the medium- to long-term inflation rate deemed desirable with the conduct of
monetary policy, there could also be an effect of making the thinking of monetary policy
conduct clear.
Those views are common to the so-called inflation targeting. However, inflation targeting
tends to often invite, partly due to its naming, the impression that policy will be conducted by
merely focusing on the inflation rate. Being easy-to-understand is of course important, but, at
the same time, it is necessary to avoid falling into the so-called "pitfall of easy-to-understand"
by conducting monetary policy looking away from the complex structure of the economy.
Among central bankers and academics, discussions have already evolved from discussions
on the old-type inflation targeting that focuses only on short-term price stability to the
framework for "flexible inflation targeting," in which flexibility in policy conduct is enhanced,
and countries that actually adopted inflation targeting have been shifting toward
implementing a flexible policy framework. For example, in England, while the annual rate of
inflation based on the consumer price index is substantially higher than the inflation target of
2 percent and has been hovering above 3 percent since January 2010, the Bank of England
has not tightened monetary policy but rather been discussing further enhancing
accommodative monetary conditions.
On the back of the move not to focus too much on short-term price stability but to aim at
ensuring stability of economic activity and prices from a long-term perspective, there is bitter
experience of the past at home and abroad. For example, during Japan's bubble period in
the second half of the 1980s, consumer prices had been extremely stable and the average
year-on-year inflation rate of the five years was 1.0 percent. Also, through the mid-2000s in
the run-up to the recent global financial crisis, an optimistic assessment has spread in the
United States that the economy finally achieved an ideal combination of high growth and low
inflation and a phrase "Great Moderation" has been widely used to express such a situation.
However, as revealed a few years later, just when the phrase was used, financial
imbalances, such as an excessive rise in asset prices and excessive debt, which caused the
recent global financial crisis were accumulating.
In that regard, the Bank introduced a framework for assessing the economic and price
situation from two perspectives - a baseline scenario of the outlook for economic activity and
prices, and risk factors and, on that basis, it conducts monetary policy. The framework was
adopted by incorporating the merits of other countries' policy conduct frameworks, including
the aforementioned inflation targeting, and also paid due consideration to the demerits. And
thus, the Bank believes that its policy framework is a more advanced one for monetary
policy. Based on such line of thinking, the Bank, in clarifying the policy time horizon,
confirmed that the criterion for continuing the virtually zero interest rate policy is the
"understanding of medium- to long-term price stability," and the policy will be continued on
condition that no problem will be identified in examining risk factors, including the
accumulation of financial imbalances that could threaten economic and price stability from a
long-term perspective as the conditions.
Establishment of an asset purchase program
The third measure is to establish a program for carrying out, for example, asset purchases.
In order to aim at a decline in longer-term market rates and a reduction in various risk
premiums, the Bank decided this time to purchase a variety of financial assets. Specifically,
as a temporary measure, the Bank will establish a program on its balance sheet and
purchase various assets, such as government securities, commercial paper (CP), as well as
exchange-traded funds (ETFs) and Japan real estate investment trusts (J-REITs). The sum
of those assets to be purchased was set to be about 5 trillion yen. The total size of the
program, including the fixed-rate operation, was set to be about 35 trillion yen.
If the Bank's risk-taking asset purchases could activate the investment stance of market
participants and attract funds into the markets, it could work in the direction of reducing risk
premiums. The Bank intends to begin the purchases as soon as possible. As mentioned in
the beginning, the reason why the Monetary Policy Meeting was moved forward to today and
tomorrow is to promptly discuss and decide on principal guidelines for the purchase of ETFs
and J-REITs, which obtained the authorization by the government pursuant to the Bank of
Japan Act, and to lay out a framework that can begin the purchases as soon as possible.
The measures included in comprehensive monetary easing are extraordinary ones as
monetary policy instruments of a central bank, and the Bank is fully aware of that. A policy
measure to encourage a decline in longer-term interest rates and a reduction in various risk
premiums will be implemented for the first time, and, in particular, a policy to purchase risk
assets by a central bank itself shouldering, for example, credit risk is unprecedented in
central bank policies. That might lead to taxpayers' burden in case the purchases should
eventually make losses, and will expand the extent of central bank's involvement in micro
resource allocation for individual industries or firms. While it goes without saying that the
Bank devises ways to minimize such adverse effects as much as possible, still it cannot be
denied that the asset purchases are approaching from the realm of traditional monetary
policy of liquidity provision to the realm that has the character of fiscal policy to be
shouldered by the government. The Bank has thoroughly considered a grave issue of to what
extent those policies should be pursued based on a central bank's own independent
judgment in a democracy. Upon that consideration, the Bank has judged that, as a central
bank which has been bestowed from the public the authority to create money, it is required
as a responsibility to conduct more effective policies, if they can be devised, in a flexible
manner for the economic and financial stability.
The establishment of the Asset Purchase Program has been decided on the Bank's own
responsibility by taking into account such contradicting two factors and upon thorough insight
into the economic and price situation. Therefore, as for the asset purchase, the Bank decided
to bundle it into a program