Hiroshi Nakaso: Japan's economy and monetary policy
Speech by Mr Hiroshi Nakaso, Deputy Governor of the Bank of Japan, at a meeting with
business leaders, Shizuoka, 23 July 2014.
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Introduction
It is my pleasure to have the opportunity today to exchange views with administrative,
financial, and business leaders in Shizuoka Prefecture. I would like to take this opportunity to
express my sincerest gratitude for your cooperation with the activities of the Bank of Japan's
Shizuoka Branch.
In April last year, the Bank of Japan introduced quantitative and qualitative monetary easing
(QQE) to achieve the price stability target of 2 percent at the earliest possible time, with a
time horizon of about two years. More than one year has passed since the Bank introduced
QQE. Japan's economy has been on a path suggesting that the 2 percent price stability
target will be achieved as expected, although we are only halfway there. Today, before
exchanging views with you, I would like to explain economic developments at home and
abroad and give you my views on the outlook. I will then talk about the recent situation of and
challenges for the financial system. Lastly, I will talk about the economy in this region.
I. Current situation of and outlook for economic activity at home and abroad
Current situation of and outlook for overseas economies
Many of you might be interested in developments in overseas economies, since many
manufacturing and exporting firms are clustered in Shizuoka Prefecture. Therefore, let me
start by talking about developments in overseas economies. Overseas economies,
particularly advanced economies such as the U.S. and European economies, have been
recovering, although the economic performance of some emerging economies remains
lackluster. As for the outlook, overseas economies are likely to continue their moderate
recovery trend. The International Monetary Fund (IMF) expects global economic growth to
accelerate moderately to 3.6 percent in 2014 and 3.9 percent in 2015 (Chart 1). Looking at
individual countries or regions, the U.S. economy registered negative GDP growth in the
January-March quarter due partly to the unusually severe winter weather. However, since
spring, a number of economic indicators have rebounded, and the recovery trend in the U.S.
economy, led mainly by private demand, has become more pronounced. Looking ahead,
given that downward pressure on the economy through fiscal austerity will diminish and
accommodative financial conditions will be maintained, the pace of recovery is likely to
accelerate gradually. Recently, some have expressed the view that U.S. potential growth
seems to have declined somewhat, that is, that the United States is suffering secular
stagnation. However, at this stage there is no firm evidence to confirm this view and neither
the Federal Reserve (Fed) nor private sector economists have notably revised down their
forecasts for medium- to long-term growth rates (Chart 2).
Turning to the European economies, the European debt problem has yet to be fully resolved,
and the year-on-year rate of change in consumer prices in the euro area has been less than
1 percent for more than six months, giving rise to some concern over deflation. Moreover, a
potential risk factor is the situation in Ukraine and Russia, which warrants due attention. That
being said, as for the recent economic situation, household and business sentiment has
improved due in part to additional monetary easing by the European Central Bank (ECB),
with financial markets being stable. In fact, GDP in the euro area has registered positive
growth for four consecutive quarters. While the euro area economy is likely to continue
recovering moderately, the effects of structural problems such as the excessive debt I just
mentioned warrant due attention. The robustness of the financial system in the European
Union has been examined through the asset quality review (AQR) and stress tests, and the
results are scheduled to be released in October this year. The outcome of these
examinations holds the key to the outlook for the European economies.
The Chinese economy continues to grow steadily, although the pace of growth has become
somewhat slower than in the past. Looking at recent developments, real estate investment
has continued to decelerate, and the economy has faced downward pressure as authorities
have continued to pursue structural adjustments. That being said, the deceleration in growth
appears to have come to a halt due partly not only to the economic stimulus measures
implemented by the authorities since spring this year, but also to a pick-up in external
demand.
Meanwhile, what I am somewhat concerned about is the emerging economies, particularly
those in Asia. While one should be careful not to lump emerging economies together, since
their economic performance differs substantially across countries and regions, it seems that
the NIEs and the ASEAN economies will continue to lack growth momentum for the time
being (Chart 3). Because the NIEs and the ASEAN economies account for a large share of
Japanese exports and Japanese firms have a large number of production sites in these
economies, attention should be paid to the outlook for the Asian emerging economies
together with developments in global financial markets.
To summarize, it is expected that the Chinese economy will continue growing stably, albeit at
a slightly slower pace, and that - from a somewhat longer-term perspective - the recovery in
the advanced economies will gradually spread to emerging economies.
Current situation of and outlook for Japan's economy
Let me move on to developments in Japan's economy. While the economy has been affected
by the front-loading of and subsequent decline in demand due to the consumption tax hike, it
has continued growing at a pace above its potential as a trend. In the household sector, a
decline in private consumption following the front-loading of demand prior to the consumption
tax hike can be observed. However, the magnitude of the decline has been broadly in line
with expectations prior to the consumption tax hike and private consumption has remained
resilient, reflecting improvements in the employment and income situation. In this context, the
Regional Economic Report released by the Bank on July 7 reported the effects of the
consumption tax hike on private consumption across Japan, and all regions, including
Shizuoka Prefecture, have maintained their assessment that private consumption as a trend
has continued recovering. In the corporate sector, business fixed investment has clearly
increased against the backdrop of the improvement in corporate profits. The recently
released June Tankan survey (Short-Term Economic Survey of Enterprises in Japan)
indicates that developments in business fixed investment plans are favorable, even in the
manufacturing sector, which has been lagging.
While domestic demand remains firm, exports have recently been sluggish. The
sluggishness in exports is essentially due to the slow growth in overseas economies such as
the emerging economies, as explained earlier. In addition, temporary factors, such as the
effects of the unusually severe winter weather in the United States and the fact that firms
prioritized domestic shipments in response to the front-loading of demand prior to the
consumption tax hike, put downward pressure on exports until around early spring. However,
even taking these factors into account, the pace of recovery in Japan's exports has been
slower than in the past when considering the pace of recovery in overseas economies and
the exchange rate of the yen. In this regard, I would like to mention three points.
The first point is that, since the global financial crisis triggered by the collapse of Lehman
Brothers, global trade patterns have changed, and this may have had a negative effect
especially on Japan's exports. Looking at the decline in trade in advanced economies
immediately after the global financial crisis, Japan was one of the countries whose exports
declined the most, despite the fact that the fallout of the crisis on Japan's financial system
was relatively minor. It has been pointed out that this is due mainly to the fact that the decline
in global demand triggered by the financial crisis was particularly pronounced for high
valueadded products such as capital goods and durable consumer goods. As you know, high
quality, high value-added products are a strength of Japan's manufacturing sector. Reflecting
this fact, the decline in global final demand hit Japan's real economy, in particular the
manufacturing sector, harder than other countries. This fact may also be a reason for the
recent sluggishness of Japan's exports. During the recent recovery phase, global business
fixed investment has been notably slower to recover than in past recoveries, and this has
substantially affected Japan's exports. Recently, however, machinery orders statistics
suggests that external demand has been on an increasing trend. If global investment
demand starts to follow a recovery trend, this will accordingly have favourable effects on
Japan's exports.
The second point is that Japanese firms' global competitiveness has eroded, although there
are different views on this point, since the concept of global competitiveness itself is the
subject of considerable debate. Looking at exports from Japan by item, exports of IT-related
goods as well as capital goods and parts, in which Japanese firms have traditionally had a
competitive advantage, have been sluggish. While competition in markets for these goods
has intensified due mainly to the rise of emerging economies, there still remain many areas,
particularly in high value-added products, where Japanese firms retain global
competitiveness. In fact, quite recently, exports of IT-related goods, particularly parts for high
value-added products, seem to have been showing signs of a pick-up, which is a welcome
development.
The third point is the effect of the relocation of production overseas, particularly in the
manufacturing sector. It is clear that during the period when the Japanese yen was
overvalued, firms relocated production overseas and that this has resulted in structural
change. However, given the time lag between the decision to relocate production and the
actual subsequent shift of production, it seems likely that the correction of the overvaluation
of the yen will restrain the pace of the relocation of production overseas going forward.
Bearing these three points in mind, with global financial markets remaining stable and the
recovery of overseas economies, including business fixed investment, gaining strength, it
seems likely that the factors hampering Japan's exports will gradually disappear. Therefore,
real exports are expected to increase moderately. Of course, since exports as a whole have
yet to pick up, continued attention without undue optimism is warranted.
Based on the recent economic situations just outlined, the Bank at the Monetary Policy
Meeting held this month conducted an interim assessment of the outlook for economic
activity and prices through fiscal 2016 included in the Outlook for Economic Activity and
Prices (Outlook Report) released in April this year. The assessment concluded that the
outlook remained essentially unchanged from that in April. Namely, a virtuous cycle among
production, income, and spending has been in place, and Japan's economy as a trend is
likely to continue growing at a pace above the growth potential. The year-on-year rate of
increase in the consumer price index (CPI) after excluding the direct effects of the
consumption tax hike is likely to be around 11⁄4 percent for some time, and reach around
2 percent in or around fiscal 2015 (Chart 4).
Developments in prices and the Bank's monetary policy
Let me next talk about developments in prices. The year-on-year rate of increase in the CPI
(excluding fresh food) in April and May this year, after excluding the direct effects of the
consumption tax hike, registered plus 1.5 percent and 1.4 percent, respectively. Inflation
remains on a moderate upward trend even after the consumption tax hike. Recently, there
has been considerable focus on the monthly figures for the CPI. However, in terms of
achieving the price stability target, more important than the monthly figures is whether the
mechanism underlying the upward trend in inflation remains in place. The trend in inflation is
determined by two factors, namely, the output gap of the economy and inflation expectations.
With regard to the first factor, the unemployment rate and the active job
openings-toapplicants ratio have recovered to the levels prior to the global financial crisis, and the
capacity utilization rate has been increasing. The output gap seems to have recently
exceeded 0 percent, that is, the long-term average (Chart 5). As for the outlook, with the
economy expected to continue growing at a pace above its potential, the improvement in the
output gap is likely to exert upward pressure on trend inflation.
The second factor, inflation expectations, with which you may not be familiar, refers to the
extent to which people expect prices to rise in the future. In Japan, with deflation continuing
for nearly 15 years, the expectation that prices will not rise had taken hold. Breaking out of
the status quo and achieving the price stability target of 2 percent in a stable manner means
that firms' and households' behavior is based on the expectation of continued inflation of
around 2 percent. In this regard, there have been signs of changes in corporate behavior,
such as the fact that an increasing number of firms have raised base pay in the annual wage
negotiations this spring, and that some firms have changed their price-setting strategy from
putting priority on low prices to putting priority on quality and reflecting increases in costs in
sales prices. In fact, according to surveys of households, firms, and economists, as well as
market indicators, inflation expectations appear to be rising on the whole (Chart 6).
The QQE policy introduced in April last year aims to raise trend inflation by bringing about an
improvement in the output gap and encouraging a rise in inflation expectations with
largescale asset purchases and a clear commitment. The policy has been having its intended
effects. Under the Bank's large-scale purchases of government bonds, long-term interest
rates have been stable. At the same time, inflation expectations have been rising on the
whole, so that real interest rates - that is, nominal long-term interest rates minus the
expected rate of inflation - have declined, thereby stimulating private demand. As a result,
the output gap has improved and inflation has accelerated. Looking ahead, with this
mechanism at work, the year-on-year rate of increase in the CPI and inflation expectations
are expected to increase. As I mentioned before, Japan's economy is likely to achieve an
inflation rate of about 2 percent in or around fiscal 2015, and thereafter gradually shift to a
growth path that sustains such inflation in a stable manner. Therefore, the conquest of
deflation in Japan is now in sight. We are, however, only halfway toward achieving the price
stability target of 2 percent. The Bank will therefore continue with QQE, aiming to achieve the
price stability target of 2 percent, as long as it is necessary for maintaining that target in a
stable manner. But, as I have consistently said, if the outlook changes due to the
manifestation of some risk factors, the Bank will make adjustments without hesitation if it is
judged necessary for achieving the price stability target.
II. Current situation in and challenges facing the financial system
Let me next turn to the financial system.
For Japan's economy to achieve sustained growth, it is critical to enhance the functioning of
financial intermediation, through which the financial system supports the economic activities
of firms and households, while also maintaining the stability of the financial system.
In what follows, let me explain the current situation in and challenges facing the financial
system in terms of its stability and functioning.
At present, there are no significant problems concerning the stability of the financial system.
Japanese financial institutions as a whole have a sufficient capital base, and even if there
should be a large domestic financial or economic shock, the likelihood that financial
intermediation will be significantly impaired is very small.
However, at the global level, following the experience of the global financial crisis, there have
been calls to prepare for potential risks in international financial markets and the financial
system in order to prevent any shocks from spreading. Against this background,
requirements of financial institutions to ensure their soundness and improve their business
management have become more stringent. Both international financial regulations such as
Basel III and national regulations have been successively introduced and implemented, and
discussions have been ongoing that could lead to internationally active financial institutions
being required to hold more capital.
The Bank of Japan is deeply committed to the aims underlying this review of international
financial regulations, namely, to further strengthen the soundness and business
management of financial institutions and to further enhance the stability of the financial
system. At the same time, if such regulations excessively constrain financial institutions'
activities, this might hamper the smooth transmission of monetary policy effects or weaken
the ability to provide support to the economy from the financial side, which warrants due
consideration in designing specific regulations. In addition, the fact that institutions and
circumstances surrounding the financial system differ across countries should be borne in
mind. The Bank will actively participate in international discussions so that these will lead to
the formulation of appropriate regulations taking account of the aforementioned
considerations.
Let me next touch on the functioning of the financial system.
With economic activity and prices improving, firms' demand for funds has also been
increasing gradually and become more widespread in terms of industries and regions, and
financial institutions are trying to actively respond to such demand. In this respect, we at the
Bank judge that the financial system has been functioning steadily to encourage economic
recovery. At the same time, the financial system is expected to play a more important role in
supporting firms' and regions' initiatives to address the medium- to long-term challenges of a
declining and aging population.
I have heard that, also in this region, there are efforts to create new industries or industrial
clusters, taking advantage of technologies accumulated in the past and of the highly
developed transportation infrastructure. In addition, while the expansion of overseas
business by local firms can be regarded as hollowing out, such overseas activities will lead to
the growth of these firms through the expansion of sales networks and the greater
international division of labor, and will deepen ties between regional economies and
overseas economies, providing new business opportunities. I am convinced that regional
financial institutions' initiatives in new areas, such as supporting firms' innovation and
expansion of overseas business, will eventually lead to a revitalization of regional
economies.
Through its on-site examinations and off-site monitoring as well as seminars, the Bank will
stand ready to help financial institutions' initiatives to support firms in areas such as financial
business practices, risk management, and the development of effective frameworks.
Another topic I would like to touch on in relation to the functioning of the financial system in
Japan is the enhancement of payment and settlement services.
In order for Japan's economy to achieve sustained growth, it is critical to enhance payment
and settlement services in response to diverse settlement needs and globalized financial
services. One of the issues included in the government's revised growth strategy is the
enhancement of funds and securities settlement at financial institutions and firms, while
utilizing the extended operating hours of the Bank of Japan Financial Network System
(BOJ-NET).
The new BOJ-NET that the Bank has been developing should contribute to the revitalization
of financial markets and the enhancement of financial services, with financial institutions
making the most of the new BOJ-NET function. From this perspective, the Bank decided, for
the time being, to extend the operating hours until 21:00 from February 2016 for financial
institutions that hold current accounts at the Bank's head office. It is up to individual financial
institutions whether to use the new BOJ-NET during the extended operating hours and how
to make the most effective use of it.
In the process of examining the extension of operating hours, the Bank held a forum
involving major market players and industry representatives. At the forum, various innovative
ideas for taking advantage of the extended operating hours of the BOJ-NET were presented.
These ideas include the same-day settlement of corporate customer transfers from their
Asian bases to domestic bases and the same-day settlement of Japanese government
bonds (JGBs) used as collateral in cross-currency repo transactions in Europe.
Developing an infrastructure that will enable the settlement of the Japanese yen and JGBs,
anytime, anywhere, will support the globalization of the yen - a longstanding challenge -
from the settlement aspect. In providing financial and settlement services to firms that have
expanded their businesses to Asia, I hope that individual financial institutions will make the
most of the new BOJ-NET, leading them to further develop their own businesses.
Other issues included in the revised growth strategy are the real-time processing of
payments in bank transfers and the attachment of invoice information to payment messages.
The provision of settlement services is one of banks' core operations, and improvements in
its infrastructure can lead to the provision of new services by banks to their corporate
customers. I believe that the banking and industry community will discuss the specifics of
these issues, and the Bank - together with the government - will support such discussions.
Concluding remarks
In concluding, let me touch on the economy of Shizuoka Prefecture.
The economy of Shizuoka Prefecture has been recovering moderately. Against the backdrop
of a moderate improvement in the employment and income situation, the decline in private
consumption following the consumption tax hike has been broadly in line with expectations
and there have recently been promising signs of improvement. In addition, due mainly to the
good performance of businesses, business fixed investment has increased, while public
investment has been hovering at a high level. These developments are backed up by the
business sentiment indicator for the region in the June Tankan survey, and the economy in
the region is likely to continue its improving trend.
That being said, the recovery in Shizuoka Prefecture has been lacking vigor compared to the
rest of the country. This is due mainly to the decline in production and exports in the region.
Specifically, triggered by the yen appreciation in the wake of the global financial crisis, major
manufacturing industries, such as the transport equipment and electrical machinery
industries, have accelerated the relocation of production and, as a result, Shizuoka
Prefecture's manufacturing sector shipments have declined by about 4 trillion yen. Given this
change in economic structure, the business sentiment of small and medium-sized
enterprises remains generally gloomy.
Against this background, the imminent challenge facing Shizuoka Prefecture is to create new
industries to more than compensate for the decline in production and exports after the global
financial crisis. I am quite encouraged to hear that promising and ambitious initiatives have
already been launched.
These include, for example, plans for new industrial clusters in the prefecture. For example,
Pharma Valley in the east of the prefecture aims to gather firms from the medical and health
care industries, Food Science Hills in the center of the prefecture aims to gather firms in
industries related to functional foods contributing to the promotion of health, and Photon
Valley in the west of the prefecture aims to gather firms from the optical and electronics
industries. In addition, the Inland Frontier Policy aiming at inviting enterprises to areas along
the Shin-Tomei Expressway, which is less susceptible to disaster risks, has been launched.
Now is also a golden opportunity to promote the attractiveness of Shizuoka Prefecture as a
tourist destination, with its history and culture, to people at home and abroad. Mt. Fuji, the
most notable sight in Shizuoka Prefecture, was registered as a World Cultural Heritage in
June last year, and an event commemorating Ieyasu Tokugawa, who was the first Shogun of
the Tokugawa government and had a close relationship with Shizuoka Prefecture, 400 years
after his death, is scheduled for next year. Moreover, the Rugby World Cup 2019 and the
Tokyo 2020 Summer Olympic and Paralympic Games will be major events that are expected
to bring various business opportunities to the regional economy, including the use of game
stadiums, training camps for players and parties concerned, and accommodation for
spectators. I am looking forward to seeing how Shizuoka Prefecture will seize these
opportunities.
Needless to say, for these opportunities to bear fruit, even stronger coordination among four
groups of "players" is critical, namely, representatives of industries in the region, the
administration that links parties concerned at home and abroad, academics and research
institutions that provide the necessary technical seeds for the development of industries, and
regional financial institutions to support these activities from the financial side. In this regard,
the Council on an Industrial Growth Strategy for Shizuoka Prefecture, chaired by Governor of
Shizuoka Prefecture Heita Kawakatsu, was established in March this year, providing a
platform for the aforementioned four players to develop growth strategies for the region in a
unified fashion. I have learned that concrete measures toward achieving structural change
are scheduled to be compiled in autumn this year. I strongly hope that an effective growth
strategy will be formulated and initiatives will be implemented swiftly under the strong
leadership of related parties.
The Bank of Japan is striving to achieve stable growth of Japan's economy with QQE. In
pursuing QQE, it is essential to carefully examine regional economies, including the
performance of small and medium-sized firms, through the Bank's nationwide branch
network, including the Bank's Shizuoka branch. In this respect, information that is kindly
provided to us from industry and financial institutions in this region is invaluable. I would like
to continue to seek your cooperation with respect to research and other activities of the
Shizuoka branch.
I sincerely hope that the various initiatives in Shizuoka Prefecture will bear fruit and the
region will enjoy further growth in the future.
Thank you.
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