Sayuri Shirai: Japan's economic activity, prices, and monetary policy -
monetary policy in the past and present
Speech by Ms Sayuri Shirai, Member of the Policy Board of the Bank of Japan, at a meeting
with business leaders, Asahikawa, 13 June 2013.
* * *
I. Introduction
Good morning. It is a great honor to have this opportunity to visit Hokkaido and meet
representatives of the city of Asahikawa. It is my first time to visit this place, so I am really
looking forward to learning from you about this region through an exchange of views. In
addition, I would like to express my sincere gratitude for your cooperation with the activities
of the Bank of Japan's local office in Asahikawa and Sapporo Branch.
As you may know, the Bank introduced a new monetary policy called Quantitative and
qualitative monetary easing (QQE) at the Monetary Policy Meeting (MPM) held on April 3
and 4, 2013. And I would like to examine this new policy here today. Let me first briefly
outline the sequence of my speech. In the next section, Section II, I will explain the Bank's
outlook for economic activity and prices in Japan on the basis of the Outlook for Economic
Activity and Prices (hereafter the Outlook Report). Then, I would like to consider QQE
- whose expected effects are incorporated in the Outlook Report - by focusing on the main
features of this new policy. In Section III, I will review the previous policy - Comprehensive
monetary easing (CME) - to facilitate an understanding of the essence of QQE, and I will
also introduce my related proposal, which was presented at the March MPM. In Section IV,
I will discuss my views and suggestions on the Outlook Report. Following my speech, I am
looking forward to receiving your candid opinions about the content of my speech as well as
the situation of the local economy.
II. Economic activity, prices, and the new monetary policy
I will begin my presentation by describing the Bank's outlook for economic activity and prices
presented in the Outlook Report released in April. After that, I will explain the features of the
new monetary policy and the transmission mechanisms.
A. Outlook for economic activity and prices
In the light of recent developments in economic activity and prices, Japan's economy has
been picking up. It is likely to return to a moderate recovery path around mid-2013, mainly
against the background that domestic demand remains resilient due to the effects of
monetary easing as well as various economic measures, and that growth rates of overseas
economies gradually pick up. Thereafter, while the economy will be affected by the
frontloaded increase and subsequent decline in demand prior to and after the two scheduled
consumption tax hikes, it is likely to continue growing as a trend from fiscal 2013 toward
fiscal 2015, at a pace above its potential, as a virtuous cycle among production, income, and
spending is maintained (Chart 1).
Regarding prices, the year-on-year rate of change in the consumer price index (CPI; all items
less fresh food) has recently been around 0 percent or slightly negative. The outlook for
prices as measured by the year-on-year rate of change in the CPI - excluding the direct
effects of the consumption tax hikes - is expected to follow a rising trend; as such, it will
reflect factors such as the improvement in the output gap (the difference between actual and
potential GDP) as well as the rise in medium- to long-term inflation expectations. According
to the "median" of the Policy Board members' forecasts, the CPI inflation is likely to reach
about 2 percent toward fiscal 2015 (Chart 2). Chart 2 indicates the rate of change in prices
with and without the effects of the consumption tax hikes.1 The output gap is expected to
follow a moderate improving trend (Chart 3). Moreover, as a tightening of labor market
conditions is expected to become evident, nominal wages are likely to see gradual upward
pressure (charts 4 and 5). In addition, some indicators suggest a recent rise in medium- to
long-term inflation expectations (Chart 6). These expectations are likely to continue on a
rising trend under QQE and the pace of increase may accelerate - especially after the actual
rate of price change turns from negative to positive this year, gradually converging to around
the 2 percent target. Import prices are also expected to continue rising during the projection
period (fiscal 2013-2015), reflecting upward pressure for the time being from developments
in the foreign exchange market and assuming that international commodity prices will follow
a moderate rising trend in line with global economic growth.
B. Upside and downside risks to Japan's economy
With respect to the upside and downside risks to the Bank's aforementioned baseline
scenario for economic activity, the following five factors were examined: (1) developments in
global financial markets; (2) performance of overseas economies; (3) firms' and households'
medium- to long-term growth expectations; (4) the extent of the front-loaded increase and
subsequent decline in demand prior to and after the consumption tax hikes; and (5) fiscal
sustainability in the medium to long term. Following a review by the Bank, these risks were
assessed as being "balanced," although uncertainty remained high, including that regarding
developments in overseas economies (Chart 7). As for upside and downside risks specific to
prices, the following uncertainties were examined: (1) developments in firms' and
households' medium- to long-term inflation expectations; (2) the responsiveness of prices to
the output gap; and (3) developments in import prices reflecting fluctuations in international
commodity prices and foreign exchange rates. After the Bank examined these matters, it
assessed that the risks on the price front as "largely balanced"; however, considerable
uncertainty surrounds developments in medium- to long-term inflation expectations (Chart 7).
Regarding these risk assessments, my personal views will be explained in Section IV.
C. Quantitative and Qualitative Monetary Policy (QQE)
Next, I would like to consider QQE, which was introduced at the MPM held on April 3 and 4.
The aforementioned Outlook Report certainly reflects the projected effects of the new
monetary policy. QQE was adopted after analyzing the effectiveness and limitations of the
previous CME, and the aim was to maintain the 2 percent price stability target adopted in
January 2013 under CME. This will be explained in detail in Section III. Here, I would like to
examine the four main aspects related to QQE.
Aspect 1: Increase in purchases of Japanese Government Bonds (JGBs) and
extension of their maturities
The first characteristic of QQE is the purchase of JGBs as the most important tool toward
achieving the 2 percent price stability target at the earliest possible time. The integration of
JGB purchases under a regular purchase operation (informally called the Rinban operation)
with the Asset Purchase Program was finally achieved, as explained in Section III. Moreover,
the average remaining maturity of the Bank's JGB purchases was decided to be extended
from the current level of slightly under three years (after integrating the two operations) to
about seven years (six to eight years) by purchasing JGBs with maturities of up to 40 years;
this was done to exert further downward pressure on the whole yield curve (Chart 8). The
yearly pace of increase in the amount outstanding of JGBs held by the Bank was set at about
50 trillion yen, and it will continue over two years, thereby doubling the amount outstanding
from the end of 2012 to the end of 2014 (Chart 9). I believe that these changes constitute a
considerable departure from previous practices both in terms of "quantity" (based on the size
of the program) and "quality" (based on the maturity length).
Aspect 2: Increase in purchases of risk assets
The second characteristic of QQE is an increase in the purchase of two risk assets -
exchange-traded funds (ETFs) and Japan real estate investment trusts (J-REITs).
Considering the market size and the risk volume borne by the Bank, the yearly purchase
amount was set at 1 trillion yen and 30 billion yen, respectively, over two years. This would
double the amount outstanding of ETFs from the end of 2012 to the end of 2014. Regarding
CP and corporate bonds, it was decided to maintain the amounts outstanding of these
holdings given the already low levels of risk premia (expected excess returns demanded by
investors relative to safe assets) after the decision in January.
Aspect 3: Emphasis on inflation expectations and adopting the "quantity" target
Third, QQE emphasizes the expectations of markets, firms, and households - particularly
medium- to long-term inflation expectations - as one of the most important channels for
achieving the 2 percent target. This feature draws a clear line between QQE and the
previous CME. If firms and households expect inflation to rise in the medium to long term,
that may positively affect the current levels of sales prices and wages. Moreover, as long as
the pace of increase in inflation expectations exceeds that in long-term nominal interest
rates, long-term interest rates in real terms will decline and thus support an accommodative
monetary environment. I will touch on the concept of inflation expectations later.
Let me add a few more comments on this issue. As described in Section III, the Bank
previously held the view that it might take some time to achieve the 2 percent target; this was
because (1) firms and households are accustomed to past low-price movements and
(2) collective efforts are necessary to strengthen potential economic growth and hence
inflation expectations. I still take this view. The important point here, however, is that there is
no time like the present. For example, the Japanese government has adopted stimulative
measures in addition to making ongoing reconstruction efforts while expressing the clear
determination to raise potential economic growth through various strategies. Expectations of
stronger monetary easing since the end of 2012 have already favorably affected some
markets, including the exchange rate, stock, and J-REIT markets. Firms and households
have a more positive outlook for the economy. In this favorable environment, I believe that it
may be possible to accelerate the pace of rise in medium- to long-term inflation expectations
in a stable manner by adopting a bold monetary policy. At the same time, I honestly feel that
the Bank should maximize its monetary easing measures to demonstrate its strong
determination to conquer deflation.
The next question is how to raise medium- to long-term inflation expectations. For this
purpose, the Bank decided to change the main operating target for money market operations
from the uncollateralized overnight call rate (i.e., interest rates) to the monetary base (i.e.,
"quantity"). There are several reasons for adopting the monetary base, which comprises cash
(banknotes and coins in circulation) and reserve deposits (financial institutions' current
account deposits with the Bank). Using the monetary base, it is intuitively easier for the
public and market participants to grasp the essence of monetary easing: an increase in the
"quantity" can easily be connected to a large-scale supply of cash, thereby creating an image
of inflation. In addition, the monetary base is often used in financial markets as a reference
for measuring the scale of monetary easing across central banks. Moreover, the monetary
base is a basic concept presented in macroeconomic textbooks, and so it is globally known.
Finally, changing the main operating target effectively signals a change in the monetary
policy framework. Thus, it was decided that the monetary base should rise at an annual pace
of about 60-70 trillion yen over two years; this would double the amount outstanding from
138 trillion yen at end-2012 to about 200 trillion yen at end-2013 and further to 270 trillion
yen at end-2014 (Chart 9). The last figure would account for nearly 60 percent of nominal
GDP - far above the levels of other advanced economies.
Aspect 4: Effective communication strategies
The fourth characteristic of QQE is that the Bank uses the number "two" a great deal:
2 percent price stability target; a time horizon of about two years; doubling the monetary
base and the amounts outstanding of JGBs and ETFs; and doubling the average remaining
maturity of JGB purchases. The Bank does so to send a clear message about the new
framework and its strong determination to achieve the 2 percent target. Indeed, positive
reactions have been received both domestically and abroad regarding the clarity of the new
communication strategy. Nonetheless, I personally believe that there is still room for
improvement in terms of communication strategies, as described in Section IV.
D. Transmission mechanism for achieving the 2 percent target under QQE
Impact on economic activity and prices
Regarding the transmission mechanism of monetary easing on economic activity under
QQE, several channels have been considered. With the first channel, the purchase of assets
continues to exert downward pressure on long-term nominal interest rates and the risk
premia of risk asset prices (Chart 8). This channel would contribute to increasing firms'
business investment, households' durable consumption and residential investment by (1) a
decline in the funding cost of firms and households, (2) improvement in firms' balance
sheets, and (3) the wealth effect.
With the second channel, the continuation of JGB purchases by the Bank may encourage
financial institutions as well as institutional and individual investors to shift some of their
portfolios to risk assets; they would do so in the process of adjusting some of their asset
management policies away from deflation-oriented strategies. The so-called portfolio
rebalance effect is intended to promote some degree of risk-taking among a wide range of
financial institutions and investors, and it is necessary to energize Japan's economy. Some
of that risk money could be allocated to viable emerging, growing firms. The effects of the
first and second channels are expected to be greater than those envisaged under the
previous monetary easing policy, CME.
Regarding the third channel, increases in medium- to long-term inflation expectations are
expected to lead to a decline in long-term interest rates in real terms, thereby increasing
business investment by firms as well as residential investment and consumption of durable
goods by households. In addition, the anticipation of higher inflation may hasten these
investment and consumption activities. These three channels may lead to an expansion of
aggregate demand, an improvement in the output gap, and a rise in medium- to long-term
inflation expectations, thereby raising the rate of price changes.
Impact on long-term interest rates
So far, I have explained the transmission mechanisms of monetary easing with regard to the
impact on economic activity and prices. Now, I would like to review the impact of QQE from
the viewpoint of long-term interest rates. Generally, it is widely known that long-term interest
rates can be decomposed into two components: (1) the risk premia (such as term premium,
liquidity premium); and (2) the expected path of short-term interest rates, as shown in
Chart 8. Based on this understanding, the Bank's JGB purchases are expected to generate
downward pressure mainly on the risk premia and then on the expected path of short-term
interest rates (this latter effect is called the ''signaling effect''). Moreover, the Bank's
commitment to continue with QQE as long as it is necessary for maintaining the 2 percent
price stability target in a stable manner is also likely to enhance the downward pressure.
Meanwhile, an improvement in the economic outlook and a gradual rise in medium- to
longterm inflation expectations may lead to an increase in the expected path of short-term
interest rates. This path may also be influenced by a rise in overseas long-term interest
rates, which reflects improvement in overseas economies. The downward pressure is also
observed in other countries, including the United States, which have purchased financial
assets under the nontraditional monetary policy.
Developments in long-term interest rates since the adoption of QQE reflect those downward
and upward pressures. As for the outlook, even in the phase of intensified upward pressure,
the continuation of the large-scale asset purchases is likely to maintain that downward
pressure, and it may even reinforce that pressure with the cumulative growth of the amount
purchased - in addition to the commitment to achieve the 2 percent target in a stable
manner. These effects, together with a gradual rise in medium- to long-term inflation
expectations, are likely to be reflected in long-term interest rates, which would eventually
stabilize at levels consistent with the 2 percent price stability target. Moreover, the Bank
continues to closely monitor market developments within a flexible operational framework
and through discussions with market participants, and it expects that both short- and
longterm interest rates will move largely on a stable path.
E. Why are inflation expectations so important?
To achieve the 2 percent target, it is important to consider the positive relationship between
the rate of price change and the output gap - a relationship known as the Phillips curve. It is
expected that the curve will steepen and shift upward as inflation expectations rise
(Chart 10). As these expectations grow, firms may find it easier than before to reflect
changes in the output gap and production cost in their sales prices, thereby contributing to a
steepening of the Phillips curve. At the same time, an upward convergence of inflation
expectations toward the 2 percent level is likely to shift the curve upward. Currently, there is
active debate among Japanese economists as to whether the curve will shift upward as the
Bank expects or remain flattened, since flattening of the curve is observed in many advanced
economies. This issue will be addressed in Section IV.
Factors contributing to flattening of the Phillips Curve
In the case of Japan, some have pointed out that deregulation (for example, in distribution
and telecommunications), intensified competition in the domestic and foreign markets as well
as the financial crisis and associated plunge in domestic demand since the second half of the
1990s have exerted constant downward pressure on corporate margins and wages.
Consequently, firms, supermarkets, and large discount stores began to set their sales prices
according to their competitors' - rather than in response to the output gap or cost
developments. The active use of online shopping has also accelerated this kind of
pricesetting behavior. The smaller the size of the firm, the lower is its capability to negotiate prices
with its client firms, which makes it difficult to transfer the input cost to the final sales prices.
This phenomenon is also evident in the Bank's March 2013 Tankan (Short-Term Economic
Survey of Enterprises in Japan). This can be referred to as firms' price-setting behavior in a
deflationary environment.
Furthermore, medium- to long-term inflation expectations dropped sharply mainly in the
1990s (Chart 11). There is a view that the long-standing negative output gap (or demand
shortage), limited structural reforms - particularly in various nonmanufacturing sectors - and
slow supply responses extended the period of sluggish productivity growth. This helped
lower the medium- to long-term growth expectations of firms and households, thereby
depressing their inflation expectations (Chart 6). Moreover, it could be said that the
prevalence of the zero lower bound, as explained in Section III, weakened the effectiveness
of monetary easing and thus contributed to lowering medium- to long-term inflation
expectations.
Converging to the 2 percent medium- to long-term inflation expectations
A number of other advanced economies successfully lowered their medium- to long-term
inflation expectations from the high levels in the 1990s, and those expectations gradually
converged to more or less 2 percent. Such a decline also coincided with a drop in actual
inflation. There is a consensus among central banks that this phenomenon is closely
associated with the establishment of central bank independence and the adoption of inflation
targeting (or a framework to emphasize price stability). In the case of the United Kingdom, for
example, the Bank of England (BOE) adopted inflation targeting in 1992, with the initial target
being set in the range of 1-4 percent. The target was subsequently changed to 2.5 percent in
1997 and further to 2 percent in 2004.2 Chart 12 shows that the medium- to long-term inflation
expectations in that country converged to around 2.5 percent in the 1990s and have been
around 2 percent since 2004. For the United Kingdom and the United States, which have
been successfully stabilizing those expectations at around 2 percent, the current view is that
expectations should be maintained at the current stabilized level. This issue will be brought
up again in Section III.
Given that inflation expectations remain low in Japan, what the Bank is trying to do is to raise
those expectations toward around the 2 percent level, which is comparable to that of other
advanced economies. In this process, the Phillips curve could become steeper and shift
upward as inflation expectations and firms' price-setting behavior change.
III. The previous Comprehensive Monetary Easing (CME) and my proposal at the
March MPM
A. What is a nontraditional monetary policy?
So far, I have explained the outlook for economic activity and prices as well as the new
monetary policy, QQE. After listening to my remarks, you may wonder why the Bank adopted
QQE, which represents a drastic leap from the previously adopted CME. To understand the
essence of QQE, it is necessary, I believe, to review the effectiveness and limitations of CME
as well as the factors that contributed to adopting the 2 percent price stability target in
January 2013 under CME. Moreover, I should explain clearly what factors and thoughts led
to my proposal at the March MPM and how they are related to QQE. That thinking was
substantially influenced by my having received many inquiries and responses from a wide
range of people domestically and abroad.
In general, monetary easing in a recessionary phase is conducted mainly through a reduction
in a very short-term nominal interest rate - namely the policy interest rate. In the case of
Japan, this refers to the uncollateralized overnight call rate. There are some cases, however,
where the policy interest rate drops to nearly zero, leaving limited room for further decline.
Japan faced this situation immediately after the collapse of Lehman Brothers in 2008.3
Under such a situation, CME attempts to create an accommodative monetary environment
by exerting downward pressure on longer-term interest rates, which remain in positive
territory despite the policy rate reaching nearly zero. For example, yields on JGBs often
function as the benchmark for measuring the long-term fixed interest rates related to
mortgages, loans, bonds, and so on. Therefore, downward pressure on JGB yields is likely to
contain funding costs, which makes it easier for firms and households to increase their
economic activities. This policy - often called the nontraditional monetary policy under the
zero lower bound on interest rates - is also applied by other central banks, such as in the
United States and United Kingdom, where very short-term interest rates have declined to
nearly zero.
B. Basic features of CME
Under CME, which was introduced in October 2010, the policy rate was lowered from around
0.1 percent to around 0-0.1 percent, which amounted to adopting the so-called virtually
zerointerest rate policy. However, as already mentioned, the main element of CME was to
generate downward pressure on longer-term interest rates by purchasing JGBs (and
Treasury discount bills [T-Bills]), and not on short-term interest rates, which had already
declined significantly. In addition to the impact on the funding cost, the JGB purchases were
expected to generate downward pressure on the risk premia, thereby supporting the
foundation of risk asset markets. In addition, the wealth effect and portfolio rebalance effect
were considered. To enhance those effects, the Bank also purchased various risk assets
directly.
For this purpose, the Bank established the Asset Purchase Program (hereafter the Program)
on its balance sheet to purchase various financial assets. The assets purchased under the
Program covered JGBs (with remaining maturity from one to three years), T-Bills, CP,
corporate bonds, ETFs, and J-REITs. The Bank concentrated its purchases of JGBs and
T-Bills to exert downward pressure on longer-term interest rates in particular. The total
amount outstanding of the Program was increased gradually from an initial 35 trillion yen to
65 trillion yen at end-2012. The amount was scheduled to expand further to 101 trillion yen
by end-2013 and to 111 trillion yen by end-2014. Thereafter, the amount of 111 trillion yen
was to be maintained for an undefined period of time (Chart 13).
On the issue of the Program after 2014, I would like to provide some details. In January
2013, the Bank introduced the open-ended asset purchasing method, which was to start in
early 2014. This meant that the Bank would purchase financial assets of about 13 trillion yen
monthly - comprising about 2 trillion yen on JGBs, 10 trillion yen on T-Bills, and 1 trillion yen
on CP and corporate bonds - without setting any termination date. Based on this monthly
purchase, the amount outstanding of the Program was expected to rise by 10 trillion yen to
111 trillion yen in 2014. The amount outstanding of 111 trillion yen was scheduled to be
maintained from 2015 onward since the quantity of monthly purchased JGBs and T-Bills
would roughly meet their maturing totals.4 Regarding CP and corporate bonds, the amount of
1 trillion yen would be allocated from 2014 onward to roughly meet the maturing total.
With my talking about the Program in this way, you may wonder whether the Bank attached
more importance to the quantity of assets, rather than to exerting downward pressure on the
yields and risk premia. Indeed, the Bank regarded both as equally important. In other words,
although the Bank emphasized downward pressure on longer-term interest rates and the risk
premia as the primary purpose of CME, in practice the Bank strengthened monetary easing
by emphasizing the expansion of the quantity and committing to achieving that at any cost.5
C. Adopting the 2 percent price stability target
In addition to introducing the open-ended asset purchasing method, an equally important
policy decision was made in January 2013. Namely, the Bank finally adopted the 2 percent
price stability target in terms of the year-on-year rate of change in the CPI, and it committed
to pursuing monetary easing to achieve this target as early as possible.
Why was the 2 percent target adopted?
Before January 2013, the Bank's view on price stability - expressed as the price stability goal
in the medium to long term - was defined as being in a "positive range of 2 percent or lower";
the expression "1 percent for the time being" was also added. So why did the Bank not
simply adopt the 2 percent target from the outset? This was because the expression had to
cover diverging views (from lower to higher) of the Policy Board members with respect to the
appropriate level of medium- to long-term inflation. Moreover, adopting such an expression
was (1) to take into account past price movements (or price perceptions among households
and firms); and (2) to accommodate the view that a longer-term goal could be achieved in
conjunction with efforts to reinforce potential economic growth through various constituents,
including the government, the Bank, financial institutions, and firms. These factors implied
that it might take time to achieve the 2 percent target.
Therefore, the numerical value of 2 percent was not excluded - even before January 2013.
Nonetheless, I retrospectively take the view that the word "goal" (especially the connotation
of the related term medo, which was adopted in the Japanese version) and the ambiguous
references to the range held nuances of passiveness. As a result, the public and market
participants were not sure whether the Bank was ultimately pursing the 2 percent level or a
lower one and whether the Bank was firmly determined to overcome deflation. Against this
background, the adoption of the 2 percent target in January 2013 was very important since it
meant that these problems were finally eliminated. Furthermore, from the beginning of my
appointment as a member of the Policy Board, I have consistently advocated that medium- to
long-term inflation should be well above 1 percent. Therefore, I regard the adoption of the
2 percent target as a major achievement in the history of the Bank's conduct of monetary
policy.
Why was the 2 percent value appropriate?
Now, some of you may wonder why 2 percent was chosen as the medium- to long-term
target. Conceptually, price stability should refer to a situation of zero inflation or no change in
general prices. Why then should the Bank need to seek higher inflation? The main reason is
that, as explained in Section II, 2 percent is a widely shared goal among many central banks
in advanced economies as the medium- to long-term inflation target. The next question is
thus why central banks should choose the value of 2 percent. It reflects the fact that central
banks commonly believe it important to avoid the aforementioned zero lower bound situation,
in which there is limited opportunity for a further decline in the policy rate.
Global discussions on the 2 percent target
For your reference, I would like to briefly introduce recent global-level discussions on this
issue. In 2010, Dr. Olivier Blanchard, Economic Counsellor and Director of the Research
Department of the International Monetary Fund (IMF), pointed out that the U.S. economy had
been facing the zero lower bound since the global financial crisis began in 2008 and that it
was proving costly. If the U.S. economy had begun with higher average inflation and thus
higher short-term nominal interest rates when entering the recession, the Federal Reserve
could have lowered the interest rate more and thereby reduced the drop in output and
deterioration of fiscal positions. Dr. Blanchard subsequently suggested that a higher inflation
target up to about 4 percent could be pursued in normal times and that medium- to long-term
inflation expectations should be anchored at that level - up from the current level of
2 percent. Moreover, new research results have been released on this issue, and they
appear to support the higher inflation target.6
Recognizing this debate, at Chairman Bernanke's press conference held after the Federal
Open Market Committee in March 2013, one journalist raised the issue of increasing the
inflation target from 2 percent to a higher level to allow a further decline in interest rates. The
chairman then acknowledged that the U.S. economy faced the zero lower bound (despite the
2 percent goal) and stressed 2 percent inflation, not zero inflation, as the appropriate price
stability goal. He said, "if you have zero inflation, you're very close to the deflation zone, and
nominal interest rates will be so low that it would be very difficult to respond fully to
recessions. And so, historical experience has suggested that 2 percent is an appropriate
balance between the cost of inflation and the cost [of the zero lower bound]."7
Moreover, as Dr. Blanchard and Chairman Bernanke observe, it is generally viewed that
deflation is less desirable than inflation after considering the benefits and costs. If deflation is
prolonged, the sales unit price and wages tend to decrease (or such a deflation expectation
prevails), such that firms and households may find that funding costs are rising in real terms
- notwithstanding very low long-term nominal interest rates. Consequently, investment and
consumption activities supported by external funding could be discouraged, thereby possibly
dampening economic growth. Moreover, in the context of Japan, deflation may lead to
excessive appreciation of the yen, sluggish asset prices, and shortages in tax revenues;
thus, a deteriorating fiscal balance results.
D. Effectiveness and limitations of