Economic Activity, Prices,
and Monetary Policy in Japan
Speech at a Meeting with Business Leaders in Kochi
Yukitoshi Funo
Member of the Policy Board
I. Recent Economic and Price Developments
A. Overseas Developments
I would like to begin my speech by talking about overseas economies. The business
sentiment of manufacturing firms on a global basis has maintained its improving trend,
although it recently has deteriorated somewhat, and the world trade volume has continued
to recover. In this situation, overseas economies have continued to grow firmly on the
whole.
In terms of the outlook, overseas economies are expected to continue growing firmly on the
whole. According to the October 2018 World Economic Outlook released by the
International Monetary Fund (IMF), the global growth rate is projected to be 3.7 percent in
both 2018 and 2019.
Looking at developments by major region, the U.S. economy has been expanding. The
European economy has continued to recover, although its growth pace has decelerated
somewhat. The Chinese economy has continued to see stable growth on the whole. Other
emerging economies and commodity-exporting economies have been recovering
moderately on the whole, reflecting in particular an increase in exports and the effects of
those economies' stimulus measures.
As for the outlook, the U.S. economy is expected to keep expanding and the European
economy is projected to continue recovering. The Chinese economy is likely to broadly
follow a stable growth path as authorities conduct fiscal and monetary policy in a timely
manner. Other emerging economies and commodity-exporting economies are likely to
continue their moderate recovery on the whole.
Risk factors to the overseas economic outlook are wide ranging, as exemplified by (1) the
U.S. macroeconomic policies and their impact on global financial markets, (2) the
consequences of protectionist moves and their effects, (3) developments in emerging and
commodity-exporting economies, including the effects of the two factors I just mentioned,
(4) negotiations on the United Kingdom's exit from the European Union (EU) and their
effects, and (5) geopolitical risks. Uncertainty is particularly high regarding future
developments in trade policies worldwide, and therefore these developments warrant
attention. I hold the view that it is important to stay vigilant regarding these risk factors,
especially now that overseas economies are continuing to grow firmly on the whole.
B. Japan's Economy and Prices
1. Economic activity
I will now discuss the economic situation in Japan. The economy is expanding moderately,
with a virtuous cycle from income to spending operating. The real GDP growth rate
registered minus 0.9 percent for the January-March quarter of 2018 on an annualized
quarter-on-quarter basis, and thereafter marked 3.0 percent for the April-June quarter, which
was above the economy's potential growth rate.1 While the contribution of net exports on
real GDP growth has remained slightly negative, that of domestic demand has turned
positive.
With regard to the outlook, Japan's economy is likely to continue its moderate expansion. In
fiscal 2018, the economy will probably continue growing at a pace above its potential.
Namely, domestic demand is likely to follow an uptrend, with a virtuous cycle from income
to spending being maintained in both the corporate and household sectors, mainly against
the background of highly accommodative financial conditions and the underpinnings
through government spending. In Kochi Prefecture, given the favorable situation in
domestic demand, various measures have been taken such as events to commemorate the
150th anniversary of the Meiji Restoration, and it is expected that these events will increase
tourist numbers. In terms of Japan's exports, these are expected to continue their moderate
increasing trend, with overseas economies expected to grow firmly on the whole. In fiscal
2019 and 2020, Japan's economy is expected to continue on an expanding trend although
the growth pace is projected to decelerate due to a slowdown in domestic demand,
reflecting the effects of the scheduled consumption tax hike, cyclical adjustments in capital
stock, and Olympic Games-related demand peaking out.2 According to the October 2018
Outlook for Economic Activity and Prices (hereafter the Outlook Report) released by the
Bank of Japan, the medians of the Policy Board members' forecasts of the economic growth
rate are 1.4 percent for fiscal 2018, and 0.8 percent each for fiscal 2019 and 2020.
2. Prices
Let me now explain price developments. Although the year-on-year rate of change in the
consumer price index (CPI) for all items less fresh food is at around 1.0 percent, it has
continued to show relatively weak developments compared to the economic expansion and
labor market tightening, remaining at around 0.5 percent excluding the effects of energy
prices.
With regard to the outlook, medium- to long-term inflation expectations are projected to rise
gradually as firms' stance is likely to gradually shift toward further raising wages and prices
with the output gap remaining positive. As a consequence, the year-on-year rate of change
in the CPI (all items less fresh food) is likely to increase gradually toward 2 percent.
Specifically, the medians of the Policy Board members' forecasts of the year-on-year rate of
change in the CPI (all items less fresh food) presented in the October 2018 Outlook Report
are 0.9 percent for fiscal 2018, and, excluding the direct effects of the scheduled
consumption tax hike, 1.4 percent for fiscal 2019 and 1.5 percent for fiscal 2020.3
2
It is assumed that the consumption tax will be raised to 10 percent in October 2019 and that a
reduced tax rate will be applied to food and beverages -- excluding alcohol and dining-out -- and
newspapers. Policies concerning the provision of free education are also factored into the forecasts,
based on information available as of October 2018.
3
Assuming that the rise in the consumption tax will be fully passed on to prices of taxable items,
excluding those to which a reduced tax rate will be applied, the effect of the October 2019
consumption tax hike on the year-on-year rate of change in the CPI (all items less fresh food) for
October 2019 onward is estimated to be 1.0 percentage point; the effect for fiscal 2019 and 2020 is
estimated to be 0.5 percentage point for each year. It also is assumed that the effects of policies
concerning the provision of free education will not be reflected in the CPI, as statistical treatment of
these effects is not yet decided.
II. Keys to Assessing the Outlook for Economic Activity and Prices
In what follows, I would like to discuss several points that I think deserve particular
attention in terms of realizing the outlook for economic activity and prices that I mentioned
earlier.
A. Supply-Demand Conditions in the Labor Market and the Income Situation
Let me first talk about supply-demand conditions in the labor market and the income
situation. As the economy has continued its moderate expansion, the output gap has
widened within positive territory; the figure for the April-June quarter of 2018 -- the most
recent data available -- was about 2 percent. Furthermore, supply-demand conditions in the
labor market have continued to tighten steadily. The year-on-year rate of increase in the
Labour Force Survey-based number of employees has been at around 2 percent, and against
this backdrop, the active job openings-to-applicants ratio has been at a level that exceeds the
peak marked during the bubble period. Moreover, a perception of labor shortage suggested
by the employment conditions diffusion index (DI) in the Tankan (Short-Term Economic
Survey of Enterprises in Japan) has heightened, and the unemployment rate has been around
2.5 percent recently. These indicators of supply-demand conditions in the labor market
show that the degree of labor market tightness has been at around the level last seen in the
first half of the 1990s or in the first half of the 1970s. In terms of the outlook, as Japan's
economy is likely to continue on a growing trend at a pace above its potential, it is expected
that the number of employees will keep increasing and that the supply-demand conditions in
the labor market will continue to tighten steadily.
Amid such supply-demand conditions in the labor market, the year-on-year rate of increase
in hourly scheduled cash earnings of part-time employees, which are responsive to
supply-demand conditions in the labor market, has exhibited relatively high growth of
around 2.0 percent on average. On the other hand, the year-on-year rate of increase in
scheduled cash earnings of full-time employees has remained at around 0.5 percent. As a
result, although total cash earnings per employee have been increasing moderately, albeit
with fluctuations, the increases have remained relatively weak compared to the labor market
tightening, partly due to the high wage elasticity of labor supply in recent years, mainly
among women and seniors. With regard to the outlook, overall employees' hourly cash
earnings are projected to increase moderately at almost the same pace as labor productivity
growth in nominal terms, and their rate of increase is expected to accelerate thereafter.
However, there is a risk that firms will remain cautious with their decisions on wage setting,
and in this context, I am paying attention to their stance regarding wages going forward.
B. Prices
Next, I will turn to price developments, taking into account supply-demand conditions in
the labor market and the income situation. The year-on-year rate of change in the CPI (all
items less fresh food and energy) has remained at around 0.5 percent.
There are likely to be two main factors behind such weak developments. One is that the
mindset and behavior based on the assumption that wages and prices will not increase easily
have been deeply entrenched among firms and households, due mainly to the experience of
prolonged low growth and deflation. The other is that the room to raise productivity and the
technological progress have allowed firms to absorb a rise in labor costs by increasing
labor-saving investment and streamlining their business process, and thereby constrain price
rises.
On the other hand, although the pace of improvement in prices has remained slow, some
changes have been seen amid the improvement in the economic and employment conditions.
For example, moves to raise sales prices are starting to be observed at a wide range of firms,
mainly in the services sector. According to the Tankan, the number of enterprises answering
that the output prices have risen has been exceeding the number of those answering that
such prices have fallen. Also, with the aging of the population, labor market conditions are
likely to tighten further and the pace of increase in hourly scheduled cash earnings of
part-time employees is expected to accelerate. In addition to such moves, if full-time
employees' wages increase with an improvement in productivity, this will lead to an
increase in households' tolerance of price rises.
While price developments are affected by various factors, I consider that the factor that
determines the underlying trend in prices is the aggregate supply-demand balance. As the
output gap remains positive, various factors behind the weak developments in prices will
likely be resolved gradually. If that happens, firms' wage- and price-setting stance and
households' tolerance of price rises will improve, and the pace of increase in inflation
expectations will accelerate gradually.
III. Conduct of Monetary Policy
Let me now turn to the Bank's monetary policy.
The Bank has set the price stability target at 2 percent in terms of the year-on-year rate of
change in the CPI and has been conducting monetary policy to achieve this target at the
earliest possible time. To this end, the Bank has been pursuing powerful monetary easing,
considering developments in economic activity and prices, as well as financial conditions,
under the framework of Quantitative and Qualitative Monetary Easing (QQE) with Yield
Curve Control introduced in September 2016. The Bank, under this framework, has been
conducting yield curve control, in which it controls short- and long-term interest rates.
Specifically, at present, according to the guideline for market operations, the Bank sets the
short-term policy interest rate at minus 0.1 percent and purchases Japanese government
bonds (JGBs) so that 10-year JGB yields will remain at around 0 percent. By conducting
this operation, short- and long-term interest rates have been stable at low levels, and I
consider that the highly accommodative financial conditions, brought about by yield curve
control, have contributed to an improvement in the output gap by stimulating firms' and
households' spending activities.
Meanwhile, prices have continued to show relatively weak developments compared to the
economic expansion and labor market tightening. Following the discussion at the Monetary
Policy Meeting (MPM) held on July 30 and 31, 2018, the Bank released its economic
projections, which showed that it would take time to achieve the price stability target of 2
percent. It also judged that, while the momentum toward 2 percent inflation had been
maintained, it was necessary to persistently continue with powerful monetary easing,
thereby maintaining the output gap within positive territory for as long as possible. Based
on this judgment, the Bank decided at the MPM to implement measures to strengthen its
commitment to achieving the price stability target and to enhance the sustainability of QQE
with Yield Curve Control.
This set of measures consists of two major components. The first is the introduction of
forward guidance for policy rates. Forward guidance is a measure that guides the future
policy path in order to strengthen market confidence and expectations toward monetary
policy. The Bank announced in its July policy statement that it "intends to maintain the
current extremely low levels of short- and long-term interest rates for an extended period of
time, taking into account uncertainties regarding economic activity and prices including the
effects of the consumption tax hike scheduled to take place in October 2019." In
consideration of these uncertainties and the price developments, the Bank will not reduce
the degree of this powerful monetary easing for an extended period of time.
The second component is the implementation of several measures to enhance the
sustainability of QQE with Yield Curve Control. For example, the Bank, while maintaining
the target level of 10-year JGB yields at around 0 percent, made clear that the yields might
move upward and downward to some extent mainly depending on developments in
economic activity and prices. I believe that allowing the long-term yields to move to some
extent will, in a broad sense, lead to maintaining market functioning. Meanwhile, it should
be noted that the Bank does not intend to raise the level of yields -- this means that, in the
case of a rapid increase in the yields, the Bank will purchase JGBs promptly and
appropriately. In addition, as for exchange-traded fund (ETF) purchases, from the same
aspect of enhancing the sustainability of the monetary policy framework, the Bank made it
clear that it might increase or decrease the amount of purchases depending on market
conditions, while maintaining the annual pace of increase at about 6 trillion yen.
The Bank also recognizes the risk that continuing powerful monetary easing will
cumulatively affect financial institutions' strength, mainly through a decrease in their
lending margins, and thus the functioning of financial intermediation will be stagnant. The
Bank intends to continue paying careful attention to the risks considered most relevant to
the conduct of monetary policy. With a view to achieving the price stability target of 2
percent, the Bank will continue conducting monetary policy in an appropriate manner,
taking account of developments in economic activity and prices as well as financial
conditions.
IV. Challenges for Japan's Economy
I would now like to express my thoughts regarding the current situation for Japan's
economy from a longer-term perspective.
According to the Bank's estimates, the potential growth rate has been in the range of 0.5-1.0
percent recently. Although the rate has risen compared to around 2010, it can be said that
Japan's growth potential has been sluggish. That said, as initiatives toward structural
reforms and a growth strategy proceed among a wide range of entities, I consider that the
boost in the country's growth potential would be accelerated through the rise in
productivity.
Looking at corporate activities, it has been a couple of years since the output gap turned
positive. Although it differs by industry, firm size, and other factors, supply-side constraints
have been the bottleneck in firms' growth on the whole. In this situation, mainly on the back
of improved profits, firms have started to increase fixed investment aimed at expansion in
supply capacity of products and services: firms often start to review their business strategy
when planning fixed investment and can improve productivity through such efforts. At the
same time, firms have been making plans for development of new high value-added
products and services by increasing research and development investment.
Moreover, firms have been taking various measures that reflect demographic changes and
tight labor market conditions, on which I now would like to elaborate using five examples.
The first is effective use of employees through initiatives including working-style reforms.
In Japan, inefficiency borne from the lack of streamlining and the practice of working long
hours are common; in my view, there is still considerable room to enhance work efficiency
through such initiatives.
The second is women's participation in the economy. In Japan, the labor force participation
rate of women in the working-age population has reached 70 percent, which is considered a
high level on a global standard. I expect that this trend will encourage firms to assign more
women to value-added work and promote them to managerial positions from now on.
The third is employment of seniors. Although their employment has been progressing, there
remains considerable room for improvement, as there are gaps between what they can
accomplish through their ability and will, and what they actually are assigned to do.
The fourth is employment of foreigners. Although their employment has been increasing
gradually, it is still vital to further develop systems to accept them.
Lastly, the fifth example is labor-saving efforts through utilization of information
technology including the use of robots. Japan is a leading country in robotics, and I believe
that we should expand its application from manufacturing operations to other kinds of work,
including administrative work.
As these initiatives toward structural reforms and a growth strategy bring about benefits
including improvement in business efficiency, they may exert downward pressure on wage
increases in the short term, but in the longer term, they will raise the productivity of the
economy as a whole, thereby strengthening its growth potential. I believe that improving
productivity would stimulate price rises through increases in wages and private
consumption. Nevertheless, even now there are firms that maintain their cautious wage- and
price-setting stance, as they are concerned, for example, about a shrinking of the domestic
market size and the issue of succession for businesses; they also lack confidence in growth
in private consumption. Let me note that raising productivity and growth potential is a
time-consuming task. Therefore, while the Bank's conduct of monetary policy stimulates
aggregate demand and suitably tight supply-demand conditions are being maintained, a
virtuous cycle in which active demand encourages progress in various initiatives should
remain intact for a long period of time. I believe that, with a view to achieving its price
stability target and realizing sustainable economic growth in a coordinated manner, the
Bank should continue with its monetary easing policy and firmly support the various
initiatives taken by a wide range of entities.