Sayuri Shirai: Japan's economic activity, prices, and monetary policy -
some perspectives on the slope of the Phillips curve
Speech by Ms Sayuri Shirai, Member of the Policy Board of the Bank of Japan, at a meeting
with business leaders, Tokushima, 27 November 2013.
* * *
I. Introduction
Good morning. It is a great honor to have this opportunity to visit Tokushima Prefecture and
meet with local representatives. This is my first visit, 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 Tokushima and the Takamatsu Branch.
As you may know, at the Monetary Policy Meeting (MPM) held on October 31, 2013, the
Bank updated its outlook for Japan's economic growth rate and rate of price changes over
the three-year period through fiscal 2015. Also in October, the Bank released the Outlook for
Economic Activity and Prices (hereafter the Outlook Report). The Outlook Report describes
the Bank's baseline scenario as well as upside and downside risks to the scenario from fiscal
2013 to fiscal 2015. I believe that promoting the public's understanding of the Bank's outlook
is an essential step in the conduct of monetary policy, so my speech today will focus on the
main features of the report.
Let me briefly describe the sequence of my speech, which contains five sections. In Section
II, I will explain the Bank's outlook for Japan's economic activity and prices (the baseline
scenario), touching on my views. In Section III, I will review the upside and downside risks to
the baseline scenario, referring to my views and my related proposal that was presented at
the October 31 MPM. In Section IV, I will discuss my current thinking on a number of
"conceptual channels" that might lead to achieving the 2 percent price stability target adopted
in January 2013 with a sustainable economic growth path based on the concept of the
Phillips curve, which shows the empirical relationship between the rate of price changes and
the output gap (the difference between actual and potential GDP). Finally, in Section V, I will
present my proposal to improve the structure of the Outlook Report, to make the Bank's
communication strategy more effective. Following my speech, I look forward to hearing your
candid opinions on its contents as well as the situation of the local economy.
II. Baseline scenario of the outlook for economic activity and prices
I will begin by describing the current condition of and the Bank's outlook for economic activity
based on the contents of the October 2013 Outlook Report, covering the projection period
through fiscal 2015. This will be followed by my views on this outlook. Then, I will present the
prices
current condition of and the Bank's outlook for in the same manner.
A. Current condition of and outlook for economic activity
Japan's economy has been recovering moderately. On the demand side, exports have been
picking up at a somewhat slower pace, but domestic demand - notably private consumption,
public investment, and housing investment - has been firm. Reflecting the differences in the
extent of recovery strength between domestic and external demand, the pace of increase in
industrial production has remained moderate while activity in the nonmanufacturing sector,
including services and construction, has been somewhat strong.
Looking ahead, while domestic demand is likely to maintain firmness, external demand is
expected to increase moderately. Therefore, Japan's economy is projected to continue
growing throughout the projection period at a pace above its potential rate of growth
(considered to be around 0.5 percent on average). The projection would remain unchanged
even if the economy were affected by the front-loaded increase and subsequent decline in
demand prior to and after the two scheduled consumption tax hikes, in April 2014 and
October 2015.
The above projection just mentioned assumes four underlying developments.
• Stimulative effects of the accommodative financial conditions on private demand are
likely to strengthen as economic activity improves.
• Overseas economies are expected to pick up gradually - particularly the advanced
economies - on the assumption that global financial markets remain generally
stable.
•
Public investment is expected to remain at a high level through the first half of fiscal
2014, mainly reflecting additional economic measures to be implemented by the
government as well as the effects of various past economic measures.
•
Firms' and households' medium- to long-term growth expectations are expected to
rise moderately, due mainly to the adoption of the regulatory and institutional
reforms and various tax reduction measures by the government, as well as firms'
efforts to expand domestic and external demand with innovative goods and
services.
A comparison of the current projection with that in the July 2013 interim assessment leads to
the judgment that the real GDP growth rates are expected to be more or less unchanged.
Nonetheless, the "median" of the Policy Board members' forecasts showed slight
modifications; namely, the real GDP growth rate is currently projected to reach 2.7 percent
(2.8 percent in the July assessment) in fiscal 2013, 1.5 percent (1.3 percent) in fiscal 2014,
and 1.5 percent (1.5 percent) in fiscal 2015 (Chart 1).
My view is more or less in line with this baseline scenario. To highlight some differences,
however, my baseline projections of the real GDP growth rates for fiscal 2014 and fiscal
2015 are somewhat lower than the median of the forecasts. This relatively conservative
outlook has remained unchanged since the time of assessment in April (when the April 2013
Outlook Report was released) and July this year. The main reason I have maintained this
outlook is that while the additional economic measures to be introduced by the government
will likely raise the economic growth rates for fiscal 2014 and fiscal 2015, I believe that at
present this positive effect may be offset by other countervailing factors - namely, the
moderate recovery pace of real exports and industrial production.
Indeed, the actual export performance has been unimpressive so far (Chart 2); and, I judged
that the outlook for real exports and industrial production should be adjusted downward to
some extent as well. A look at developments in overseas economies shows that the
economic growth landscape has changed drastically this year. In other words, the growth
dynamic has been reversed, and emerging and commodity-exporting economies are losing
momentum while advanced economies are improving. This dynamic is likely to continue
since the pace of increase in the economic growth rate is likely to be faster in advanced
economies than in emerging and commodity-exporting economies in the future. However, the
recovery path in the advanced economies is neither robust nor strong, since their output
gaps are likely to remain negative throughout the projection period.1 Although the
improvement in external demand is likely to increase Japan's exports of items such as
automobiles and capital goods, this increase may not be as large as that in the past recovery
phase owing to the effects of the ongoing shift of production sites overseas and a change in
the dynamic of international competitiveness.
B. Current condition of and outlook for prices
The year-on-year rate of increase in the core consumer price index (headline CPI excluding
fresh food) has been positive since June this year and has recently been in the range of
0.5-1.0 percent. In the October 2013 Outlook Report, it was judged that the outlook for the
year-on-year rate of change in the core CPI (excluding the direct effects of the consumption
tax hikes) was expected to follow a rising trend and was likely to reach around 2 percent -
the price stability target - toward the latter half of the projection period.
This baseline scenario reflects the following assumptions about the developments of three
factors that will primarily determine the inflation rate going forward.
•
The aggregate supply and demand balance (output gap) is expected to follow a
moderate improving trend and expand toward the latter half of the projection period.
Nominal wages are likely to see gradual upward pressure as a tightening of labor
supply and demand conditions becomes evident.
•
Medium- to long-term inflation expectations are likely to continue on a rising trend
with continued monetary easing, partly supported by a rise in the observed inflation
rate, gradually converging to around 2 percent.
•
Import prices are expected to exert upward pressure for the time being, reflecting
developments in international commodity prices and foreign exchange rates.
Comparing the current projection with that in the July 2013 interim assessment, the October
2013 Outlook Report concluded that the projected rates of change in the core CPI (excluding
the direct effects of the consumption tax hikes) are more or less unchanged. However, the
median of the Policy Board members' forecasts changed slightly; namely, the rate of change
in the core CPI is projected to reach 0.7 percent (0.6 percent at the July assessment) for
fiscal 2013, while those for fiscal 2014 and fiscal 2015 remain the same at 1.3 percent and
1.9 percent excluding the effects of the tax hikes, and at 3.3 percent and 2.6 percent
including the effects of the tax hikes, respectively (Chart 1).
This baseline scenario is more or less consistent with my assessment. However, some
differences are present; that is, under my baseline scenario, projections for fiscal 2014 and
fiscal 2015 are somewhat lower than the median of the Policy Board members' forecasts. As
is the case with the April and July 2013 assessments, I judge that the core CPI is expected to
rise toward 2 percent at a more moderate pace than that of the median. My relatively
conservative views for fiscal 2014 and fiscal 2015 arise from the assumption that a rise in
medium- to long-term inflation expectations toward 2 percent is likely to occur gradually from
now on and that it may take some time for an improvement in the output gap to be reflected
in the observed rate of inflation.
III. Upside and downside risks to the baseline scenario
Next, I would like to review the upside and downside risks to the Bank's baseline scenario
that were presented in the October 2013 Outlook Report. After that, I will present my own
views. Before proceeding, I would like to note that the judgment on risk factors is subject to
adjustment in the future assessments, depending on changes in economic conditions.
A. Risk to economic activity
The October 2013 Outlook Report puts particular stress on the following five factors as
upside and downside risks to the Bank's baseline scenario for the economy (or real GDP
growth rates).
• Performance of overseas
economies: warranting close attention are the effects of
new energy sources and consequences of fiscal problems in the United States,
European debt problems, China's excess production capacity and debt issues, and
economic developments together with developments in the global financial markets
in some emerging and commodity-exporting economies that are facing current
account deficits.
•
Developments in households' employment and income situation: close attention
should be paid to whether firms, in the face of intense competition, will increase
wages by taking into account an improvement in corporate profits.
•
Effects of the consumption tax hikes:2 while the tax hikes will have adverse effects
on households' real disposable income, the adverse effects on consumption may be
mitigated to some extent by (1) scheduled economic measures to be taken by the
government, (2) the high probability that the tax hikes are already factored in among
households, and (3) the positive effect of alleviating households' future concerns
over the fiscal condition and the social security system.
• Developments in firms' and households' medium- to long-term growth
expectations:
these expectations may be affected by future regulatory and institutional reforms as
well as tax reforms, firms' innovation, and households' income situation. From a
somewhat long-term perspective, some positive effects from the hosting of the
Tokyo 2020 Summer Olympic Games might be expected.
• Medium- to long-term fiscal
sustainability: a decline in confidence in fiscal
sustainability may lead the economy downward through, for example, excessive
rises in long-term interest rates. The opposite would occur if confidence in the path
toward fiscal consolidation strengthens.
Following a review of these upside and downside risks, the October 2013 Outlook Report
assessed that risks to the Bank's baseline scenario are "balanced" as a whole.
B. My views and proposal on risks to economic activity
In principle, I view the aforementioned list of risk factors as important elements. However, I
do not feel very comfortable with the Bank's overall risk assessment related to Japan's
economy as being "balanced." This is because, based on my observation of various data, the
downside risks appear to be somewhat greater than the upside risks at this stage. In
addition, I found it important to indicate in a frank manner my awareness of greater downside
risks to the public and market participants, as this might contribute to enhancing their
confidence in the Bank's conduct of monetary policy and thereby provide them with a greater
sense of security regarding the future economic situation. Therefore, at the MPM held on
October 31, 2013, I voted against the risk assessment described in the Outlook Report and
presented a new proposal (the first point of my proposal that I made at the MPM). My
proposal was to insert the following description in the last part of subsection "A. Risks to
Economic Activity" in Section II titled "Upside and Downside Risks," in the Outlook Report:
"on the whole, attention should be paid to the downside risks since there is a high degree of
uncertainty regarding developments in overseas economies and households' employment
and income situation."
Let me explain my views on the risks to economic activity in detail. Overseas economies
remain unlikely to fall into severe recession or face tail risk. However, since April 2013 I have
been claiming consistently that "on balance, the risks are tilted somewhat to the downside."
This is because of uncertainty associated with the pace of recovery in overseas economies.
Moreover, considerable time has passed since the yen depreciated sharply from late 2012,
but the rate of growth in real exports appears to have remained sluggish, even after taking
into account the J-curve effect and the slow pace of recovery in overseas demand. This
means that the mediocre performance of exports may be reflecting structural factors - in
addition to cyclical factors - such as a continuing shift of Japanese firms' production sites to
overseas and a change in their international competitiveness.
Moreover, compared with the projections in the April and July 2013 assessments, I judge that
uncertainty over developments in global financial markets and overseas economies has
increased moderately, which may lead to underperformance in my baseline scenario. My
concerns are focused especially on the following aspects.
• Developments in global financial markets: as recovery in advanced economies
proceeds, differences in the monetary policy stance among major central banks may
become more apparent. This may cause frequent changes in market participants'
views regarding the direction of accommodative monetary policy measures and the
interpretations of forward guidance. The resulting impact of such behavior of
investors on financial markets and the global economy warrants close attention.
•
The performance of the U.S. economy: owing in part to postponement of the
resolution of fiscal and debt issues until early 2014 as well as to the associated
political and economic uncertainties, it is not clear whether the U.S. economy will be
able to post economic growth above its potential growth rate - which is an annual
rate of about 2.2 percent for 2013 to 2018 as projected by the Congressional Budget
Office (CBO). Recent economic growth rates have been higher than the potential
rate. This is a welcome development, but the pace of growth in business fixed
investment and private consumption (excluding automobiles) has been slow, and
therefore these developments require caution. The recovery in the housing market
should also be closely monitored, since there is some uncertainty whether the
recovery in the number of mortgage applications will be solid amid higher levels of
mortgage interest rates and stringent lending attitudes toward first-time buyers.
• The performance of the European
economy: the euro area economy has bottomed
out and shows signs of a moderate pick-up in recent months. Japan's exports to
Europe have also begun to increase. However, the banking sector within the euro
area remains fragmented, and thus countries in the area still have lending interest
rate differentials. Attention needs to be paid to uncertainty regarding Asset Quality
Reviews and stress tests to be conducted by the European Central Bank (ECB) over
the twelve months from November 2013 and the associated recapitalization process
that may occur. The recent disinflation trend in the euro area may aggravate the
repayment burden of peripheral countries as they seek to reduce their public- and
private-sector debt, hampering their economic recovery. The internal devaluation in
the euro area may also become harder to achieve.
• Developments in emerging and commodity-exporting economies: given that growth
in these economies has been lacking momentum in recent months, it is possible that
a weaker-than-projected growth performance will materialize. Countries facing
structural problems (such as current account deficits) as well as strong cross-border
links with global financial markets may be more prone to the reversal of capital flows
and changes in liquidity conditions in the securities and foreign exchange markets.
The resultant tightening of financial conditions, together with the necessity to tighten
the fiscal and monetary policies to cope with capital outflows in these economies,
may undermine their economic recovery path.
• Performance of the Chinese economy: while the rate of economic growth
accelerated from 7.5 percent in the second quarter of 2013 to 7.8 percent in the third
quarter, the sustainability of the current economic growth rate is uncertain, given the
rise in the ratio of private-sector debt to GDP, concerns over the shadow banking
system, the rapid pace of real estate price hikes in the metropolitan areas, and
unresolved excess production capacity in some industries.
As for domestic demand, greater attention should be paid to the downside risks on the
following fronts, relative to the assessments made in April and July 2013.
•
Developments in wage growth: there is a possibility that the rate of wage growth will
not catch up with that of inflation. Alternatively, wealth effects may not sufficiently
offset a potential decline in real disposable income. Wealth effects appear to have
become less pronounced, since the rising trend in stock prices and exchange rates
appears to have leveled off from the second half of 2013.3 On this front, future asset
price movements - together with the recent rise in stock prices and the yen's
depreciation - should be monitored closely. While private consumption will remain a
major driving force of Japan's economic growth in the immediate future, it may not
be as resilient as projected once the effects of the front-loaded increase in demand
prior to the consumption tax hike in April 2014 dissipate.
• Developments in business fixed
investment: business fixed investment is expected
to increase in the fields of maintenance and replacement, energy savings and
rationalization, and investment in earthquake resistance as well as research and
development (R&D). This is because many firms have postponed their investment
for several years due to a series of negative shocks. Nonetheless, investment to
expand production capacity may be limited if firms do not foresee a sustainable
increase in domestic sales. On the whole, growth in business fixed investment may
turn out to be more moderate than projected, particularly in the manufacturing
sector, where increased investment has just begun to take place.
•
Sustainability of households' and firms' medium- to long-term growth expectations: a
sustainable increase in consumption and business fixed investment as well as
associated credit demand may not be feasible without a steady increase in growth
expectations. For example, according to the Bank's Opinion Survey on the General
Public's Views and Behavior conducted in September 2013, the "growth potential
diffusion index (DI)" of Japan's economy deteriorated from minus 26.7 percentage
points in June to minus 36.8 percentage points in September. This may, however,
be attributable to the fact that the September survey was conducted before the
announcement of Tokyo's successful bid to host the 2020 Summer Olympic Games.
C. Risks to prices
Turing to risk factors related to prices, the October 2013 Outlook Report points out the
following upside and downside risks.
•
Developments in firms' and households' medium- to long-term inflation expectations:
while there is a possibility that inflation expectations may not readily rise in reflection
of the moderate decline in prices and wages observed in the past, there is also a
possibility that they will rise relatively quickly with a rise in observed inflation and
wages. Effects on these expectations of a price increase associated with the
consumption tax hikes in items across the board warrant attention.
•
Uncertainty regarding the responsiveness of prices to the output gap: attention
needs to be paid to whether firms will raise prices and wages in accordance with the
extent to which the supply and demand balances in goods and services as well as in
the labor market tighten over time.
•
Developments in import prices: there is a high degree of uncertainty regarding
developments in import prices reflecting fluctuations in international commodity
prices and foreign exchange rates, and the extent to which such developments are
passed on to domestic prices.
In the Outlook Report, the Bank assessed upside and downside risks on the price front as
being "largely balanced," although considerable uncertainty surrounds developments in
medium- to long-term inflation expectations.
D. My views and proposal on risks to prices
The aforementioned list of risk factors related to prices has been covered sufficiently.
However, I do not agree with the overall assessment of risks on the price front as being
"largely balanced," since, based on my observation of various data, the downside risks
appear to be greater than the upside risks at this stage. As in the assessments made in April
and July 2013, I have held the view that "on balance the risks are tilted somewhat to the
downside." Currently, however, I hold the strong view that greater attention should be paid to
the downside risks at this stage. This is why I voted against the assessment described in the
Outlook Report at the MPM held on October 31, 2013, with a new proposal (the second point
of my proposal). My proposal was to insert the following description in the last part of
subsection "B. Risks to Prices" in Section II titled "Upside and Downside Risks," in the
Outlook Report: "on the whole, attention should be paid to the downside risks, because there
is a high degree of uncertainty regarding developments in medium- to long-term inflation
expectations and the responsiveness of prices to the aggregate supply and demand
balance." Let me explain my concern in more detail.
Recent Developments in Medium- to long-term inflation expectations
Developments in "medium- to long-term" inflation expectations that are affecting the
intercept of the Phillips curve have been closely monitored by the Bank as one of the
essential factors for achieving the 2 percent target. The related indicators exhibited a rapid
increase in medium- to long-term inflation expectations from late 2012. In recent months,
however, while some indicators showed an uptrend, several others have showed a slow
pace of increase or been more or less flat (Chart 3).4 Also, these inflation expectations are
still well below the 2 percent target and thus there is uncertainty as to whether these
expectations will rise to the level of 2 percent during the projection period. For example,
breakeven inflation (BEI) rates increased rapidly in line with the yen's depreciation from late
2012, although such a strong correlation had not been present earlier (Chart 5). However,
the BEI rates appear to have become more or less constant since mid-2013, and this trend
appears to be in line with the relatively stabilized exchange rate of the yen against the U.S.
dollar.
Changes in price responsiveness to the output gap
Another important factor that could contribute to the achievement of the 2 percent target - in
addition to the increase in inflation expectations - is an increase in the "responsiveness of
prices to the output gap" (or the slope of the Phillips curve). In general, the slope of the
Phillips curve steepens when firms find it easier to raise their sales prices or pass their input
costs on to their sales prices given the level of the output gap. Also, an increase in the
frequency of price adjustments will promote a steepening in the Phillips curve. The current
situation signals a possibility that the price-setting environment of firms may be improving.
Meanwhile, severe competition among firms may discourage them from raising their sales
prices, if their concerns increase over a possible loss of market share. Especially in fiscal
2014, the Phillips curve may remain largely unchanged owing to the high degree of
uncertainty associated with the consumption tax hike. If many firms perceive that the price
increase triggered by the tax hike could be sufficiently large to constrain household domestic
demand, they may partially postpone raising their final sales prices (those related to the
effect of the output gap and a rise in inflation expectations) beyond the increase related to
the tax hike in and after fiscal 2015 - that is, not fully raised within fiscal 2014. In such an
event, the responsiveness of prices to the output gap would remain limited and the outcome
for prices in fiscal 2014 could be lower than projected by the Bank. Please note that this
remark has nothing to do with the debate on the timing of the tax hikes. In this regard, let me
remind you that I have been supporting the scheduled introduction of the consumption tax
hikes, with a view to maintaining fiscal soundness and sustainability of the social security
system.
My proposal related to the assessment on the "path" toward achieving the 2 percent
target
Based on the observations just described, I judged that the current path toward achieving the
2 percent target entails uncertainty. Reasons for this judgment can be summarized as
follows.
•
Although prices of a wide range of consumption items have begun to increase, the
fact that the core CPI inflation rate has been increasing in positive territory is largely
attributable to the lagged impact of the yen's depreciation at this stage and the
increase in energy prices. The effects to the price rise of the improvement in the
output gap and an increase in inflation expectations need to be confirmed with more
evidence.
•
The pace of the increase in medium- to long-term inflation expectations appears to
have moderated or become more or less flat in recent months.
•
There is a considerable difference between medium- to long-term inflation
expectations and the 2 percent target.
Thus, my judgment is not consistent with the assessment of the October 2013 Outlook
Report placed in the final paragraph in Section III titled "Conduct of Monetary Policy," which
said that "Japan's economy has been following the path toward achieving the 2 percent price
stability target as expected." I voted against this assessment and proposed that the
expression "as expected" be replaced with This constituted the third
"at a moderate pace."
point of my proposal.
IV. Conceptual channels for achieving the 2 percent target
One thing that I wish to emphasize is that I continue to support the 2 percent target with
sustainable economic growth path. My determination to make as much effort as possible to
achieve this target has remained intact. In this light, in Section IV of my speech I will present
my current thinking on the "conceptual channels" that could lead to achieving the 2 percent
target. Here, I intentionally used the term "conceptual." This is because increasing "medium-
to long-term" inflation expectations and anchoring them at around the 2 percent level - which
the Bank is currently pursuing through quantitative and qualitative monetary easing (QQE) -
is a challenging task that no other major central bank has ever undertaken in the past.
Therefore, there is uncertainty regarding the realization of these channels at this point, and I
feel that I should wait for more evidence to confirm their achievability. If these channels
materialize gradually, I judge that the downside risks to the baseline scenario would decline
accordingly.
A. The estimated Phillips curve in the case of Japan
In formal economic terms, with a view to raising inflation toward 2 percent, it is important to
consider the relationship between the rate of price change and the output gap - a
relationship known as the Phillips curve. The October 2013 Outlook Report presented the
estimated Phillips curve for the observation period of 1983-2013 (Chart 6). The year 1983
was chosen as a starting year for the observation period, because the impact of the oil
shocks that occurred in the 1970s had likely dissipated by that year. The Phillips curve was
estimated for the entire observation period and for two subset periods (from 1983 to 1995
and from 1996 to 2013), as shown respectively by lines A, B, and C in Chart 6.
The charts suggest two features: (1) line C, using the data of a more recent observation
period, appears to be shifting downward, almost parallel to line B; and (2) the slope of line C
appears to be flatter than that of line A, for which the observation period is longer. While
various factors influence both features simultaneously, let me list some that may be
considered to have affected each of these features.5
It is possible that some of the factors
affected both the shift in the Phillips curve and its slope. However, for the sake of simplicity, I
will separate the factors into those that have mainly shifted the Phillips curve and those that
have mainly steepened its slope.
(Main factors contributing to a downward shift in the Phillips curve)
• Decline in medium- to long-term inflation expectations: the sharp drop in inflation
expectations in the 1990s may be associated with declines in the potential growth
rate and growth expectations for the economy (Charts 7 and 8). Indeed, the average
real GDP growth rate dropped from 4.3 percent in the 1980s to 1.5 percent in the
1990s, and further to 0.6 percent in the 2000s.
• Negative wage
gap: average wages have dropped and the resultant lower level of
real wages has not been consistent with that of labor productivity, partly as a result
of deregulation in the labor market since the late 1990s. Unit labor costs have also
been on a declining trend. In this circumstance, firms may have incentives to lower
their sales prices as a result of improved profit margins driven by lower labor costs
(Chart 9).
•
Declining trend of durable consumer goods: mild deflation has been affected by a
persistently declining trend in the prices of durable consumer goods (a decline of
about 4.5 percent on average from 1997 to 2011), which account for about
10 percent of the total CPI weight. Such a tendency has also been seen overseas,
including in the United States, but the decline in durable consumer goods prices -
specifically, prices of televisions and personal computers - is more pronounced in
Japan despite minor differences in quality. Underlying factors may be national
differences in the competitive environments of the retail sectors and quality
adjustment.
(Main factors contributing to a flattening in the slope of the Phillips curve)
•
A structural shift to the services sector: in general, the frequency of price changes in
the serv