Ryuzo Miyao: Economic activity and prices in Japan and monetary policy
Speech by Mr Ryuzo Miyao, Member of the Policy Board of the Bank of Japan, at a meeting
with business leaders, Nagasaki, 12 November 2014.
* * *
The charts can be found at the Bank of Japan's website.
Introduction
Thank you for giving me this opportunity to exchange views with people representing
Nagasaki Prefecture, who have taken time to be here despite their busy schedules. Please
allow me to express my gratitude for your cooperation with the activities of the Bank of
Japan's Nagasaki Branch.
Today, I will review economic activity and prices in Japan, whose economy has been
recovering moderately, and then discuss the Bank's monetary policy. My concluding remarks
will touch briefly on the economy of Nagasaki Prefecture. Following my speech, I would like
to listen to your views on the actual situation of the local economy and to your candid
opinions.
I. Recent developments in economic activity and prices
A. Continued moderate recovery in Japan's economy
Japan's economy has continued to recover moderately as a trend, although some weakness,
particularly on the production side, has been observed, due mainly to the effects of the
subsequent decline in demand following the front-loaded increase prior to the consumption
tax hike (Chart 1).
I will elaborate on the recent developments related to Japan's economy. Overseas
economies - mainly advanced economies - continue to recover, although a lackluster
performance has still been partly seen (Chart 2). Specifically, the recovery in the U.S.
economy is increasingly taking hold, as household spending has been firm, reflecting a
favorable employment situation, and such movements are spreading to the corporate sector.
The European economy continues on its moderate recovery trend, supported mainly by the
resilience in private consumption, although the adjustment pressure associated with the debt
problem remains and a downtrend in the inflation rate has been observed. The Chinese
economy has continued to grow stably on the whole, due mainly to an improvement in
external demand and the stimulus measures by the government, albeit under downward
pressure from an overhang in supply capacity in the manufacturing sector and adjustments in
the real estate market. The NIEs have been improving somewhat due to a rise in exports to
the United States, although differences by country stand out. On the other hand, the ASEAN
economies as a whole have been lacking growth momentum despite an improvement in
exports and private consumption.
Reflecting this situation, Japan's economy has continued to recover moderately as a trend.
Regarding external demand, exports have been relatively weak on the whole recently, due to
such factors as the continued weakness in exports to the ASEAN economies, the sluggish
growth in exports to China, and the materialization of the effects of downward pressure on
exports to the United States resulting from the expansion of overseas production, mainly by
automakers. Meanwhile, public investment maintains its high level, mainly due to the effects
of the early implementation of the initial budget for fiscal 2014. As for the corporate sector,
business sentiment and corporate profits have generally maintained favorable levels despite
being affected by the decline in demand following the front-loaded increase. As a result,
business fixed investment has been on a moderate uptrend, albeit with some fluctuations. In
the household sector, private consumption has been resilient as a trend, with the
employment and income situation improving steadily. It can be assessed that private
consumption has been affected mainly by the decline in demand following the front-loaded
increase, and the effects, which were clearly seen in the April-June quarter of 2014, have
been waning on the whole when excluding the somewhat prolonged impact on sales of
durable goods such as automobiles and household electrical appliances, as well as housing
investment.1 Reflecting this situation, industrial production declined substantially in the
AprilJune quarter and has been showing some weakness thereafter due in part to inventory
adjustments, mainly in durable goods and construction goods.
On the price front, the year-on-year rate of increase in the consumer price index (CPI, for all
items less fresh food and excluding the direct effects of the consumption tax hikes) has
generally been around 11⁄4 percent in the first half of fiscal 2014. The rate of increase in the
CPI less food and energy has been in the range of 0.5-1.0 percent (Chart 3).
B. Outlook for economic activity and prices
I will now turn to the baseline scenario of the outlook for economic activity and prices in
Japan from fiscal 2014 through fiscal 2016 and its underlying mechanism (Chart 4).
1. Outlook for economic activity
With regard to the outlook for economic activity, as domestic demand is likely to maintain
firmness, exports are expected to head for a moderate increase, and a virtuous cycle from
income to spending is likely to be maintained in both the household and corporate sectors.
I will elaborate on the background to this outlook. First, overseas economies are expected to
moderately increase their growth rates as advanced economies continue to see firm recovery
and its positive effects gradually spread to emerging economies. In particular, the U.S.
economy is expected to gradually accelerate its pace of recovery as the firmness in the
household sector spreads to the corporate sector. In this situation, exports are expected to
head for a moderate increase partly because of foreign exchange rate developments.
Japanese major exporting firms' continued efforts to increase production and procurement on
a global basis could contribute to restraining the pace of increase in exports. On the other
hand, further improvements are expected in two areas: exports of goods, such as capital
goods and electronic parts and devices, that maintain high competitiveness, and travel credit,
a component of services in the current account, in accordance with an increase in the
number of foreign visitors to Japan (Chart 5).2
Second, on the back of improvements on the supply side of the economy, the resilient trend
in consumption is likely to be maintained.3 Although it warrants attention that consumption of
durable goods and other goods has been affected by the decline in demand following the
front-loaded increase for a somewhat prolonged period, it deserves special mention that
consumption - which has been posting higher growth - has been the driving force of
1
Demand-side statistics, such as the Family Income and Expenditure Survey, show that there has been some
weakness in recent developments in private consumption that cannot be explained by the decline in demand
following the front-loaded increase. For example, developments in household nominal income exhibited by the
Family Income and Expenditure Survey have shown a substantial downward deviation from those in total cash
earnings shown in the Monthly Labour Survey, and this could be attributable to sample bias.
2
There has been an increasing number of foreign visitors to Japan with diverse backgrounds and interests, and
efforts to capture their various demands for sightseeing have been progressing. For specific details of the
situation in each region, see the October 2014 issue of the Regional Economic Report released by the Bank
(only the summary of the report is available in English).
3
For a more detailed explanation of the improvements on the supply side of the economy, see Ryuzo Miyao,
"Japan's Economy and Monetary Policy," Speech at the 2014 Autumn Annual Meeting of the Japan Society of
Monetary Economics, Bank of Japan, October 18, 2014.
economic recovery over the past two years or so without being accompanied by notable
increases in exports and business fixed investment, which had previously been the driving
factors of economic recovery (Chart 6). Meanwhile, there have been improvements in the
various aspects of the supply side, or in other words, the potential strength of the economy,
and the economy's capacity to generate income - as represented by corporate profits,
employment and income, and labor force participation - has been increasing on the whole
with the progress in positive efforts by firms and households (Charts 7 through 9). Since this
basic trend will likely continue, expectations for permanent income in the economy as a
whole will improve and anxiety and uncertainty regarding future employment conditions will
decline further. The recovery trend in consumption will therefore be maintained.4
Third, the decline in crude oil prices since summer 2014 will positively affect the real
economy in terms of both corporate profits and households' real income (Chart 11). The
decline in crude oil prices to date seems to be attributable to both the demand factor of slack
in global demand and the supply factor of production increases in, for example, the United
States. It is difficult to make an accurate forecast of developments in crude oil prices, but
based on the assumption that these prices will start to rise moderately from the current level
in line with the pace of growth in the global economy, the positive effects exerted through the
underpinning of corporate profits and household income are expected to materialize to a
certain degree, while downward pressure on the year-on-year rate of change in the inflation
rate will remain for the time being.
Fourth, financial conditions are likely to become more accommodative. As the Bank steadily
pursues quantitative and qualitative monetary easing (QQE), which was expanded on
October 31, 2014, upward pressure on nominal long-term interest rates will likely be
contained and asset prices accordingly will be underpinned, together with improvements in
fundamentals such as the accelerating pace of recovery in the U.S. economy and the
improving trend in corporate profits in Japan. These factors will support the accommodative
financial conditions as a whole, and such a trend is likely to strengthen (Chart 12).
Based on these assessments, a virtuous cycle of economic activity will be maintained,
supported by a firm increase in domestic demand and a moderate increase in exports of
goods and services, and the economy is expected to continue growing at a pace above its
potential, while fluctuations in demand stemming from the scheduled second consumption
tax hike are anticipated in fiscal 2015.
2. Outlook for prices
In assessing price developments, it is necessary to consider the following three aspects: the
aggregate supply and demand balance (the output gap), which shows the utilization of labor
and capital; medium- to long-term inflation expectations; and import prices.
First, the output gap, estimated by the Bank, has recently been around zero, which is the
historical average, despite being affected by the front-loaded increase and subsequent
decline in demand prior to and after the consumption tax hike (Chart 13). Firms seem to
regard the decline in demand as temporary, and are maintaining their positive hiring stance.
More firms have faced insufficient capacity, mainly in nonmanufacturing. Therefore, a trend
in which the output gap will be positive (in excess demand) is likely to take root, and from
fiscal 2015 onward, the gap is expected to move further into excess demand territory and
upward pressure on prices is likely to steadily increase.
Second, medium- to long-term inflation expectations appear to be rising on the whole from a
somewhat longer-term perspective, and are likely to gradually converge to around 2 percent
- the price stability target - as the Bank pursues QQE, which was expanded on October 31,
2014 (Chart 14).
Third, as for import prices, while the recent depreciation of the yen will exert upward pressure
on consumer prices, a decline in international commodity prices, including crude oil prices,
will exert downward pressure on consumer prices. In particular, the effects of the decline in
crude oil prices - based on the outlook for these prices, to which I referred earlier - will
continue to exert a considerable degree of downward pressure on consumer prices until
around summer 2015, as these effects will spread to electricity and gas prices, in addition to
prices of petroleum products such as gasoline (Charts 11 and 15).
Considering the above points, the year-on-year rate of increase in the CPI (for all items less
fresh food and excluding the direct effects of the consumption tax hikes) is likely to reach
around 2 percent in or around fiscal 2015. I personally hold the view that the rate of increase
in the CPI will likely be kept at around the current level of around 1 percent until summer
2015, mainly because downward pressure associated with the decline in crude oil prices will
contain upward pressure on prices. Thereafter, the rate of increase is likely to accelerate
gradually toward the second half of fiscal 2015 and reach around 2 percent - the price
stability target - in or around that half, as the effects of the decline in crude oil prices will
dissipate and the output gap will continue expanding in positive territory (Chart 16).
3. Balance of risks
Risks to the Bank's aforementioned baseline scenario regarding economic activity include
the following: developments in overseas economies, particularly the U.S., European, and
emerging economies, and their effects on Japan's exports; the effects of the two rounds of
consumption tax hikes; and firms' and households' medium- to long-term growth
expectations. Risks regarding prices include developments in medium- to long-term inflation
expectations, in the output gap, and in import prices. I view these upside and downside risks
to economic activity, as well as to prices, as generally balanced.
II. Monetary Policy
A. Expansion of QQE
At the Monetary Policy Meeting held on October 31, 2014, the Bank decided to expand QQE,
in order to ensure that the price stability target of 2 percent would be achieved at the earliest
possible time (Chart 17).
Specific measures of the expansion are as follows. First, the Bank will accelerate the annual
pace of increase in the monetary base from about 60-70 trillion yen to about 80 trillion yen.
Second, it will increase purchases of Japanese government bonds (JGBs) so that the
amount outstanding of its holdings will be increased by about 30 trillion yen from an annual
pace of about 50 trillion yen to about 80 trillion yen. The average remaining maturity of the
Bank's JGB purchases will also be extended from the former period of about seven years to
a flexible range of about seven to ten years. Third, the amount outstanding of the Bank's
holdings of risk assets such as exchange-traded funds (ETFs) and Japan real estate
investment trusts (J-REITs) will be tripled to an annual pace of about 3 trillion yen and about
90 billion yen, respectively. The Bank will make ETFs that track the JPX-Nikkei Index 400
eligible for purchase.
The Bank introduced a price stability target of 2 percent in terms of the year-on-year inflation
rate of the CPI in January 2013, as well as QQE in April 2013, to achieve the target at the
earliest possible time, with a time horizon of about two years. With the aim of achieving the
target, the Bank decided to continue with QQE, as long as it was necessary for maintaining
that target in a stable manner.
More than one and a half years have passed since the introduction of aggressive monetary
easing, and in the meantime it has strongly supported the recovery in economic activity from
the financial side. As a result, the year-on-year rate of change in the CPI, which was minus
0.5 percent in March 2013 immediately before introducing QQE, is now around 11⁄4 percent.
To be sure, weak developments in demand following the consumption tax hike and the
substantial decline in crude oil prices have been exerting downward pressure on prices, and
the year-on-year rate of increase in the CPI slowed to 1.0 percent in September. A temporary
weakness in demand has already started to wane, and a decline in crude oil prices will have
positive effects on economic activity from a somewhat longer-term perspective and push up
prices. Nevertheless, if the current downward pressure on prices remains, albeit in the short
term, there is a risk that conversion of the deflationary mindset, which has been progressing
steadily so far, might be delayed.
Deflation has continued for a protracted period in Japan and, unlike countries such as the
United States, where inflation expectations have already been anchored at around 2 percent,
Japan is in the process of raising, to around 2 percent, the inflation rate that the general
public perceives as representing price stability. In this process, if the actual rate of increase
does not accelerate - even for a short term - there is a risk that the momentum for inflation
expectations thus far will lose steam. It is also necessary to pay attention to the point that
adaptive expectation formation - where the inflation rate for previous periods affects people's
formation of the expected inflation rate - is prominent to some degree in Japan. To prevent
the manifestation of such risks and maintain the improving momentum of expectation
formation, the Bank judged it appropriate to expand QQE and decided such expansion.
Before the expansion, JGB purchases had been conducted with an average remaining
maturity of about seven years; as a result, there had been a substantial decline in yields in
the somewhat short-term zone, while yields in the somewhat longer-term zone remained at
relatively higher levels. Now that the average remaining maturity has been extended and set
within a flexible range, this will put further downward pressure on interest rates across the
entire yield curve. Furthermore, in order to conduct flexible JGB purchases, the Bank
decided to announce the monthly schedule and details of JGB purchases for the following
month on the last business day of each month.5
B. Effects and costs of the expansion of QQE
I would now like to explain how I assessed the expected effects as well as the potential costs
and risks of the expansion of QQE before voting in favor of the decision.
Let me first describe the effects of the expansion of QQE. With the introduction of QQE in
April 2013, which has put further downward pressure on interest rates across the yield curve
and strongly influenced asset prices, financial conditions in Japan have become more
accommodative, and this has strongly supported improvements in corporate profits,
employment, and wages. Amid increasing capacity of firms and households to generate
income and a widening acknowledgment of the prospects for a sustainable improvement in
demand, upward pressure on prices has been increasing.6 A baseline scenario for the
outlook for economic activity is that a virtuous cycle from income to spending will be
maintained, and improvements on the supply side of the economy, which represent the
potential strength of the economy, are expected to progress steadily in areas such as firms'
profitability and households' labor supply. In this situation, the expansion of QQE is expected
to produce stronger effects.
Specifically, given an increase in firms' profitability, extremely accommodative financial
conditions will drive their positive efforts and risk-taking activities, thereby further heightening
economic stimulus effects. Large-scale purchases of JGBs can exert downward pressure on
longer-term interest rates and upward pressure on asset prices. If fundamentals such as
corporate profits improved at the same time, asset price rises will become more sustainable
and justified. With the heightening strength of the economy, the recent expansion of QQE will
promote sustainable increases in spending and is expected to produce sustainable policy
effects (Chart 12).
So, how should we assess the potential costs and risks of the expansion of QQE? For
example, regarding the risk that expansion of unconventional easing measures, such as the
purchases of JGBs, will only cause a temporary asset price bubble and thus make the
economy unstable, I think that the key is whether the expansion of such measures is coupled
with improvements in the growth potential of the supply side and in firms' competitiveness,
and whether a structural transformation in the economy - such as restructuring of
unprofitable businesses - will, after being postponed, be stimulated. On this point, as I have
emphasized on many occasions, I judge that this risk has been mitigated, since firms'
positive efforts to heighten the potential strength of the economy have progressed steadily
and this trend is likely to continue. As I have just explained, asset price rises that accompany
improvements in fundamentals become more sustainable and justified, and the potential
negative side effect of accumulation of financial imbalances will likely be suppressed.
For the same reason, I consider that the risk of economic rejuvenation being delayed - in
other words, the risk that monetary easing would allow funds to circulate among firms,
including nonviable firms - will likely be mitigated to a certain degree. That is, if firms' ability
to proceed with the postponed disposal of the negative legacies and business succession
increases as decisive measures produce further positive effects, and if such measures
strongly support these firms' efforts, business fixed investment, a structural transformation in
the economy, and economic rejuvenation are likely to progress.7 As a result, I think that this
may then accelerate a virtuous cycle that bolsters the potential strength of the economy and
the effectiveness of the policy measures.
The economic recovery in Japan seems to have strengthened its sustainability, as corporate
profits have been on an improving trend and potential strength has heightened further
through the implementation of the measures in 2013. Corporate profits have increased while
monetary easing has been strengthened and stock prices remain on a rising trend, and a
similar situation has been observed in the United States (Charts 12 and 18). Given these
improvements, it is likely that firms' positive efforts to improve profits and strongly proceed
with a structural transformation of unprofitable businesses have been encouraged by the
extremely accommodative financial conditions. I think that the expansion of QQE strongly
supports such efforts.
C. Prospects for an exit
Some argue that it has become more difficult to envisage an exit from monetary easing due
to the expansion of QQE. However, I do not completely agree with this argument. Let me
explain my thinking behind this view.
One of the important aims of the expansion of QQE was that the 2 percent target would likely
be achieved earlier than would be the case without such expansion, and that it would provide
a better outlook for the feasibility of achieving the target. Due to the expansion of QQE, I
personally think that it is quite probable that the 2 percent target will be achieved in a
balanced manner - accompanying improvements in corporate profits, employment, and
wages - in the second half of fiscal 2015. In fact, I expect that the rate of inflation will
accelerate from summer 2015, with the waning effects of the decline in crude oil prices in
2014 (Chart 16).
If this scenario materializes, it will become possible in the second half of fiscal 2015 to expect
with greater certainty that the 2 percent target will be achieved in a stable manner.
Consequently, with the expansion of QQE, I see it as highly likely that there will be a start to
discussions of a specific exit strategy - for example, how to slow the pace of asset
purchases, just as the Federal Reserve had been doing until recently, and how to take steps
to return to an interest rate policy - in the second half of fiscal 2015, when the 2 percent
target will likely be achieved.
Nominal interest rates are formed based on the outlook for economic activity and prices as
well as term premiums. The Bank has been exerting downward pressure on interest rates
with purchases of JGBs. However, if upward pressure on interest rates strengthens in line
with improvements in economic activity and prices, interest rates may stop declining or even
start rising even if the Bank continues to purchase JGBs.
At the Monetary Policy Meeting held on October 31, 2014, the Bank carefully examined the
outlook for economic activity and prices. It assessed that downside risks to prices had
increased and thus it had become necessary to take additional policy action. With a clear
commitment to supporting the economic recovery in the form of implementing drastic
additional easing at this juncture, when a virtuous cycle is being maintained, stronger effects
of the policy can be expected. As a result, it may be possible to achieve the 2 percent target
and start discussing an exit strategy sooner - to be specific, as early as in the second half of
fiscal 2015. After carefully examining the expected effects as well as costs and risks, I judged
it appropriate to decide in favor of the additional easing.
D. Significance of the joint statement of the government and the bank
I would now like to call attention to the significance of the joint statement of the government
and the Bank on overcoming deflation and achieving sustainable economic growth that was
released in January 2013. The main points of the statement are as follows.
(1) The Bank, based on the recognition that efforts by a wide range of entities toward
strengthening the competitiveness and growth potential of Japan's economy will make
progress, sets the price stability target at 2 percent in terms of the year-on-year rate of
change in the CPI, and will aim to achieve this target at the earliest possible time.
(2) The government will not only flexibly manage macroeconomic policy but also formulate
measures for strengthening the competitiveness and growth potential of Japan's economy -
including all possible decisive policy actions, such as carrying out bold regulatory and
institutional reforms and better utilizing the tax system - and promote them strongly. In
addition, in strengthening coordination between the government and the Bank, the
government will steadily promote measures aimed at establishing a sustainable fiscal
structure.
It is clearly expressed in the statement that the Bank and the government will jointly make
these efforts toward the same end. The Bank decided on the additional easing to show its
heightened determination to overcome deflation early and achieve sustainable economic
growth with price stability in line with the statement. The Bank strongly expects that the
government's efforts will also continue to progress vigorously and steadily in line with the
statement.
Concluding remarks: the economy of Nagasaki prefecture
My concluding remarks will touch on the economy of Nagasaki Prefecture.
For hundreds of years, Nagasaki has been an international hub of cultural exchanges and
open to the world, as epitomized by Dejima - an artificial island that was the only place
authorized by the government for direct trade and exchange between Japan and the outside
world during the Edo period. While nurturing a unique regional culture, Nagasaki has played
a major role in the modernization and development of monozukuri, or manufacturing, mainly
in heavy industry such as shipbuilding. In addition to such history and tradition, it is blessed
with ample tourism resources, such as remote islands, hot springs, and fresh agricultural and
marine products, as well as an appealing food culture.
In the shipbuilding industry, which is a key industry of the prefecture, the "Year 2014
Problem" - referring to a situation whereby a substantial decline in order backlogs for new
shipbuilding might result in empty docks in 2014 - had been a matter of concern until about
two years ago. However, it now seems that, due to the depreciation of the yen and a rise in
the reputation of Japan's energy-saving, high-quality ships, the shipyards in Nagasaki have
regained their competitiveness and seen an upswing in demand. Now, they face shortages of
workers and staff due to the continuing high operating ratio.
In another key industry, tourism, there are two sets of candidate sites in Nagasaki for
placement on the UNESCO World Heritage List under the category of culture. Specifically, in
2014, "Churches and Christian Sites in Nagasaki" was added as a candidate by the
government, following the endorsement of "Sites of Japan's Meiji Industrial Revolution" in
2013. To promote tourism in Nagasaki, various measures have been taken to attract visitors
from home and abroad; for example, it has one of the world's top three nightscapes, and the
construction of the Nagasaki route of the Kyushu Shinkansen bullet train is heading toward
completion in 2022. Given these factors, I expect that the prefecture will have a golden
opportunity to increase its number of visitors.
Meanwhile, the population in Nagasaki, particularly in remote islands, has been declining,
and, above all, the prefecture faces continuing outflows of young people to other prefectures.
Moreover, I have heard that there are other challenges. Specifically, the weakening of
business bases for various local industries - such as fisheries, as evidenced by a decline in
catches - and for small firms has yet to show any improvement. Needless to say, these are
common problems that many other regional economies in Japan face.
The Nagasaki prefectural administration has implemented measures to address these
problems. To raise the income of residents in the prefecture so that young people can enjoy
living in the region, the prefecture has been making efforts to capture external demand,
mainly from Asian neighbors, such as by actively promoting the arrival of international
cruises, while further strengthening the competitiveness of manufacturing and tourism as well
as agriculture, forestry, and fisheries, all of which have advantages and are the pillars of the
local industries. In support of such initiatives, I have heard that lively discussions have been
held at Nagasaki Summit, organized through an industry-academia-government
collaboration, and this has been playing a critical role in the revitalization of local economy
and communities.
The joint efforts toward attracting external demand and tapping domestic demand have been
steadily bearing fruit. We at the Bank wish you every success in these efforts and will
continue to provide support as much as possible as the central bank.