Takahide Kiuchi: Recent developments in economic activity, prices and
monetary policy
Speech by Mr Takahide Kiuchi, Member of the Policy Board of the Bank of Japan, at a
meeting with business leaders, Ishikawa, 23 June 2016.
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I. Economic activity and prices in Japan
A. The Bank of Japan's view
The Bank of Japan explains its assessment of the current situation and outlook for Japan's
economic activity and prices in the Statement on Monetary Policy, which is released after
each Monetary Policy Meeting (MPM), and in the Outlook for Economic Activity and Prices
(the Outlook Report), which is published four times each year. Therefore, I will first give you
an overview of its assessment of the current situation and outlook based on the latest
Outlook Report and Statement on Monetary Policy.
Japan's economy has continued its moderate recovery trend, although exports and
production have been sluggish, due mainly to the effects of the slowdown in emerging
economies. The outlook through fiscal 2018 envisages that, although sluggishness is
expected to remain in exports and production for the time being, domestic demand is likely to
follow an uptrend, with a virtuous cycle from income to spending being maintained in both the
household and corporate sectors, and exports are expected to increase moderately. Thus,
Japan's economy is likely to be on a moderate expanding trend.
As for prices, the year-on-year rate of change in the consumer price index (CPI, all items less
fresh food) is likely to be slightly negative or about 0 percent for the time being, due to the
effects of the decline in energy prices, and thereafter accelerate toward 2 percent.
Meanwhile, assuming that crude oil prices will rise moderately from the recent level, the
timing of the year-on-year rate of change in the CPI (all items less fresh food) reaching
around 2 percent - the price stability target - is projected to be during fiscal 2017.
Thereafter, the year-on-year rate of change in the CPI (all items less fresh food) is likely to
be around 2 percent on average.
B. My personal view
I believe that Japan's current growth rate and inflation rate are generally stable, in light of the
economy's growth potential, and that there is a relatively high probability of this situation
continuing during the projection period in the April 2016 Outlook Report.
However, when expressed in figures, my view is fairly cautious compared with the medians
of the Policy Board members' forecasts. This is mainly because I believe that (1) there is not
a driving force from the demand side - including in terms of the effects of monetary easing -
that will bring about economic growth at a pace clearly higher than its potential; (2) there are
downside risks to the medians of the Policy Board members' forecasts in terms of demand
both at home and abroad; and (3) as a result of these factors, the output gap is expected to
remain more or less at a neutral level, making it difficult to expect that the underlying trend in
inflation will rise markedly.
Next, I will mention several points of attention regarding the outlook for economic activity and
prices based on my view.
1. Stagnant potential growth rate
According to the Bank's estimates, the potential growth rate of Japan's economy, which
represents from the supply side - the pace of growth that is consistent with the economy's
growth potential, is still at a low level in the range of 0.0-0.5 percent. No notable
improvement has been observed in the past several years, either. In particular, in line with
the sluggish rate of increase in total factor productivity (TFP), which reflects technological
advances, the rate of increase in labor productivity - which considerably affects firms'
wagesetting behavior, which in turn impacts private consumption and prices - has continued to be
stagnant.
However, the output gap, which represents the degree of utilization of capital and labor, has
generally maintained a neutral level over the past several years. This means that Japan's
economy has continued to show stable growth that is more or less consistent with its growth
potential.
2. Medium- to long-term growth expectations and business fixed investment
Although business fixed investment has been on a moderate increasing trend, it has not
grown as strongly as had been expected when considering the high levels of corporate
profits.
I think that the fact behind this situation is that, while the high levels of profits in recent years
had been brought about largely by improvement in price factors that cannot necessarily be
considered sustainable - namely, improvement in the terms of trade reflecting changes in the
exchange rates and commodity prices - the prospects for future sales volume have not
improved. In this respect, the potential growth rate is still at a low level and is expected to
improve only very moderately; therefore, firms may not significantly change their cautious
stance on business fixed investment in the domestic market.
3. Sluggish private consumption
Private consumption has been resilient, but I think that it is still sluggish. It seems that
pricerelated factors that once curbed private consumption, such as the consumption tax hikes and
price increases for food and daily necessities, have been fading away recently. However,
wages have not improved by as much as had been expected, as seen in the fact that the
base pay increase resulting from the labor-management wage negotiations this spring seems
to have been somewhat lower than the level in 2015. This has led to households' cautious
outlook for wages, which might be one factor restraining private consumption.
I would note that these developments in wages might be attributable to persistent concerns
among firms that a rise in labor costs, including an increase in base pay, may undermine the
future situation for corporate profits amid the lack of a rise in the expected productivity growth
rate and in the expected medium- to long-term economic growth rate.
In addition to households' cautious outlook for wages arising from firms' stance of curbing
labor costs, future concerns that are rooted in the fiscal condition and the social security
system may be another factor restraining private consumption among a broad range of age
groups.
4. Overseas economies and downside risks to Japan's exports
The expectations for a global economic downturn that mounted at the beginning of 2016
have receded somewhat recently, reflecting improvements in U.S. and Chinese economic
indicators and the stabilization of crude oil prices. However, it is difficult to expect the U.S.
economy in its current status to act as a strong driving force of the global economy.
Therefore, the scenario of advanced economies leading the global economic recovery has
remained unrealized.
In emerging economies, business fixed investment has been weak due to excess production
capacity and excess debt, eroding the global economy's current recovery potential. These
problems could destabilize global financial markets, particularly through adjustments in the
corporate bond markets in emerging economies that may be triggered by, for example,
changes in the flow of funds caused by the U.S. monetary policy. Moreover, I am paying
attention to the possibility that, if the global economy shows signs of a slowdown again,
resulting in a decline in energy prices, there will be growing risks on the financial front,
including (1) adjustments in the markets for high-yield bonds, mainly those issued by
energyrelated firms, and (2) heightened credit risk involved in financial institutions' exposure to
these firms.
In light of this export environment, I have continued to regard developments in overseas
economies and global financial markets as the most serious downside risks to Japan's
economy.
5. Developments in the underlying trend in inflation
Since the beginning of fiscal 2016, the year-on-year rate of change in retail prices of
consumer goods - mainly processed food - has tended to shift downward. Presumably, this
is because at the beginning of the fiscal year, the price increases did not spread as much as
in the past two years owing to (1) the depreciation of the yen having come to a pause,
(2) private consumption having been sluggish, partly due to the effects of irregularly warm
weather, and (3) the pace of wage increases having remained only moderate.
Under these circumstances, I expect that the year-on-year rates of change in the indicators
of the underlying trend in prices, such as the CPI (all items less fresh food and energy) and
the CPI (all items less food and energy), will decelerate somewhat over the next several
months. Moreover, I do not assume that the year-on-year rate of change in the CPI (all items
less fresh food) will reach the price stability target of 2 percent by fiscal 2018, the last year of
the projection period in the April 2016 Outlook Report.
Even so, as the expected decline in the underlying trend in inflation for the time being is
largely attributable to the disappearance of temporary factors such as the depreciation of the
yen, I expect that prices will generally stay stable. While the level of the underlying trend in
inflation - represented by, for example, the year-on-year rate of change in the CPI (all items
less fresh food and energy) - is lower than the price stability target of 2 percent, I do not
believe that this is causing any particular problem for current economic activity because the
rates do not deviate widely from firms' and households' medium- to long-term inflation
expectations.
II. Conduct of monetary policy
The Bank introduced Quantitative and Qualitative Monetary Easing (QQE) in April 2013 and
then QQE with a Negative Interest Rate in January 2016, with a view to achieving the price
stability target of 2 percent in terms of the year-on-year rate of change in the CPI at the
earliest possible time.
Against these decisions, I have been insisting on a change to QQE - including a reduction in
the pace of the Bank's asset purchases - and a review of the negative interest rate policy,
based on an examination and a comparison of positive effects and side effects of these
measures. Furthermore, I think that enhancement of facilities to provide liquidity is important,
in order to maintain financial system stability through securing the smooth functioning of
financial markets and financial intermediation.
I would like to explain the organization of the thinking behind my policy stance.
A. Rebalancing of Two Mandates of the Bank's Policy
The two mandates of the Bank's policy are to ensure price stability and financial system
stability. Monetary easing measures in recent years - such as QQE and the negative interest
rate policy - have proceeded with emphasis placed on price stability, based on the
recognition that financial system stability has been sufficiently secured.
I admit that the financial system can be assessed as being generally stable at present.
However, potential vulnerability in the financial system has increased under the prolonged
low-interest rate environment, and this trend has been augmented by the large-scale
monetary easing. Therefore, I think that the outlook is by no means optimistic.
From this viewpoint, I have continued to cast a dissenting vote on the negative interest rate
policy since its introduction through the most recent MPM held in June 2016. I have
considered that negative interest rates would decrease the functioning of financial markets
and financial intermediation, as well as impair the stability of the JGB market and smooth
conduct of the Bank's JGB purchases, and therefore an interest rate of 0.1 percent - the
same rate as before - should be applied to all current account balances excluding the
amount outstanding of the required reserves held by financial institutions at the Bank.
Moreover, I think it is time for the Bank to shift the focus of its policy from price stability to
financial system stability. I believe that such a shift will eventually benefit the Bank in
pursuing the ultimate goal of contributing to the sound development of the national economy
through achieving the intermediate objectives, i.e., the Bank's two mandates, in a
wellbalanced manner.
B. Necessity to maintain the sound functioning of financial intermediation
In recent years, financial institutions' profitability - represented by operating profits from core
business - and loss-absorbing capacity have been declining, particularly among regional
financial institutions. Downward pressure on their net income also seems to have increased
recently, due in part to the fact that profit taking, mainly through sales of investment trusts,
has become difficult in a situation where changes have been observed in the depreciating
trend of the yen and the increase in stock prices that continued to be seen over the past
several years. Furthermore, there is concern that the profit environment for financial
institutions might become increasingly severe, mainly due to a further narrowing of interest
rate margins on loans and a greater reduction in yields on securities - both of which followed
the introduction of the negative interest rate policy - as well as to a rise in credit costs.
In this situation, banks may take excessive risks at a time of profit deterioration in an attempt
to increase their profits, but they may become excessively risk averse in the future, mainly
because losses will be incurred by a possible worsening of economic and financial
developments. This could negatively affect economic activity and financial markets by
exacerbating firms' and households' borrowing constraints and through banks' fire sales of
assets.
Furthermore, from a longer-term perspective, the impairment of banks' financial soundness
might also have negative effects on the efficiency and productivity of the economy. To give
an example, banks with declining loss-absorbing capacity might postpone appropriate
treatment of borrowers with weak performance amid a continued decline in banks'
profitability. This may cause a situation in which capital and labor are being allocated to
inefficient firms, and thus result in pushing down the rate of increase in TFP in the overall
economy over the long term.
With these points taken into account, the malfunctioning of financial intermediation through
the impairment of banks' financial soundness might further push down the potential growth
rate of the economy, which is currently at a low level in the range of 0.0-0.5 percent.
Monetary policy is usually thought to affect the demand side of the economy. However, if the
policy impairs financial system stability, the supply side of the economy - for example, the
productivity growth rate and the potential growth rate - may also be adversely affected,
causing losses in social welfare.
C. Concerns about the stability of the JGB market and smooth conduct of the
bank's JGB purchases
Since the introduction of the negative interest rate policy, the JGB market has been
increasingly unstable - as evident from heightened volatility of JGB yields. I consider that this
has exerted negative effects on the stability of financial markets as a whole. In this situation,
there have been adverse effects on the smooth conduct of the Bank's JGB purchases. For
example, the bid-to-cover ratios of its JGB purchasing operations have declined somewhat
and there is a growing tendency for the bid rates to fall below the market rates.
Before the introduction of the negative interest rate policy, financial institutions did not face
particular problems in selling JGBs to the Bank and in turn increasing funds in their current
accounts at the Bank to which an interest rate of 0.1 percent was applied without their taking
interest rate risk. However, given that many financial institutions attach more importance to
obtaining stable income gains rather than having temporary capital gains, I consider that they
have become significantly discouraged to sell JGBs to the Bank and increase funds in their
current accounts at the Bank. This is because the difference between the yields of JGBs held
by financial institutions and the interest rates applied to current accounts at the Bank has
widened with the introduction of the negative interest rate policy.
In addition, with the introduction of the negative interest rate policy, the Bank adopted a
multiple-tier system in which the outstanding balance of each financial institution's current
account at the Bank is divided into tiers, with different interest rates - including a negative
interest rate - being applied to each tier. Because of this, financial institutions, particularly at
the beginning of the introduction of the policy, have tended to reduce or not increase the
Policy-Rate Balance, to which a negative interest rate is applied. As a result, they are
proceeding with purchases of JGBs, particularly those with super-long maturities that are still
offered with positive yields, and I think that this is one of the factors behind further tightening
of the JGB market conditions and somewhat unstable conduct of the Bank's JGB purchases.
Given this, I consider that the decline in JGB yields, particularly those on JGBs with
superlong maturities, since the introduction of the negative interest rate policy is not necessarily
evidence that the policy has been exerting positive effects stably.
I would like to note that, with the increase in the amount outstanding of its JGB holdings, the
Bank is also increasing the amount of reinvestment in JGBs resulting from redemption. Thus,
even though the target for the pace of increase in the amount outstanding of its JGB holdings
remains the same, the gross amount of the Bank's JGB purchases has been increasing.
Also, fiscal 2016 marks an important point in considering the supply-demand balance of
JGBs. It is the year in which the gross amount of the Bank's JGB purchases is expected to
almost reach the gross amount of JGB issuance by the government. This implies that it is
becoming difficult for the Bank to maintain the pace of increase in the amount outstanding of
its JGB holdings solely by purchasing from the market the equivalent amount of JGBs issued
by the government. It is considered that the Bank increasingly will need to purchase JGBs
from financial institutions before redemption of such JGBs up to the amount needed for it to
maintain the pace of increase in the amount outstanding of its JGB holdings. Given this, it is
necessary to sufficiently recognize that it was at this exact timing that the negative interest
rate policy - which discourages financial institutions to sell JGBs - was introduced.
D. Future conduct of monetary policy
My assessment is that QQE, which focuses on JGB purchases, already has exerted a
considerable effect, as evidenced by the closing of the negative output gap at an early stage
and the subsequent correction of the weak prices.
However, I consider that the additional effects of QQE have been diminishing, given that the
continued decline in long-term real interest rates, which is considered to be the main source
of policy effects, already has come to a halt. On the other hand, numerous side effects of
QQE arising from the Bank's JGB purchases have not diminished; rather, they seem to be
increasing steadily. These side effects include (1) various problems stemming from the
distortion of the JGB market - for example, a risk of instability in the financial system caused
by impairment of the proper functioning of the JGB market in terms of liquidity and the
pricediscovery function, and a risk that drastic fluctuations in JGB prices will cause revisions to
prices of other financial products and assets; (2) a limit to the Bank's JGB purchases and
increased volatility in the market in case of arising concerns among market participants about
such a limit; and (3) deterioration in the Bank's financial soundness in the course of
normalizing monetary policy.
Under these circumstances, I believe that, by reducing the pace of the Bank's JGB
purchases - or the annual pace of increase in the amount outstanding of its JGB holdings -
the balance between the positive effects and side effects of QQE could be improved while
ensuring stability in the JGB market. In the meantime, if the Bank does not reduce the
amount outstanding of its JGB holdings, it will be possible to avoid a rise in long-term real
interest rates - a factor that leads to a decline in policy effects - thereby firmly ensuring the
accumulated effects of the Bank's JGB purchases. On this basis, I have been proposing
since April 2015 to reduce the annual pace of increase in the amount outstanding of the
Bank's JGB holdings. In proceeding with the reduction, I think that it is possible to diminish its
effects on financial markets by providing a thorough explanation, or forward guidance, to the
markets that the reduction will actually enhance the stability and sustainability of the Bank's
JGB purchases.
Moreover, I think that measures such as the review of the negative interest rate policy give
due consideration to the stability of the functioning of financial markets and financial
intermediation, which are critical infrastructures of economic activity. Implementation of such
measures will bring about efficient resource allocation through appropriate operation of said
functioning, and thereby support positive efforts by the government and firms toward
increased productivity so that such efforts lead to a higher potential growth rate and
ultimately to an improvement in people's lives.
Lastly, I believe that improving communication with financial markets and enhancing flexibility
are the immediate challenges for the Bank in the conduct of monetary policy.
As the Bank has emphasized its stance of achieving the price stability target of 2 percent at
the earliest possible time, overly heightened expectations for additional monetary easing
tend to be observed in financial markets whenever there is an expectation that the Outlook
Report will present a delay in the projected timing of the year-on-year rate of change in the
CPI (all items less fresh food) reaching around 2 percent. In addition, since the introduction
of the negative interest rate policy, views have become increasingly widespread that the
Bank will launch unforeseen easing measures at an unexpected timing. I presume that these
phenomena not only have become one of the factors behind reduced predictability of
monetary policy and increased volatility in financial markets, but also have led to impairment
of the credibility of the Bank's monetary policy conduct. For this reason, I consider it
important that the Bank thoroughly communicate with financial markets regarding its conduct
of monetary policy and bear in mind the need to provide a detailed explanation so as to
narrow the perception gap between them.
In order to achieve the 2 percent price stability target, I think that it is vital to have a positive
change in economic structure that would increase the underlying trend in inflation - through,
for example, efforts by the government and firms - and that a considerable period of time will
be required for this to take place. Therefore, rather than aiming to achieve the 2 percent price
stability target through monetary policy alone in the short term, I believe that resetting the
time frame for achieving the target to the medium to long term and conducting monetary
policy in a flexible manner - coupled with an improvement in communication with financial
markets - will lead to maintaining economic and financial market stability. This will result in
reaching the Bank's ultimate goal of contributing to the sound development of the national
economy.