Takahide Kiuchi: Recent developments in economic activity and prices
and future monetary policy
Speech by Mr Takahide Kiuchi, Member of the Policy Board of the Bank of Japan, at a
meeting with business leaders, Kanagawa, 28 February 2013.
* * *
I. Current situation of overseas economies and their prospects for a moderate
recovery
A. Easing of tension in global financial markets
I would like to start my speech with a look at overseas economies. Developments in global
financial markets continue to require vigilance, especially in terms of the European debt
problem and the fiscal problem in the United States. Nevertheless, tension in the financial
markets has eased significantly since around autumn 2012, as evidenced by the
repurchasing of risk assets such as currencies of emerging economies and stocks and the
selling of advanced economies' government bonds and the yen, which had been purchased
as a safe currency. Three things seem to be at work in the background to these
developments. First, in Europe and the United States, a decline has occurred in tail risks -
risks with a low probability of materialization but a devastating impact if they materialize. This
reflects the fact that in Europe the possibility of disintegration of the euro has fallen
significantly, supported by (1) the approval of new disbursement of financial assistance to
Greece, (2) some progress achieved in fiscal consolidation and economic structural reforms
by peripheral European countries such as Portugal and Spain, and (3) the introduction of
safety valves such as the European Stability Mechanism (ESM). In addition, at the beginning
of 2013 the United States avoided the "fiscal cliff," a state in which the expiration of
largescale tax cuts and substantial fiscal spending cuts threatened to occur simultaneously.
Second, investors' confidence has returned due to expectations regarding policy measures,
as central banks in advanced economies such as the United States and Europe as well as
Japan have conducted aggressive monetary easing. Third, expectations have grown that the
global economy will pick up, as the U.S. and Chinese economies have firmed since autumn
2012.
B. Gradual pick-up in overseas economies from a deceleration phase
While overseas economies remain in a deceleration phase as a whole, signs of a pick-up
have been observed. The U.S. economy has been on a moderate recovery trend. Business
sentiment that had been cautious due to concerns over the fiscal cliff has improved
somewhat, and business fixed investment has shown signs of a pick-up. In the household
sector, firmness in housing investment and car purchases has become pronounced partly
due to the effects of the decline in long-term interest rates. As for the outlook, the recovery
trend in the U.S. economy is likely to gradually strengthen in the latter half of 2013, as the
effects of expiration of tax cuts wane and uncertainties diminish in regard to fiscal spending
cuts and the debt ceiling problem.
Economic activity in the euro area remains weak. From the latter half of 2013, however,
economic activity is likely to gradually recover particularly in core countries such as Germany
and France. This is because (1) disturbances in financial markets have been diminishing;
(2) the degree of fiscal austerity, while continuing, has eased somewhat; and (3) the
competitiveness of peripheral countries' exports has begun to recover with the progress in
structural reforms, including reductions in labor costs.
The Chinese economy has been generally picking up since autumn 2012, as the
government's expansionary fiscal measures centered primarily on infrastructure investment
and monetary easing measures have been producing positive effects. The real GDP growth
rate in the January-March quarter of 2013 is expected to recover to the 8.0-9.0 percent level
for the first time in a year.
In these circumstances, looking at the outlook for the global economy as a whole, the real
GDP growth rate is expected to accelerate moderately from 3.2 percent in 2012 to
3.5 percent in 2013 and 4.1 percent in 2014, according to the latest World Economic Outlook
released by the International Monetary Fund (IMF) in January 2013. If the global economy -
led by emerging economies - registers growth rates as projected, the rates will be above the
historical long-term average.
II. Current situation of Japan's economy and its prospects, with the key factor of
a pick-up in overseas economies
A. Leveling out of Japan's economy
Japan's economy remained relatively weak during the latter half of 2012, as exports and
production decreased significantly due mainly to the deceleration in overseas economies,
which in turn adversely affected domestic demand such as business fixed investment in the
manufacturing industry. However, recent developments show that the pace of decrease in
exports has been moderating and production appears to have stopped decreasing. Based on
these developments, at the Monetary Policy Meeting (MPM) held on February 13 and 14,
2013, the Bank of Japan revised upward its basic assessment of the domestic economy,
from an assessment that the economy remained relatively weak to an assessment that it
appeared to have stopped weakening.
The leveling out of production is mainly attributable to three factors. First, the effects of the
ending of subsidies for purchasing energy-efficient cars, which temporarily exerted strong
downward pressure on car production, have fallen off. Second, the effects of the recent
developments in the relations between Japan and China, which dealt a serious blow
particularly to exports of cars and related items, have eased somewhat. And third, the pace
of decrease in exports has been moderating as overseas economies such as the United
States and China have shown some signs of picking up. Nevertheless, while exports are
showing some signs of leveling out, it is necessary to closely monitor whether a clear
increase will occur in exports, which are expected to become the driving force of a
fullfledged economic recovery. Consequently, uncertainty remains over how Japan's economy
will achieve a full-fledged recovery.
B. Effects of fiscal policy measures, the depreciation of the yen, and the rise in
stock prices
Japan's growth rate for 2013 is expected to rise relatively steadily, in line with the
accumulation of temporary boosting effects of various policy measures. First, the
implementation of the supplementary budget for fiscal 2012 of about 20 trillion yen is
expected to have an effect, particularly in public investment, from the April-June quarter of
2013 onward. Second, the recent developments in foreign exchange rates and stock prices -
supported in part by expectations for the new administration's economic and fiscal policies as
well as for the Bank's enhancement of monetary easing - are expected to gradually have
positive effects mainly in exports and private consumption. Third, a front-loaded increase in
demand prior to the hike in the consumption tax scheduled in April 2014 is likely to take place
particularly in demand for housing and durable consumer goods.
According to the median of the forecasts of the majority of the Bank's Policy Board members
in the interim assessment of the October 2012 Outlook for Economic Activity and Prices,
released in January 2013, the real GDP growth rate is expected to be 1.0 percent for fiscal
2012, accelerate to 2.3 percent for fiscal 2013, and decline to 0.8 percent for fiscal 2014
even after accounting for the effects of the consumption tax hike. The year-on-year rate of
change in the consumer price index (CPI) for all items less fresh food is expected to rise
gradually reflecting an improvement in the output gap as a result of the economic growth rate
continuing to exceed the potential growth rate. As for the median of the forecasts, the
yearon-year rate of change in the CPI is projected to be minus 0.2 percent for fiscal 2012,
0.4 percent for fiscal 2013, and 0.9 percent for fiscal 2014 excluding the direct effects of the
consumption tax hike. Meanwhile, with regard to risk factors, attention should be paid to the
prospects for the European debt problem, the momentum toward recovery for the U.S.
economy, the possibility of emerging and commodity-exporting economies making a smooth
transition to a sustainable growth path, and the effects of the recent developments in the
relations between Japan and China. With these factors taken into consideration, a high
degree of uncertainty remains concerning Japan's economy.
III. Downside risks to the economic outlook
A. Weak recovery of overseas economies
With respect to the aforementioned baseline scenario of the outlook for economic activity and
prices in Japan, I consider the downside risks to be rather large.
The greatest concern arises from the possibility of the deceleration in overseas economies.
Although overseas economies are likely to gradually emerge from their current deceleration
phase, the sustainability of their recovery will likely remain unpredictable. In the United
States, housing investment and private consumption are expected to be the driving force of
the pick-up in the economy in the short run; if the recent uptrend in long-term interest rates
strengthens suddenly, however, this could adversely affect funding for housing investment
and car purchases. Attention should also be paid to the risk that the persisting uncertainty
over fiscal policy could exert downward pressure on the U.S. economy with an influence on
public sentiment.
With regard to the euro area, it is necessary to remain continually vigilant against the risk that
financial markets could suffer renewed disturbance if political and social instability hinders
fiscal consolidation and economic structural reforms and if slow progress in coordinating
national interests hampers Europe's ongoing integration such as the formation of fiscal and
banking union. In addition, since banks' lending attitudes have not shown signs of easing,
there is a risk that funding constraints could prevent the economy from emerging from the
deceleration phase for a long time.
As for China, the government's policy stance is the focus of attention. Because aggressive
fiscal measures adopted after the Lehman shock left many issues unresolved - such as
excessive capital stock and an overheating in the real estate market - China's previous
administration had remained cautious about public spending despite a decelerating
economy. The current administration also appears to be maintaining a cautious stance. In
addition, the Chinese government remains vigilant against (1) a rise in the inflation rate,
(2) an upturn in major cities' housing prices, which the previous administration had sought to
contain, and (3) a rapid expansion in shadow banking such as trust business, where
personal assets are flowing in to gain high returns. The possibility should therefore not be
ruled out that the government will reverse its accommodative stance on fiscal policy. In terms
of monetary policy, the People's Bank of China has indicated its intention of placing top
priority on controlling inflation. Moreover, in response to the expansion in bank lending in
January 2013, the authorities have reportedly instructed large banks to constrain lending.
The authorities have stated their intention of strengthening risk management associated with
shadow banking, in which case there is a risk that infrastructure investment and real estate
investment will be significantly suppressed.
B. Continuation of a large negative output gap in the major economies
Aside from the short-term downside risks I have mentioned, there is concern over the
medium to long term: it could take time before the U.S. and European economies, as well as
the Chinese economy, overcome the aftereffects of the credit bubble. Similar to what
occurred in Japan, firms will likely continue their cautious stance on employment and
households' medium- to long-term income expectations are likely to weaken in view of the
persistently high unemployment rate, causing the economies to lag behind in achieving a
self-sustaining recovery with an expansion of employment and income. What I wish to
highlight here is that since the Lehman shock, the output gap - which indicates the
aggregate demand and supply balance - has been largely negative across the advanced
economies. According to the Organisation for Economic Co-operation and Development
(OECD), the output gap in the advanced economies, after having reached minus 4.0 percent
of GDP in 2009, is expected to exceed minus 3.0 percent in 2013, at minus 3.3 percent. In
the OECD's projections for the output gap as of November 2012, the output gap of Japan is
minus 2.1 percent for 2013, but that of the United States and of the euro area is substantially
more negative.
The large negative output gap in the advanced economies indicates a prolonged excess in
production capacity and labor in the aftermath of the credit bubble, appearing in the form of
balance-sheet adjustments. This type of situation causes firms to post lower profits and
further restrain investment, and causes households to lower their income expectations and
restrain consumption, exerting downward pressure on the already-declining inflation rate.
With this situation spreading widely in the major economies, which are Japan's main export
destinations, considerable uncertainty will inevitably remain over Japan's export environment
in the long run.
C. Expansion of trade deficit and financial market stability
With regard to the downside risks to Japan's economy, due attention should be paid to the
continued trend in the expansion of trade deficit and its effects on financial markets. As I
mentioned, Japan's economic growth rate is expected to rise relatively smoothly for the time
being, but the recovery of overseas economies could lack momentum. In addition, imports of
raw materials are expected to remain at a high level. This situation could cause Japan's
trade deficit to expand. An expansion of the trade deficit causes the yen to depreciate mainly
through changes in the supply-demand balance in foreign exchange markets. This could
then destabilize financial markets, because not only a buoyant economy and a rise in import
prices but also a reduction in surplus funds in the domestic markets cause long-term interest
rates to rise. Attention should therefore be paid to the effects of the expansion of trade deficit
on financial markets as well as economic activity.
Furthermore, long-term interest rates could rise if credibility of the conduct of fiscal policy is
undermined. The rise in long-term interest rates could significantly affect Japan's economy,
and depending on the degree of the rise, could also affect the economy by greatly
aggravating instability in the banking system. Long-term interest rates in Japan have been
stable so far, and this may be regarded as evidence that the credibility of fiscal policy is
being maintained. However, given that unexpected events may trigger sudden and nonlinear
changes in market sentiment, as experienced with the European debt problem, it is
necessary to continue careful monitoring to identify the changes as risk factors.
IV. Developments in prices and wages in Japan and their characteristics
Before I move onto my next topic of monetary policy conduct, I would like to discuss
developments in prices and wages in Japan, which are closely linked to my topic, and give
my personal view on the background to the prolonged deflation.
A. Historical developments in Japan's inflation rate and a comparison with other
major economies
Since the 1980s, Japan's inflation rate has remained at a consistently low level, unlike the
case of other major economies. According to the OECD, during the decade from 1985 to
1995, the year-on-year rate of change in the CPI in the G-7 countries was 3.3 percent on
average, while in Japan it was 1.4 percent. For the 15 years thereafter, from 1996 to 2011,
the year-on-year rate of change in the CPI in the G-7 countries was 1.9 percent on average,
while in Japan it was minus 0.1 percent. The difference between the averages of Japan's
inflation rate and those of the G-7 countries remained mostly unchanged: approximately
1.9 percent for the first ten years from 1985 and around 2.0 percent for the 15 years
thereafter, when Japan's economy fell into deflation. This indicates that, during the 25 years
as a whole, Japan and the other major economies generally experienced a long downtrend in
their inflation rates.
I see in this the possibility that Japan's deflation might have been brought about by the
downtrend in global inflation.
In particular, a large negative output gap - a state of excessive supply - continues to be
seen in the major economies since the Lehman shock, on the back of balance-sheet
adjustments in the aftermath of the credit bubble. This has created an environment where the
inflation rate is subject to downward pressure, and such developments overseas could also
be considered to have exerted downward pressure on price developments in Japan.
B. Major factor behind the difference between inflation rates in Japan and the
United States: the service sector
I would also like to compare and examine price developments in Japan and abroad. For
example, if we compare price developments in Japan and the United States, in Japan the
year-on-year rate of change in the CPI was minus 0.2 percent on average between 1997 and
2011, while in the United States it was 2.4 percent, resulting in a gap of 2.6 percentage
points. The major factor behind this was a difference in the contribution of prices of services
less rent, which accounted for about one-third of the 2.6 percentage point gap, or
0.9 percentage point. When rent was included, services prices accounted for almost
twothirds of the gap, or about 1.7 percentage points. In my view, the fact that services prices are
typically susceptible to developments in wages may indicate the reason why Japan's price
structure is prone to deflation and suggest how deflation can be overcome.
C. Relationship between the potential growth rate, wages, and prices
As seen earlier, according to the OECD, since 2009 - when the negative output gap
expanded worldwide due to the effects of the Lehman shock - the negative output gap in
Japan has not been particularly large compared with other major economies, and this
suggests that the level of the output gap does not solely determine the level of the inflation
rate. In considering the cause of deflation in Japan, attention should therefore be paid to the
supply-side factors, such as the rate of increase in labor productivity and the economy's
potential growth rate.
In Japan, there is a relatively strong correlation between the potential growth rate per capita
and medium- to long-term inflation expectations. This relationship is considered to reflect the
customary practice prevailing between employers and employees: when medium- to
longterm growth expectations declined after the bursting of the economic bubble, Japanese firms
tended to adjust wages rather than employment, and workers tended to accept such
adjustments. Although Japan has experienced prolonged deflation that is unprecedented
among major economies, its unemployment rate has remained very low relative to other
economies and the employment situation has shown outstanding stability. In the United
States, on the other hand, employment has fallen but declines in wages and prices have
remained quite limited amid economic deterioration. These contrasts show how means of
adjustment in the labor market differ between Japan and the United States.
With these points taken into account, an end to deflation and a further rise in Japan's inflation
rate require efforts to strengthen the growth potential to raise the economy's potential growth
rate and subsequently boost growth expectations. Such improvements are expected to result
in an increase in services prices through a rise in the rate of wage increase. However, if
wages increase unaccompanied by a strengthening in the growth potential and a rise in
productivity, this will depress corporate profits, which in turn could restrain business fixed
investment and hamper steady economic growth. The possibility of a resultant deterioration
in the employment and income situation is a matter of concern. On the other hand, if the
inflation rate increases while the growth potential does not strengthen and wage inflation
remains unchanged, the general standard of living will fall in real terms. In sum, the
economic condition to be sought is a balanced increase in wages and prices on the basis of
a strengthened growth potential.
V. Current and future conduct of monetary policy
A. Decisions made at the MPM held on January 21 and 22, 2013
At the MPM held on January 21 and 22, 2013, the Bank decided to take additional steps to
provide monetary accommodation decisively by introducing two measures: the "price stability
target" of 2 percent in terms of the year-on-year rate of change in the CPI; and the
"openended asset purchasing method" for the Asset Purchase Program (hereafter the Program). In
addition to these two measures, another important decision was the strengthening of policy
coordination between the government and the Bank. The Bank, together with the
government, decided and released "Joint Statement of the Government and the Bank of
Japan on Overcoming Deflation and Achieving Sustainable Economic Growth."
The Bank had previously adopted a "price stability goal in the medium to long term," judged
to be in a positive range of 2 percent or lower in terms of the year-on-year rate of change in
the CPI, and set a goal at 1 percent for the time being. As I will explain in detail later, the
Bank replaced this goal with the "price stability target" of 2 percent for the following reasons.
First, there is an increasing awareness among the general public that even if the Bank were
to use the term "price stability target" it would not conduct monetary policy in an automatic
manner in pursuit of a certain inflation rate. And second, as progress is achieved through
efforts by a wide range of entities - such as those by the government to strengthen the
competitiveness and growth potential of Japan's economy - an increase is likely to occur in
the inflation rate at which firms and households perceive price stability - the basis for their
economic activity. There is uncertainty with regard to how the strengthening of the growth
potential of Japan's economy will proceed, but the Bank expects the setting of this very
ambitious target to have the secondary effect of encouraging efforts by a range of entities. In
this regard, the "price stability target" of 2 percent could serve in a sense as a kind of
"slogan" for the general public in the revitalization of Japan's economy.
Moreover, the Bank has introduced the "open-ended asset purchasing method" without
setting any termination date, to clearly show its strong determination to achieve the "price
stability target" of 2 percent, which it considers will result in greater policy effects. Under the
current purchasing method - which makes a commitment in terms of the future level of the
total size of the Program - the total size of the Program will be increased to 101 trillion yen
by end-2013 from 65 trillion yen at end-2012, as had been planned earlier. From January
2014 and for some time, the Bank will purchase about 13 trillion yen in financial assets,
including about 2 trillion yen of JGBs, every month without setting any termination date.
B. The Bank's price stability target and its importance
Next, I would like to discuss in more detail the inflation targeting system, looking at examples
of overseas systems. Article 2 of the Bank of Japan Act stipulates that "currency and
monetary control by the Bank of Japan shall be aimed at achieving price stability, thereby
contributing to the sound development of the national economy." This tells us that achieving
price stability is the precondition for the sound development of the national economy and that
the sound development of the national economy - which deeply impacts public welfare - is
the ultimate target of the monetary policy conduct. Based on this thinking, in policy conduct
aimed at achieving the price stability target, it is most important to aim at contributing to the
stability and development of the economy in the medium to long term, and to carefully
conduct policy while monitoring the soundness of the financial system. At the same time, it
must be noted that policy conduct aimed at guiding the inflation rate to the target in an
automatic manner in fact entails the risk of hampering medium- to long-term economic
stability.
C. Flexible inflation targeting system
The introduction of an inflation target by the Reserve Bank of New Zealand in 1988 was a
first among the central banks of the major economies, followed by the central banks of
Canada and the United Kingdom. In New Zealand, the central bank aimed at the target
rigidly in the beginning, but later it was recognized that this rigidity was destabilizing the
economy. For this reason, the introduction of an inflation target was deferred by the central
banks of Japan, the United States, and other major economies in Europe. Subsequently,
however, central banks adopting an inflation target have made adjustments to boost
flexibility. Many of the central banks have not specified the timing for achieving the target.
Even the Bank of Canada - which specified the term for achieving the target as "typically
within a horizon of six to eight quarters" - allows adjustments in the length of the term
depending on developments in economic activity and prices to ensure the target's flexibility.
As a result, central banks in major economies are at present conducting policy aimed at
achieving sustainable growth with price stability while assessing the current developments
and outlook for economic activity and prices as well as examining various risks, including
those stemming from the accumulation of financial imbalances. This policy framework is
often referred to as the flexible inflation targeting system. The price stability target adopted
by the Bank of Japan is based on the same thinking. The Bank has clarified that it will aim to
achieve this price stability target of 2 percent "at the earliest possible time." The intention
behind this clarification is that, as discussed earlier, in achieving an inflation target it is
important - from the viewpoint of ensuring medium- to long-term stability of the economy - to
secure flexibility in the policy conduct while carefully ascertaining risks arising from, for
example, the accumulation of financial imbalances. The Bank will aim to achieve the target
"at the earliest possible time" on this basis.
In other major economies, central banks have introduced inflation targets with the aim of
containing rising inflation and reinforcing their independence from the government by
ensuring the transparency of their policy conduct. The Bank of Japan, on the other hand, has
introduced the price stability target in an attempt to overcome deflation. This point differs
from the inflation targets of other central banks, and therefore the Bank's action may be
regarded as an unprecedented endeavor.
D. Votes at the MPMs held in January and February
So far, I have explained the decisions made at the MPM held on January 21 and 22, 2013. At
the meeting, I voted against the introduction of the price stability target of 2 percent in terms
of the year-on-year rate of change in the CPI. The main reasons for my vote have already
been outlined in the minutes of the MPM, which were released on February 19. Although my
remarks here will thus repeat them, I would like to briefly review the three reasons outlined in
the minutes. First, while the inflation rate consistent with sustainable price stability pursued
by the Bank is considered to be largely affected by the general public's current perception of
price developments, 2 percent in terms of the year-on-year rate of change in the CPI had
rarely been achieved in the past two decades, and based on the general public's current
perception of price developments that is built on such past experience, the 2 percent inflation
rate is considerably higher than the inflation rate that is considered at this point to be
consistent with sustainable price stability. Second, this suggested that, even if the central
bank were to set 2 percent inflation as a target, this alone is highly unlikely to substantially
influence inflation expectations. Third, efforts by a wide range of entities toward
strengthening the growth potential of Japan's economy are essential in order to achieve the
2 percent target, but if the 2 percent target were set before such efforts made progress and
the effects of these efforts were confirmed, this could impair the credibility of monetary policy
due to considerable uncertainty regarding achievement of the target. For these reasons, I
judged that the Bank's commitment to do its utmost to achieve the target of 1 percent in
terms of the year-on-year rate of change in the CPI for the time being would further enhance
the policy effects and be more appropriate in the current situation.
Subsequently, at the MPM held on February 13 and 14, I voted for the public statement that
included the following sentence: "the Bank has set the price stability target at 2 percent in
terms of the year-on-year rate of change in the CPI." I still hold the view that it is not an easy
task to achieve the price stability target of 2 percent. Neither is there a significant change in
the general public's perception of price developments at present. However, in line with the
recognition that a range of entities, including the government and the private sector, will fulfill
their respective roles to overcome deflation, I considered that financial market developments
after the introduction of the price stability target of 2 percent appeared to reflect expectations
for the Bank's monetary policy and the government's various policy measures, and that it
was important to further increase credibility regarding the Bank's decision on the price
stability target of 2 percent from the viewpoint of overcoming deflation. While monitoring the
effects of monetary policy and their spread through the economy, the Bank will conduct
policy aimed at achieving this target in a responsible manner, by carefully communicating its
policy intentions and considering a decisive action for additional monetary easing as
necessary.
E. The Bank's policy stance on achieving the 2 percent price stability target
In my opinion, the Bank's decision to introduce the open-ended asset purchasing method
with the aim of achieving the 2 percent price stability target indicates that asset purchases
through market operations will continue to form the core of the Bank's policy to enhance
monetary easing. Specifically, this decision is based on the idea that the Bank will give
greater consideration to producing policy effects by affecting market prices, which is what the
comprehensive monetary easing policy has been aiming for. This means encouraging a
decline in longer-term interest rates and a reduction in risk premiums and thereby ensuring
financial conditions that allow firms and households to raise funds at low cost.
There seems to be a range of views in financial markets currently on the feasibility of the
2 percent price stability target. If any doubt arose in the markets over the Bank's stance on
achieving the target, this could reduce the policy effects. Therefore, with a view to avoiding
such a situation and continuing to clearly show the Bank's strong determination to achieve
the target, it is important to steadily conduct asset purchases under the Program in a
sustainable manner and thereby produce the intended policy effects. In this regard, I will
discuss three points: steadily increasing the amount outstanding of the Program;
strengthening coordination with the government and maintaining fiscal consolidation; and
communication to the public to gain understanding of the Bank's policy intention.
F. Issues regarding the operation of the asset purchase program
First, let me mention an issue concerning the payment of interest under the complementary
deposit facility, or the payment of interest on excess reserve balances of financial institutions'
current accounts at the Bank. This issue needs to take into account the fact that
undersubscription - that is, aggregate bids falling short of the Bank's offers - has been
occurring frequently in the fixed-rate funds-supplying operation against pooled coll