Sayuri Shirai: Japan's economic activity, prices, and monetary policy -
the medium-term outlook and the expansion of monetary easing
Speech by Ms Sayuri Shirai, Member of the Policy Board of the Bank of Japan, at a meeting
with business leaders, Hiroshima, 26 November 2014.
* * *
The charts can be found at the Bank of Japan's website.
I. Introduction
Good morning, everyone. Today, I feel honored to have an opportunity to meet with local
representatives here. Let me also express my sincere gratitude for your cooperation with the
activities of the Bank of Japan's Hiroshima Branch. In my speech, I would like to talk about
the Bank's baseline scenario described in the October 2014 Outlook for Economic Activity
and Prices (hereafter the Outlook Report), as well as the Bank's decision made on October
31 to expand quantitative and qualitative monetary easing (QQE).
II. Outlook for economic activity and prices, and risk assessment
I will begin by describing the current economic conditions and the Bank's baseline scenario,
followed by those for price developments, and then the upside and downside risks to the
baseline scenario - all of which were presented in the Outlook Report. My own views will
also be mentioned. The medium-term outlook is based on information available by
endOctober, and incorporates the expected effects of the expansion of QQE. It also assumes the
implementation of the second round of the consumption tax hike in October 2015 as
stipulated in the current relevant law. Let me highlight three major changes related to the
economic environment that have emerged since the interim assessment made in July this
year. These are (1) a decline in a wide range of commodity prices, especially crude oil
prices, from around July; (2) a moderate deceleration in the pace of economic activity in
Europe and emerging economies, including China; and (3) increased volatility in global
financial and capital markets triggered mainly by heightened geopolitical risk and changes in
investor sentiment reflecting the normalization of the Federal Reserve's monetary policy.
A. Current situation of and outlook for economic activity
Japan's economy has continued to recover moderately as a trend, although some
weakness has remained in consumption and production. The weakness is due mainly to (1)
a decline in domestic demand following the front-loaded increase before the consumption tax
hike was implemented in April 2014, (2) somewhat weaker export developments, and (3) the
effects of irregular weather during the summer. Corporate profits for fiscal 2014 remain high
despite a sharp decline in domestic demand following the front-loaded increase, after rising
significantly in fiscal 2013. Partly reflecting this, firms maintain a strong incentive to carry out
business fixed investment; some of them, including small and medium-sized enterprises
(SMEs), have actually adjusted upward their investment plans for fiscal 2014. In addition, the
year-on-year change in nominal employee income (defined as the per capita nominal wage
multiplied by the number of employees) has been on a rising trend, which continues to
support consumption activity.
According to the Bank's baseline scenario of the outlook for economic activity, in the
second half of fiscal 2014, private consumption is likely to remain resilient with the
employment and income situation continuing to improve steadily; business fixed investment
is projected to increase steadily; and exports are expected to head for a moderate increase
as overseas economies recover. Therefore, a virtuous cycle among production, income, and
spending is likely to be maintained in both the household and corporate sectors. The
accommodative financial environment, which was strengthened further by the Bank's recent
decision on the expansion of monetary easing, will continue to support the economic
recovery. Note that the outlook assumes a gradual increase in firms' and households'
medium- to long-term growth expectations, as well as the potential growth rate, in line with
progress in the government's growth strategy and firms' initiatives toward improving
productivity and their tapping of potential domestic and external demand. As a result, the
economic growth rates for fiscal 2015 through fiscal 2016 are projected to exceed the
potential economic growth rates (Chart 1).
My outlook for economic activity - which has consistently remained lower than the median
of the Policy Board members' forecasts throughout the projection period - was revised
downward this time. My downward revision for fiscal 2014 was mainly due to the
greaterthan-expected decline in private consumption caused by the consumption tax hike. At the
time of the Bank's interim assessment in July, many firms had judged that the adverse
impact of the consumption tax hike was largely within their expectations. In reality, however,
it turned out that an actual decline in domestic demand was greater in the April-June quarter
this year; the recovery process since August has also been slower than expected. These
developments can be attributed to not only a decline in real disposable income but also the
bad weather and the limited wealth effects reflecting a sluggish performance of the stock
market.
In this regard, I had disagreed four times consecutively with the Bank's risk assessment that
was described in the Statement on Monetary Policy released immediately after each
Monetary Policy Meeting (MPM) from January through early April this year. The
disagreement reflected my concern that the Bank's Statement on Monetary Policy referred
only to developments in overseas economies as a risk factor, and did not mention the pace
of improvement in the employment and income situation in Japan as a downside risk. It is
now clear that this risk has materialized and played a major role in the downward revision to
the Bank's outlook. Nevertheless, private consumption recently started to recover gradually
and the consumption level will likely recover to the level observed before the front-loaded
increase by around the January-March quarter of 2015.
Regarding exports, my risk assessment has also been consistently tilted downward because
of concerns about sluggish external demand. This time, I revised downward my outlook on
exports because the downside risk had materialized somewhat. However, since my outlook
on imports was adjusted downward as well, the net impact on the trade balance is projected
to remain limited.
My projection is that the growth rates for both fiscal 2015 and 2016 will likely be much
higher than the rate for fiscal 2014. However, they have been adjusted downward somewhat,
mainly for private consumption, from my July interim assessment. This adjustment reflects
my observation that the rate of increase in nominal employee income may slow down
somewhat in fiscal 2015 and 2016 because of the following. (1) Slower growth in corporate
profits for fiscal 2014 relative to that in 2013 - although still at a high level - may result in
slower growth of nominal wages for regular workers in fiscal 2015. (2) A further expansion in
employment is becoming increasingly difficult since unemployed workers have largely
disappeared except for those caused by mismatches. (3) Additional labor hours generated by
newly employed workers have been declining since many women and elderly people who
are willing to work often prefer short-time working hours. (4) Current employment growth
includes many non-regular workers whose wage growth remains limited, while there is a
declining trend in employment growth among regular workers in manufacturing, whose
productivity growth and thus wage growth have exceeded other sectors. Finally, (5) it is not
yet confirmed whether households' expectations regarding future income will follow a rising
trend.
The estimated potential economic growth rate has been repeatedly revised downward and
currently remains below 0.5 percent (Chart 2). I judge that this decline reflects not only a
deceleration in the growth of capital stock and the total factor productivity (TFP) but also a
constraint on economic growth imposed by a labor shortage, which has become increasingly
evident in the construction, restaurant, retail, transportation, and tourism sectors, notably
among SMEs. The potential growth rate is expected to rise from fiscal 2015 mainly through
an accumulation of capital stock, an improvement in TFP growth, and a reallocation of the
labor force through restructuring of the corporate sector and a shift in existing business
models toward ones that provide higher value added or goods and services that stimulate
demand. It is also expected that greater efforts will be made by the government to reform the
social security and tax systems, to promote female employment, resolve the problem of
having too many children on waiting lists for nursery schools, and promote economic growth
strategies - thereby contributing to the reduction of constraints on economic growth.
To summarize my outlook, the potential growth rate will rise gradually toward about 1 percent
over the projection period. Over the same period, economic growth is projected to be around
or below the potential growth rate for fiscal 2014. Economic growth will likely be much
greater than the potential growth rate for fiscal 2015, due to the adjustment process of
returning to the conditions observed before the front-loaded increase in domestic demand
prior to the consumption tax hike. Economic growth for fiscal 2016 is likely to moderately
exceed the potential growth rate.
B. Current situation of and outlook for prices
Current price developments show that the year-on-year rate of increase in the consumer
price index (CPI, all items less fresh food) declined from May 2014 and is recently around
1 percent. The major factors determining inflation rates are the aggregate supply and
demand balance (the output gap), medium- to long-term inflation expectations, and import
prices. The output gap turned positive to around 0.4 percent in the January-March quarter of
2014, but then dropped again into negative territory, to around minus 0.1 percent in the
AprilJune quarter owing to the adverse impact of the consumption tax hike. The output gap is
very recently improving slowly, reflecting mainly a continuous increase in employment.
Medium- to long-term inflation expectations are rising on the whole from a somewhat
longerterm perspective. As for import prices, upward pressure - mainly from the depreciation of the
yen and the rise in energy prices - has already begun to weaken.
According to the Bank's baseline scenario of the outlook for prices, the year-on-year rate
of increase in the CPI (excluding the direct effects of the consumption tax hikes) is likely to
be at around the current level for the time being, and subsequently accelerate gradually and
reach around 2 percent around the middle of the projection period; that is, in or around fiscal
2015 (Chart 3). Thereafter, the CPI inflation is likely to edge up as medium- to long-term
inflation expectations will converge to around 2 percent and the output gap is expected to
continue expanding in positive territory. In other words, after achieving inflation of around
2 percent in or around fiscal 2015, Japan's economy is projected to shift to a growth path that
sustains such inflation in a stable manner. It is assumed that a trend in which the output gap
will be positive is likely to take root in the second half of fiscal 2014 and thereafter is
expected to move further into excess demand territory, thereby increasingly exerting upward
pressure on prices, and that such positive price developments will help to raise medium- to
long-term inflation expectations to converge to around 2 percent. Meanwhile, import prices
will likely be pushed down by the recent declining trend in commodity prices on the one
hand, and pushed up by recent developments in foreign exchange rates on the other.
With regard to medium- to long-term inflation expectations, the Bank generally makes a
judgment on the movements of the inflation expectations as a whole using a wide range of
related indicators. This is because there is no single data set that represents inflation
expectations and the indicators entail statistical problems, such as various biases, and
exhibit divergent movements from each other. The Bank's sample indicators include the
inflation expectations of households, firms, economists, and Japanese government bond
(JGB) market participants, as well as those inferred from market data such as the break-even
inflation (BEI) rate and the inflation swap rate. The Bank regularly releases these data under
the headline chart title "Inflation Expectations" in its Monthly Report of Recent Economic and
Financial Developments as well as in the Outlook Report. Among the data, the most relevant
indicators for the Bank are those projected more than one year ahead, which are regarded
as representing medium- to long-term inflation expectations (Charts 4-1 and 4-2).
As mentioned, the Bank projects that medium- to long-term inflation expectations will
converge to around 2 percent, since this will sustain inflation at around 2 percent in a stable
manner. Thus, the judgment as to whether medium- to long-term inflation expectations will
converge is essential to realize the Bank's baseline scenario. In this regard, it may be said
that the Bank has already passed the halfway point on the path toward achieving the
2 percent price stability target, but it has not yet attained the goal. Chart 5 shows the
longterm performance of inflation expectations based on economists' survey data in Japan and
the United States. In the United States, medium- to long-term inflation expectations (i.e., five
years ahead) have remained stable and have been anchored at around 2 percent. By
contrast, it is difficult to say that those of Japan have been anchored even at around
1 percent, accompanied by greater fluctuations compared with the United States. More
importantly, it is clear that Japan was not able to avoid mild deflation even when medium- to
long-term inflation expectations remained around 1 percent. This is why the Bank considers it
important to raise inflation expectations above the current level of around 1 percent or so and
is striving to stabilize them at around the 2 percent level to ensure that the economy
overcomes deflation.
Regarding my outlook for prices, I revised downward somewhat my projection for fiscal
2014 from my interim assessment in July; it also remains lower than the median of the Policy
Board members' projections. This downward revision reflects the following considerations.
(1) The output gap improvement is likely to slow. (2) Some figures on medium- to long-term
inflation expectations (such as those for households and those of some economists) remain
leveled off, while others (such as BEI rates, inflation swap rates, those of JGB market
participants, and corporate sector expectations related to changes in firms' own sales prices)
declined from around this summer; moreover, due to a decline in actual inflation rates from
May this year, medium- to long-term inflation expectations are unlikely to exhibit a rising
trend on a sustainable basis (Charts 4-1 and 4-2). Finally, (3) the lagged impact of a
commodity price drop is likely to be reflected in the CPI. As a result of the revision, the rate of
inflation will likely remain more or less at around 1 percent for the time being, then start to
pick up gradually toward the first half of fiscal 2015 - suggesting some delay in the timing of
a pick-up in inflation.
My projection - for fiscal 2015 and 2016 was also revised downward - but very moderately
- relative to my July interim assessment. The downward revision was small because the
effects of the expanded QQE were incorporated. Without such a policy action, the downward
revision would have been larger. This enabled me to maintain roughly the same outlook
throughout the projection period: namely, that the inflation rate of 2 percent is likely to be
reached toward the end of the projection period. Meanwhile, the Outlook Report describes
the Bank's baseline scenario as reaching around 2 percent around the middle of the
projection period; that is, in or around fiscal 2015. However, I considered it better to replace
this with the expression by the end of the projection period - since this better reflects the
views of a greater number of Policy Board members, including myself. For this reason, I
submitted a proposal to suggest such a replacement at the MPM held on October 31.
Now, let me explain why my outlook has been consistently more conservative than the
Bank's baseline scenario. This is because I anticipate that the upward pressure from the
labor shortage on wages will likely take place more gradually. Similarly, I judge that the
upward pressure of improvement in the output gap as well as a rise in medium- to long-term
inflation expectations on the inflation rate will emerge at a slower pace. In other words, a
nation like Japan, given its rapid aging and low birth rate, may face somewhat limited
potential domestic demand compared with other economies that enjoy more favorable
demographics. Thus, the output gap improvement is unlikely to give rise to a rapid pace of
wage increases and inflationary pressure compared with other economies. Moreover, I
maintain the view that inflation expectations will rise gradually.
Another thing I would like to point out is that, as I have mentioned in the past, a consumption
tax hike will have a certain influence on the judgment on underlying price developments.
For example, inflation will be pushed upward in accordance with the degree of the tax hike
for the following twelve months. Thus, the Bank attempts to analyze the trend behavior of
actual inflation by removing the direct effects of the consumption tax hike (Chart 3).
Moreover, since short- and medium- to long-term inflation expectations will also be affected
during the period prior to the tax hike, the Bank also takes into consideration figures that are
obtained by mechanically excluding the direct effects of the tax hike (Chart 4-2). Of course,
the tax hike also indirectly affects the inflation rate and inflation expectations through the real
economy. But since it is technically difficult to remove these indirect effects of the tax hike, it
should be noted that the Bank is removing only the direct effects for the sake of simplicity.
Thus, in assessing whether medium- to long-term inflation expectations are likely to gradually
converge to around 2 percent, this issue should be noted. In other words, the judgment
needs to be made as to whether an increase in these expectations reflects the underlying
trends based on the virtuous cycle among production, income, and spending - not the next
anticipated tax hike.
C. Upside and downside risks (risk factors)
As described in the October 2014 Outlook Report, the upside and downside risks to the
Bank's baseline scenario of the outlook for economic activity include (1) developments
in exports, (2) the effects of the consumption tax hikes, (3) firms' and households' medium-
to long-term growth expectations, and (4) fiscal sustainability in the medium to long term. The
Bank assesses these risks as being balanced. Meanwhile, the upside and downside risks
to the Bank's baseline scenario for prices cover (1) developments in firms' and
households' medium- to long-term inflation expectations, (2) developments in the output gap,
(3) the responsiveness of inflation to the output gap, and (4) developments in import prices.
The risks to the price outlook are assessed as entailing substantial downside risks - and the
overall risk assessment was revised downward from "being largely balanced" for the first time
since the introduction of QQE.
As for my risk assessment related to the economy, the downside risks remain somewhat
greater than the upside ones. First, there is a risk that domestic private consumption will
weaken because of a continuous decline in real disposable income and a potential
deterioration in household sentiment. Second, there is a risk that heightened uncertainty
regarding the outlook for the global economy and the tepid pace of the domestic economic
recovery will result in lower exports and domestic business fixed investment. Third,
households' and firms' medium- to long-term growth expectations may not rise if there is no
progress in implementation of the government's growth strategy or firms' efforts to boost
competitiveness.
In my assessment on risks to prices, the risks remain tilted somewhat to the downside. In
particular, I am paying close attention to the movements of households' and firms' medium-
to long-term inflation expectations. In addition, it may take time for the slope of the Phillips
curve - that is, the responsiveness of inflation to the output gap - to steepen. This is
because it may take some time for firms to adjust their price-setting behavior in the new
environment in which they can pass on the rise in production costs and wages to their sales
prices.
III. Expansion of quantitative and qualitative monetary easing
I would now like to discuss the Bank's latest policy action, namely, the expansion of QQE
decided at the MPM held on October 31, together with my personal views.
A. The Measures adopted under the expansion of QQE
In the most important change, the Bank decided to accelerate the annual pace of increase in
the monetary base - the main operating target for money market operations - from the pace
of about 60-70 trillion yen to about 80 trillion yen (an addition of about 10-20 trillion yen). To
achieve this target, the amount outstanding of JGB holdings will be increased from an annual
pace of about 50 trillion yen to about 80 trillion yen (an addition of about 30 trillion yen). With
a view to encouraging a further decline in interest rates across the entire yield curve,
moreover, the Bank will conduct purchases of JGBs in a flexible manner in accordance with
financial market conditions. In doing so, the average remaining maturity of the Bank's JGB
purchases will be extended from about seven years to about 7-10 years (an extension of
about three years at maximum). In addition to JGBs, the Bank decided to increase the
purchases of risk assets such as exchange-traded funds (ETFs) and Japan real estate
investment trusts (J-REITs) so that their amounts outstanding will be tripled and increase at
an annual pace of about 3 trillion yen and about 90 billion yen, respectively. The Bank will
also make ETFs that track the JPX-Nikkei Index 400 eligible for purchase.
B. Reasons for expanding QQE: the bank's view
Having said this, let me discuss why the Bank decided on the expansion of QQE. As
explained earlier, Japan's economy has continued to recover moderately as a trend and is
expected to continue growing at a pace above its potential. However, on the price front, due
to some recent concerns, the Bank found it appropriate to take pre-emptive action to address
them. Namely, the Bank was concerned that somewhat weak developments in demand
following the consumption tax hike and a substantial decline in crude oil prices had been
exerting downward pressure on prices.
It is true that a temporary weakness in demand has already started to wane, and that the
decline in crude oil prices will have positive effects on economic activity from a somewhat
longer-term perspective - through improvements in the terms of trade and real disposable
income - and will 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 so far been progressing steadily - might be delayed or reversed. To pre-empt
manifestation of such risks and to maintain the momentum of inflation expectation formation,
the Bank judged it appropriate to expand QQE. The reason behind the latest decision on the
expansion was that the Bank considered Japan's economy to be facing a critical moment in
the process of conquering deflation and that its unwavering determination should again be
conveyed.
C. My views on additional monetary easing
On this policy action, I voted for the expansion of QQE at the MPM held on October 31.
While I would like to refrain from commenting on the details, since the contents of the
discussion at the MPM as a rule should be disclosed only in the form of the minutes and
transcript, let me discuss here my general views on monetary easing. As pointed out earlier, I
have consistently held the view - since the introduction of QQE in April 2013 - that it will
likely take longer than two years to achieve the 2 percent target in a sustainable manner.
And as my outlook for prices, I have stated that the rate of CPI inflation will rise closer to
2 percent toward the end of fiscal 2015. In April 2014, I felt it important to express my outlook
more precisely since the projection period was extended by one year through fiscal 2016 -
even though there was no fundamental change in my outlook. Accordingly, I have described
my outlook from this April as the inflation rate of 2 percent is likely to be reached toward the
end of the projection period.
Let me remind you that the Bank is conducting monetary easing with the aim of achieving
2 percent inflation in a stable manner with sustainable economic growth - rather than merely
achieving 2 percent in a specific year and failing to meet the target in subsequent years. This
approach is called a flexible inflation targeting framework. Under this framework, I have
expressed my view that it is desirable to attempt to achieve the 2 percent target with a time
span of more than two years to avoid imposing an excessive burden on firms and
households. In line with this view, I made it clear this April that my outlook for economic
activity and prices has assumed the continuation of QQE during and beyond fiscal 2015.
On the continuation of QQE, I had considered that an annual pace of increase in the
monetary base of about 60-70 trillion yen could be maintained at least until around April
2015. This time-line seemed appropriate, since the doubling of the monetary base - as
clearly stipulated in the Bank's public statement released on April 4, 2013 - was expected to
be achieved only by around April 2015 under the annual pace of increase of about
60-70 trillion yen. Thereafter, one likely option would be a continuation of monetary easing
with the same annual pace of increase in the monetary base in an open-ended form with the
same composition of asset purchases. Alternatively, since I personally viewed that the
2 percent target would likely be reached by fiscal 2016, another possibility would be a greater
focus on the continuation of monetary easing until around then, with potential modification of
the composition of asset purchases.
Last year, meanwhile, I referred to two potential cases for considering additional easing.
The first was the case where downside risks to the Bank's outlook for economic activity and
prices materialized and it was necessary for the Bank to sharply revise downward its outlook.
The second was the case where the Bank's credibility over monetary policy conduct was at
risk of being questioned by the public and the market. For example, there was the risk that
the Bank was perceived as not doing enough to fulfill its commitment, a commitment that has
been emphasized repeatedly since the introduction of QQE. That is, if the Bank's outlook
changes due to the manifestation of risk factors, the Bank will make adjustments without
hesitation if this is judged necessary for achieving the 2 percent price stability target. In my
view, together with the CPI inflation and some indicators related to medium- to long-term
inflation expectations showing some decline, this time there was a higher likelihood that
these two cases would materialize. To avoid this, I concluded that it was necessary to give
first priority to ensure the path toward the 2 percent price stability target by means of
additional action. By not acting, the Bank might risk its credibility. Such a circumstance would
not only render my outlook infeasible but also undermine the feasibility of the 2 percent target
itself.
On the effectiveness of monetary policy, I have been thinking that it might be better to put a
greater emphasis on monetary easing effects that promote the portfolio rebalancing channel,
as I will explain later. Therefore, I expect that the additional easing, which lengthens the
average remaining maturity of long-term JGBs and increases the purchases of risk assets,
would further enhance the transmission channels of monetary policy.
D. The transmission channels related to QQE
Next, I would like to touch on the transmission channels of the Banks's monetary easing.
QQE aims to exert downward pressure on nominal and real long-term interest rates through
a range of transmission channels, thereby lowering funding costs as well as raising asset
prices. Ultimately, these changes are expected to boost the aggregate demand of firms and
households, and raise the rate of inflation toward around 2 percent. Given that JGB
purchases are the main instrument under QQE, I will briefly discuss the transmission
channels with a focus on JGB purchases.
To simplify the discussion, let me categorize the transmission channels into three types. The
first transmission channel is called the signaling channel, in which the Bank transmits its
future monetary easing policy stance to the public and the market through JGB purchases.
This would possibly lower market expectations over the future path of short-term interest
rates, thus lowering nominal and real long-term interest rates. The resultant decline in
riskfree interest rates would likely raise the prices of securities and real estate; a decline in
interest rates and an increase in the value of collateral would lower firms' and households'
funding costs. The resultant decline in hurdle rates would also help expand the amount of
business fixed investment made by each firm; an increase in a wide range of asset prices
held by firms and households would promote business fixed investment and consumption.
The greater soundness of financial institutions' balance sheets and capital would likely
promote greater risk-taking behavior, and thus, more active investment and lending
domestically as well as abroad. This channel is likely to initially exert stronger downward
pressure on nominal long-term interest rates, but as the rate of inflation begins to pick up,
these interest rates are expected to rise gradually.
The second channel is called the portfolio rebalancing channel, in which the Bank exerts
downward pressure on the term premium and thus lowers nominal and real long-term
interest rates. This channel aims to encourage financial institutions (and investors) to change
the composition of their portfolios, thereby lowering funding costs and raising asset prices
directly. When the Bank purchases JGBs from the market, the amount of JGBs held by
financial institutions declines against the increase in their current account balances at the
Bank. Since the current account balances and JGBs are incomplete substitutes, financial
institutions would likely try to increase JGBs again and reduce their current account balances
accordingly, leading to a decline in long-term interest rates. As a result, the financial
institutions may find it more attractive to invest in other potentially riskier financial assets with
relatively higher returns. The lower the substitutability between the current account balances
and JGBs, the greater the portfolio rebalancing incentive. Moreover, the longer the remaining
maturity of JGBs purchased by the Bank, the lower the substitutability between the current
account balances and JGBs. In other words, the Bank's purchases of longer-term JGBs
would result in a decline in the net supply of these bonds circulating in the market, so that the
average remaining maturity of JGBs transacted in the market would be shortened. This
would lead to a decline in the term premium.
Generally, the longer the average maturity of government bonds purchased by a central
bank, the greater the downward pressure on the term premium. As a result, financial
institutions would face a decline in the interest rate risk volume, which would enhance their
capacity to take on greater risk and their incentive to invest in riskier assets. Initially,
investment in riskier assets would be most likely to take place in financial assets with a high
degree of substitutability for government bonds - such as corporate bonds and loans - or
whose expected returns ar