Takehiro Sato: Recent economic and financial developments, and
monetary policy
Speech by Mr Takehiro Sato, Member of the Policy Board of the Bank of Japan, at a meeting
with business leaders, Hakodate,4 December 2013.
* * *
I. Introduction
On April 1, 2013, the Bank of Japan's Hakodate Branch celebrated its 120th anniversary. I
would like to take this opportunity to express my sincere gratitude for your long-term
cooperation with the activities of the Hakodate Branch. In today's speech, I will begin by
focusing on economic and financial developments in Japan and abroad, as well as the
Bank's recent monetary policy. I will then touch briefly on the economy of southern Hokkaido.
Following my speech, I would like to hear your views on actual conditions in the local
economy and on the Bank's conduct of monetary policy.
II. Current situation of and outlook for Japan's economy and the global economy
A. Outlook for the global economy
The general outlook for the global economy had temporarily become somewhat cautious due
to the instability in global financial markets toward this summer. The global economy,
however, is expected to gradually improve as global financial markets as a whole have
regained stability, despite still showing nervousness.
Specifically, with regard to the direction of U.S. monetary policy, speculation among investors
about an earlier-than-expected reduction by the Federal Reserve in the pace of its asset
purchases became heightened from around late May 2013. This triggered instability in global
financial markets, as evidenced by the simultaneous declines in stock prices, bond prices,
and in the value of currencies in some emerging economies. The forecast for global
World Economic Outlook
economic growth presented in the released by the International
Monetary Fund (IMF), which had continued to be revised downward in the recent past, was
revised further downward in October, mainly for emerging economies (Chart 1). This revision
to the global economic forecast was mainly due to the revisions made to the outlook for
emerging economies while that for advanced economies as a whole was left unchanged, and
this seems to have certain implications for the outlook for the global economy, mainly in
terms of risk factors.
More specifically, the U.S. economy is on a recovery path, albeit at a moderate pace, against
the background of progress in households' balance-sheet adjustments and an improvement
in the housing market. The European economy is starting to pick up against the backdrop of
the amendments in the fiscal austerity policy and the bottoming out of business and
household sentiment (Chart 2). The Chinese economy has also been expanding at a stable
pace from this summer since the authorities - while taking the stance of pursuing a better
quality of economic growth - have been implementing a small-scale economic package to
prevent the economy from slowing down further (Chart 3). Emerging economies' financial
markets continue to show nervousness on the whole, but recently have regained stability
because the Federal Reserve's reduction in the pace of its asset purchases was postponed
(Chart 4). Improvement in the U.S. and European economies, as well as positive
developments that are within the scope of stable growth in the Chinese economy, both of
which have gradually been exerting positive effects on economies such as those of South
Korea and Taiwan, have contributed to somewhat brightening the outlook for the global
economy in the short term.
Under such circumstances, regarding risk factors in the short term, I am focusing especially
on (1) the outcome of the postponed fiscal problem in the United States and (2) the possible
destabilization in global financial markets that may occur at around the time when the
Federal Reserve reduces the pace of its asset purchases. Regarding the first factor, the
political situation in the United States continues to require vigilance. As for the second factor,
I am concerned that, although global market participants have factored in the postponement
of the Federal Reserve's reduction in the pace of its asset purchases, the timing of such
reduction is uncertain and they continue to speculate on when the Federal Reserve will
actually make this move.
In the medium term, I am concerned about the recent disinflationary trends and possible
declines in potential growth rates both in the United States and Europe. A disinflationary
trend has recently become evident, especially in the euro area (Chart 5). As background to
this, the fall-off of the effects of (1) the previous year's energy price hike and (2) the increase
in the value-added tax rate is often pointed out. Moreover, there are other factors, such as
(1) a decline in wages seen in some peripheral countries; (2) financial institutions'
balancesheet adjustments; (3) the malfunctioning of financial intermediation due to the decline in
asset prices; and (4) the sluggish economic activity, which in part reflects the effects of the
aforementioned factors. All four of these factors are common to what Japan had experienced
during the post-1990s period of deflation.
Although these disinflationary trends have exerted some effects on short-term inflation
expectations so far, medium- to long-term inflation expectations remain intact. Such
expectations in the United States and the euro area seem to be stable at around 2 percent
(Chart 6). In light of Japan's experiences, however, a persistently low inflation rate entails a
risk that people's expectations might change, leading to a decline in medium- to long-term
inflation expectations in line with the actual inflation rate. Concerns over deflation in the
United States are not yet as high as those in the euro area, but I consider it necessary to
keep in mind the risk that not only short-term inflation expectations but also medium- to
longterm expectations for the United States might decline given that the actual inflation rate has
recently been below the level in the Federal Reserve's outlook, partly due to the declining
trend in energy prices brought about by the so-called shale gas revolution.
Regarding the potential growth rates that I have raised as another concern for the medium
term, it has been pointed out from various quarters that there is a possibility of potential
growth rates in advanced economies being somewhat lower than those before the 1990s, in
reflection of the slowdown in the pace of increase in labor input and in technological
innovation.1 The recent growth rates in emerging economies are lower than those prior to the
Lehman shock, and there is much argument on whether the low growth rates are caused by
cyclical or structural factors. If the decline in the potential growth rates has not been
particularly significant, the current disinflationary trends seen in the United States and the
euro area are due to the slack persisting in production capacity and in the labor market. And
thus it can be said that the disinflationary pressure will start to weaken as this slack
dissolves. But another interpretation is that the recent decline in the potential growth rates
caused not only a decline in the natural rate of interest, but also a decline in the inflation rate
that is consistent with developments in the natural rate of interest.
As I have stated, depending on how the potential growth rates are understood, the inflation
outlook - and consequently the implications for macroeconomic policy - can change. In this
sense, the change in the Federal Reserve's communication regarding the aforementioned
reduction in the pace of its asset purchases is noteworthy. Let me explain this in detail.
Although the Federal Reserve uses the unemployment rate and inflation rate as major
benchmarks to determine the reduction in the pace of its asset purchases, it had seemed to
me that, considering the series of messages from the Federal Reserve, it did not initially
place much emphasis on the fact that the actual inflation rate remained below the longer-run
goal it had set. However, it caught my attention that the Federal Reserve pointed not only to
the general economic situation and fiscal problem as the reasons for postponing the
reduction in the pace of its asset purchases in September 2013, but also to the inflation rate
undershooting its longer-run goal. Also, I find it interesting that the Governing Council of the
European Central Bank (ECB) surprisingly decided to reduce its policy rates in November on
the grounds that the inflation rate had declined by more than it expected, and that it revised
the price outlook downward. Central banks in major economies are seeking the optimal
policy mix in a low-inflation environment, but it looks as though they are on a path similar to
the one that the Bank has followed for years to this point.
B. Outlook for Japan's economy
Japan's economy has been recovering moderately. While it will be affected by the two
scheduled consumption tax hikes, the economy is likely to continue growing at a pace above
its potential, as a trend, on the assumption that the global economy will follow a moderate
growth path (Chart 7).
I would like to explain this assessment of the current situation of and outlook for Japan's
economy in line with the baseline scenario presented in the Outlook for Economic Activity
and Prices (hereafter the Outlook Report) released on October 31, 2013. Japan's economy
registered high growth of around 4 percent on an annualized basis in the first half of 2013.
This growth was led by strong domestic demand; for example, (1) public investment
continued to increase as positive effects of various economic measures came to take hold
fully and (2) private consumption remained resilient, reflecting an improvement in consumer
sentiment supported by the depreciation of the yen and a rise in stock prices. According to
the first preliminary estimate for the July-September quarter of 2013, the real GDP growth
rate decelerated after recording high annualized growth rates of around 4 percent for two
consecutive quarters, mainly due to a decrease in exports, with private consumption being
more or less flat on the whole. Since the turn of 2013, exports have been picking up at a
somewhat slower pace, reflecting signs of weakness observed in some emerging
economies, and there has been a contrast between the performance in domestic and
external demand. In this regard, the current economic recovery is quite unique compared to
the recovery phases after World War II, which typically were led by increases in exports and
production. However, in the short term, exports are expected to increase moderately thanks
to a pick-up in overseas economies, and domestic demand is likely to retain its resilience due
to the front-loaded increase in demand prior to the consumption tax hike. In this situation,
real GDP growth rates are expected to rise again from the October-December quarter of
2013 through the January-March quarter of 2014, and the real GDP growth rate for fiscal
2013 is expected to reach close to 3 percent.
The growth rate for fiscal 2014 is likely to dip temporarily in the April-June quarter due to a
decline in demand subsequent to the front-loaded increase in the previous quarters.
However, I do not expect an economic downturn such as what we experienced at the time of
the previous consumption tax hike in 1997. This is because the current economic situation
differs in some aspects from that of the previous tax hike. Specifically, (1) the government is
preparing an economic package with a total size of about 5 trillion yen; (2) emerging
economies, some of which suffered from simultaneous declines in stock prices, bond prices,
and in the value of their currencies this year, are becoming resilient to negative shocks
compared to 1997, when the Asian currency crisis occurred, due to the establishment of
backstops such as the accumulation of foreign reserves; and (3) Japan's financial system
has been stable as a whole. Given these factors, domestic demand is likely to maintain
firmness as external demand is expected to increase. After the second half of fiscal 2014,
Japan's economy is likely to continue growing at a pace above its potential as a virtuous
cycle among production, income, and spending will be maintained. The median of the Policy
Board members' forecasts for fiscal 2014 remains more or less unchanged from that in the
July 2013 interim assessment. This is because foreign and domestic factors are expected to
offset each other; while a decline in the forecast for global economic growth, mainly for
emerging economies, as shown in the IMF's World Economic Outlook released in October
2013, will exert negative effects on Japan's external demand, the government's economic
package will produce positive effects on the economy. Another consumption tax hike is
expected in October 2015, but the background to the economic outlook for fiscal 2015
remains basically the same as that for fiscal 2014, and the median of the Policy Board
members' forecasts for fiscal 2015 is unchanged from that in the July 2013 interim
assessment.
It should be noted, however, that this economic outlook is based on the assumption that
global financial markets will remain stable on the whole. Specifically, (1) the reduction in the
pace of asset purchases by the Federal Reserve, which was postponed once, will be
smoothly executed and will not cause turmoil in global financial markets; (2) international
commodity markets will remain stable despite retained geopolitical risks in the Middle East;
(3) the European sovereign debt problem will not cause turbulence in the financial markets;
and (4) the U.S. economy will not experience turmoil stemming, for example, from a
longterm government shutdown or default on government debt. If any of these assumptions
collapses, this would affect Japan's economy to a considerable degree through turmoil in
global financial markets. In addition, I personally would like to keep paying close attention to
the possibility of declining potential growth rates in major economies, including the U.S.
economy, and the associated disinflationary trends in the U.S. and European economies.
C. Outlook for prices in Japan
As revealed in the minutes of the Monetary Policy Meeting held on October 31, 2013, I cast a
dissenting vote regarding the descriptions of the outlook for prices in the Outlook Report, so I
may not be in the right position to explain the baseline scenario of the outlook for prices in
Japan. Thus, in the following section, I would like to express my views on prices by pointing
out the main differences between my views and the baseline scenario.
Looking back at price developments up to the present, the year-on-year rate of change in the
consumer price index (all items less fresh food; hereafter prices) has been moving in line
with the baseline scenario against the backdrop of the depreciation of the yen, the hike in
energy prices, and bottoming out in prices of digital appliances. Prices have already risen to
close to 1 percent.
However, the effects of these factors are likely to wane after having hit the peak in the
July-September quarter of 2013, if we assume that foreign exchange rates and energy prices
will be unchanged from the current level. Thus, even if the effects on prices of improvement
in the output gap due to the high economic growth in the first half of 2013 appear in fiscal
2014, it seems unrealistic to expect prices to continue rising significantly above the 1 percent
level achieved in fiscal 2013 given the recent flattened Phillips curve (Chart 8). This is why
my outlook for prices for fiscal 2014 and 2015 is weaker than the median of the Policy Board
members' forecasts.
Of course, my cautious outlook for prices also contains upside risks. After the bursting of the
bubble economy, Japan rarely experienced an "inflationary period" in which prices exceeded
the 1 percent level on a year-on-year basis, except for a period of time in 2008. The cases of
prices exceeding 1 percent were only temporary because these were examples of cost-push
inflation caused by the depreciation of the yen and high energy prices. Accordingly, inflation
expectations did not shift upward at that time. If inflation of around 1 percent lasts for a
certain period, the expectation formation of households, firms, and markets might change,
leading to a significant upward shift in inflation expectations. This is because such
expectations tend to be adjusted by the actual inflation rate.
This holds true in the case of relatively short-term inflation expectations, however, and it is
highly uncertain whether a short-term rise in the actual inflation rate could affect medium- to
long-term inflation expectations (Chart 9). On top of that, given that short-term inflation
expectations might have become stickier due to the deflation that has lasted for nearly
15 years, there is greater uncertainty over long-term inflation expectations.
The results of various surveys conducted on households, firms, economists, and bond
market participants reveal a rise in their inflation expectations as a whole. However, in most
of these surveys, it is hard to discern accurately the degree to which this is caused by the
increasing probability of the consumption tax hikes. As for breakeven inflation (BEI) rates -
that is, the expected inflation rates calculated from the yield differentials between fixed-rate
and inflation-indexed bonds - my personal view is that these rates are not necessarily
appropriate for representing the inflation expectations of Japan's economy or financial
markets as a whole. This is because BEI rates are also susceptible to the aforementioned
consumption tax hike problem. In addition, (1) they are possibly affected by changes in the
liquidity risk premium on inflation-indexed bonds to a non-negligible degree due to the limited
market liquidity of those bonds, and (2) BEI rates are also affected by the inflation
expectations of some foreign investors who expect a rise in inflation (Chart 10). The BEI
rates of 10-year inflation-indexed bonds with a guarantee at maturity (deflation floor) issued
from October 2013 have been around 100 basis points. It is worth noting that the BEI rates
calculated by these bonds will remain at such a low level for the next ten years even with the
two consumption tax hikes in 2014 and 2015 totaling 5 percentage points.
Regarding upside risks to the price outlook, I am paying close attention to wage
developments as well. Labor unions tend to put emphasis on maintaining their employee
headcount rather than increasing wages. Given this, it is a striking change to see both the
progress of three-way discussions among the government, employers, and labor unions and
the evidence that some business leaders who are influential in industry have recently taken a
positive stance toward raising base salaries, reflecting the government's persuasive efforts. It
is an important first step for the discussions to work as a catalyst to change the negative
expectations that "wages will not increase" into positive ones.
However, in order to change people's expectations, it is important that an increase in base
salaries should not merely be a one-time event but continue for several years, and/or that
people form expectations for such a continuation. Taking into consideration the structural
downward pressure on scheduled cash earnings that stems from the recent increase in the
number of part-time employees who work for short hours and the rising trend in the ratio of
part-time employees to total employment, it is doubtful whether a rise in base salaries, mainly
of full-time employees at some large firms, will constitute a significant wage rate hike from a
macroeconomic viewpoint (Chart 11). Some statistics show that the share of large firms'
personnel expenses to total personnel expenses accounted for only about 25 percent in
Japan as of fiscal 2012 (Chart 12).
It is also worth mentioning the image of the labor market if wages were to increase
considerably in Japan, even if such increases are made mostly by large firms. The wage
Phillips curves for Japan and the United States - with the unemployment rate on the x-axis
and the wage inflation rate on the y-axis - imply the possible changes that could occur in the
labor market when wages increase considerably in Japan (Chart 13).
Generally speaking, in the United States, if employment adjustments are needed, firms cut
their employee headcount instead of wages in order to close unprofitable businesses in an
expedient manner. As a result, nominal wages continue to grow at a rate of about 2-4
percent irrespective of the phase of the economic cycle, and the U.S. economy has a
structure that makes it hard to fall into deflation, since excess labor supply is unlikely to be
maintained. In Japan, on the contrary, employment adjustments through dismissals have
been limited so far, and adjustments in personnel expenses have been executed mostly
through wage reductions. This means that the Japanese labor market has a structure
whereby the consolidation and reorganization of inefficient businesses tend to take longer
and the share of labor in income distribution tends to remain at a high level; this slows the
economy's metabolism and allows excess labor supply to be retained. Thus, in Japan,
sharing the cost of employment adjustments thinly and broadly in the labor market seems to
be a factor of mild deflation.
In order to realize sustainable increases in base salaries in Japan regardless of the
economic situation, business leaders should be aware that they will have to face an increase
in fixed costs, particularly during a recession. This might increase their incentives to cut
employees, although not as drastically as in the United States, to realize increases in base
salaries and avoid a rise in fixed costs at the same time. As a consequence, these moves
might lead to an increase in volatility in the unemployment rate. In this case, the wage
Phillips curve for Japan may flatten as in the United States; that is, increases in fixed costs
might be adjusted using the employee headcount rather than wages.
Taking into account these points, sustainable increases in nominal wages may raise the
inflation expectations of households, firms, and market participants, turn people's
deflationary mindset toward positive inflation expectations, and lead to overcoming deflation
becoming more likely. At the same time, however, it should be noted that the social cost of
employment adjustments might increase due to heightened volatility in the unemployment
rate. There is no free lunch, because an increase in wages boils down to the problem of how
to distribute national income between compensation of employees and operating surplus.
Economic growth is therefore indispensable to raising wages in a society as a whole
(Chart 14).
III. Recent conduct of monetary policy
A. Pursuing quantitative and qualitative monetary easing
It has been eight months since the Bank introduced quantitative and qualitative monetary
easing (QQE) on April 4, 2013. Since then, Japan's economic activity and prices have
basically followed the expected path, in line with the baseline scenario in the Outlook Report.
It should be noted that, although price developments have started to become upbeat, the
inflation rate has only risen to close to 1 percent. Given the downside risks that I mentioned
earlier, we are only halfway to realizing the price stability target. The Bank will continue with
QQE steadily, with the aim of achieving the price stability target of 2 percent (Chart 15).
With regard to the relationship between the economic outlook and monetary policy, the
median of the Policy Board members' forecasts for economic activity provided in the October
2013 Outlook Report factors in the effect of the two scheduled consumption tax hikes.
Japan's economy is likely to continue to see high growth at a pace above its potential
through fiscal 2014 and 2015, even taking into account temporary declines due to the
consumption tax hikes. As long as the effect of the consumption tax hikes on the real side of
the economy is projected to be just a temporary swing in demand and within the scope of the
Bank's expectations, the Bank will not have to launch any additional preemptive measures.
Let me turn to the relationship between the price outlook and monetary policy. There is a
large gap between the baseline scenario in the Outlook Report and market consensus, and
many market participants seem to be expecting that a future downward revision to the
baseline scenario will trigger further strengthening of the monetary easing. It might not be
appropriate for a policymaker to make comments on every single view held by market
participants, but let me say just a few words to avoid any misunderstanding. The Bank does
not assume a particular linear path toward reaching the 2 percent inflation rate. For example,
the 1.3 percent inflation rate, which is the median of the Policy Board members' forecasts for
fiscal 2014 presented in the Outlook Report, is not an intermediate target toward achieving
the 2 percent target. It should also be noted that, with implementation of QQE, the Bank
intends to shift people's expectations via a marked change in its monetary policy through an
initial bold move, after which it would adopt a wait-and-see stance to carefully monitor the
permeation of policy effects. This means that the Bank is breaking away from the incremental
approach adopted under the comprehensive monetary easing. That being said, I understand
that this is the time to carefully monitor the emergence of policy effects, taking account of the
future economic and price conditions.
It should also be noted that, on April 4, the Bank took all possible policy measures that would
be available for the time being. Therefore, additional easing measures, if any, could be
counterproductive in terms of shifting people's expectations. It is true that the Bank has
reiterated in its statement released after Monetary Policy Meetings that it "will examine both
upside and downside risks to economic activity and prices, and make adjustments as
appropriate." My understanding is that the downside risks described here refer to tail risks,
including significant turbulence in global financial markets that would be comparable to the
Lehman shock and the European sovereign debt crisis, and do not concern such trivial
matters as a small divergence of the outlook for economic activity and prices from the
baseline scenario.
B. Price stability target and conduct of monetary policy
Although I cast a dissenting vote on the introduction of the price stability target at the January
2013 Monetary Policy Meeting, I have approved of the policy commitment regarding the
target since April, with the exception of the description of the price outlook in the Outlook
Report. This is because I understand that the price stability target should be regarded as a
flexible framework, and that it is not necessary to consider 2 percent as a rigid target.
Let me elaborate on this point. As noted in the policy statement, "the Bank will continue with
quantitative and qualitative monetary easing, aiming to achieve the price stability target of
2 percent, as long as it is necessary for maintaining that target in a stable manner." In terms
of "aiming to achieve the price stability target" and "maintaining that target in a stable
manner," it is almost impossible to stably maintain the inflation rate specifically at 2 percent,
given the time lag required for the permeation of monetary policy effects and uncertainty
regarding such permeation. Rather, the 2 percent price stability target should be regarded as
a flexible concept in which there is an allowance for a certain range for upward and
downward deviations of the actual inflation rate from the target, similar to other central banks'
frameworks of inflation targeting. In this regard, the Bank does not intend just to achieve the
2 percent price stability target at all costs, but instead aims to bring about a situation where
the national economy achieves sound development and prices rise moderately in a balanced
manner as improvement in the employment situation brings wage hikes. I understand that
the 2 percent price stability target should be regarded as representing such a desirable
situation.
C. Challenges related to forward guidance
As any policy is accompanied by both pros and cons, a policy is carried out based on the
judgment that the former will surpass the latter. Similarly, as shown in the minutes of the
Monetary Policy Meeting on April 3 and 4, 2013, QQE was decided after carefully weighing
the associated pros and cons. This weighing reflects the subjective value judgments, and
therefore some who put emphasis on the adverse effects of QQE criticize it as reckless
because it was decided without discussions on an exit strategy. Others point out that the
Bank should explain more clearly the path to an exit - that is, provide clearer forward
guidance.
Although these criticisms and comments are somewhat understandable, one of the purposes
of QQE is to shift people's expectations, which had been diminished by the chronic deflation.
Discussions on an exit strategy at this point could lead to a contradiction of this policy
intention. In other words, discussing an exit strategy when launching a new policy could
create the same situation as making fire with one hand while at the same time extinguishing
it with the other. It should also be noted that, as evidenced by the Federal Reserve's decision
in September 2013 to postpone the reduction in the pace of its asset purchases, efforts to
enhance policy transparency and secure policy flexibility may create a tradeoff. That is,
improving transparency does not necessarily yield desirable results. Rather, too much
information from a central bank might be difficult for market participants to digest, and could
eliminate the central bank's flexibility in responding to a change in economic and price
conditions. Based on this idea, I am of the position that the Bank should show its guidance in
a flexible and appropriate manner in response to changes in the outlook for economic and
price conditions.
I should note that the Bank's current attempt - namely, aiming to achieve the 2 percent price
stability target within about two years to overcome deflation - is unprecedented. This attempt
to push up the inflation rate within a fixed timeframe is completely different from the
conventional philosophy of forward guidance, which expects to influence longer-term interest
rates by committing to continuing monetary easing as long as necessary and thereby
bringing forward future demand. Thus, it is not appropriate to categorize the Bank's current
monetary policy as "traditional" forward guidance, as currently implemented by other central
banks such as the Federal Reserve and the ECB (Chart 16).
In addition, forward guidance entails the dynamic inconsistency problem (or time
inconsistency problem) - that is, even if a central bank commits to continuing the policy as
long as necessary, this commitment might be broken at some point. The notable example is
that global financial markets became unstable after Chairman Bernanke of the Federal
Reserve indicated a specific schedule for reducing the pace of its asset purchases in late
May 2013. In this regard, other major central banks that adopt unconventional monetary
policies are facing new challenges as to how to ensure the effectiveness of their forward
guidance. That is to say, these central banks will keep trying to determine what kind of
commitment is needed to make the public and market participants believe that such
commitment will be fulfilled.
D. Toward accumulating the monetary base
The Bank has disclosed its monetary base target and balance sheet projections up until the
end of 2014 as part of its efforts to achieve the price stability target with a time horizon of
about two years. According to the projections, the expected amounts outstanding of the
monetary base and Japanese government bonds (JGBs) at the end of 2014 are around
270 trillion yen and around 190 trillion yen, respectively. The amounts outstanding of both the
monetary base and JGBs have been accumulated almost in line with the Bank's projections,
and they are within range of reaching the amounts projected for the end of 2013, to
200 trillion yen and 140 trillion yen, respectively (Chart 17).
However, whether or not the Bank will be able to accumulate the target amount of the
monetary base as expected depends on the stance of financial institutions with regard to
making bids for the Bank's ma