Ryuzo Miyao: Economic activity and prices in Japan and monetary policy
Speech by Mr Ryuzo Miyao, Member of the Policy Board of the Bank of Japan, at a meeting
with business leaders, Nagano, 13 November 2013.
* * *
Introduction
Thank you for giving me this opportunity to exchange views with people representing Nagano
Prefecture, who have taken time to be here despite their busy schedules. Please allow me to
express my gratitude for your cooperation with the activities of the Bank of Japan's
Matsumoto Branch and the local office in the city of Nagano.
Today, I will review economic activity and prices in Japan, whose economy has been
recovering moderately, and then discuss the Bank's monetary policy. My concluding remarks
will touch briefly on the economy of Nagano Prefecture. Following my speech, I would like to
listen to your views on the actual situation of the local economy and to your candid opinions.
I. Recent developments in economic activity and prices
A. Moderate recovery in Japan's economy
Economic activity in Japan stopped weakening after the turn of 2013. Domestic demand
remained resilient, partly due to the effects of monetary easing and various economic
measures. Overseas economies were gradually heading toward a pick-up. Against this
background, the economy then returned to a moderate recovery path around the middle of
the year (Charts 1 and 2).
I will elaborate on the recent developments in Japan's economy. As for external demand,
although some emerging economies other than China and commodity-exporting economies
have shown signs of weakness, overseas economies as a whole are gradually heading
toward a pick-up. Specifically, (1) the U.S. economy continues to recover moderately against
the backdrop of firm private demand, (2) the European economy has stopped weakening,
and (3) the Chinese economy has been stabilizing. On the back of these factors and partly
supported by developments in foreign exchange rates, exports have generally been picking
up, albeit at a moderate pace. As for domestic demand, business fixed investment as a
whole has been picking up, as corporate profits and business sentiment are improving; in
addition to the resilience in business fixed investment in the nonmanufacturing sector,
positive developments have started to be seen in that in the manufacturing sector. While
public investment has continued to increase, as positive effects of various economic
measures have come to take hold fully, housing investment has also been increasing.
Private consumption has remained resilient, reflecting an improving trend in consumer
sentiment from a somewhat long-term perspective as well as recent improvement in the
employment and income situation. Reflecting such developments in domestic and external
demand, industrial production has been increasing moderately. An improvement in activity in
the nonmanufacturing sector, including services and construction, has been more evident
than that in production in the manufacturing sector.
As for the outlook, Japan's economy is expected to continue its moderate recovery (Chart 3).
To elaborate, overseas economies - mainly the advanced economies - are expected to
gradually pick up. Emerging economies other than China and commodity-exporting
economies, some of which are exhibiting weakness, will likely continue to lack growth
momentum for the time being. However, from a somewhat long-term perspective, their
growth rates are likely to start picking up again with an improvement in the advanced
economies. Under these circumstances, exports and industrial production are expected to
increase moderately, and domestic demand is expected to remain firm. The pick-up in
business fixed investment will become pronounced as moves to undertake postponed
investment for maintenance and replacement spread in tandem with continued improvement
in corporate profits. Private consumption is expected to maintain its resilience, underpinned
by an improvement in the employment and income situation. In this way, a virtuous cycle will
operate more clearly both in the corporate and household sectors.
Meanwhile, as for prices, the year-on-year rate of change in the consumer price index (CPI)
for all items less fresh food turned positive in mid-2013 and has recently been in the range of
0.5-1.0 percent, as prices of energy-related items such as petroleum products and electricity
have been rising and cost increases have been passed on to selling prices with resilient
private consumption. As for the outlook, although the upward pressure from energy-related
items will weaken gradually, the year-on-year rate of change in the CPI is expected to
continue to follow a rising trend as medium- to long-term inflation expectations will rise with a
moderate improvement in the aggregate supply and demand balance.
What I have presented is generally consistent with the path toward achieving the 2 percent
price stability target, which I described in a speech in April 2013 at a meeting with business
leaders in Gifu.1 In that speech, I presented a path consisting of the following five stages:
(1) recovery in the world economy; (2) accommodative financial conditions, reflected in asset
prices and foreign exchange rates; (3) a gradual rise in the potential growth rate of Japan's
economy accompanied by an increase in business fixed investment and structural reforms;
(4) an improvement in the output gap amid firm household spending; and (5) a gradual
heightening in inflation expectations. I then emphasized that, with this path, it was important
that the year-on-year rate of change in the CPI rise above 1 percent during fiscal 2014. I
continued that, if the virtuous cycle of the five-stage path was maintained thereafter and the
medium- to long-term trend inflation rate increased toward 2 percent, the actual inflation rate
was expected to approach the 2 percent price stability target. After about half a year,
although the recovery in the world economy - the first stage of the path - has lagged
somewhat behind and household spending - the fourth stage - has turned out to be
somewhat stronger than expected, it can be judged that the path is generally on track to
achieve the 2 percent price stability target. In particular, the recovery in private consumption,
as well as in the nonmanufacturing sector, affects a wide range of economic activity, and
therefore may support upward pressure on a broad range of prices.
B. Risks to the outlook for economic activity and prices
As I have described, Japan's economy is likely to continue its moderate recovery. However,
both upside and downside uncertainties exist over the economic outlook, such as the
following, and I am paying slightly more attention to the downside risks overall.
First, there is uncertainty regarding developments in overseas economies. In particular,
some emerging economies other than China and commodity-exporting economies are facing
structural problems such as current account deficits, and thus pose downside risks. I also
recognize that attention should be paid to the possibility that the recovery in the U.S.
economy and the world economy may be delayed depending on the consequences of the
fiscal problem in the United States.
Second is developments in households' employment and income situation. For domestic
demand to continue to maintain its firmness in the future, the key issue is whether a virtuous
cycle whereby improvement in the employment and income situation supports consumption
will be maintained. In this regard, despite some downside risks, I see a possibility that the
mechanism of upward momentum may operate, about which I will explain in the next section.
Third is the effects of the consumption tax hikes. The hikes will have adverse effects on
households' real disposable income, but the effects are likely to be mitigated to some extent
by, for example, the government's various economic measures. On this basis, whether these
effects will slow the economy by more than expected depends on the employment and
income situation and developments in prices at each point in time. Therefore, attention
should be paid to the effects of the consumption tax hikes.
Fourth, firms' and households' medium- to long-term growth expectations are subject to
uncertainty. These expectations may be either raised or lowered depending on firms'
innovations, such as their creative efforts to boost demand, on progress in regulatory and
institutional reforms, and on future developments in tax reforms.
C. Issues to be considered regarding private consumption and inflation
expectations
1. Sustainability of the resilience in private consumption
The current economic recovery is characterized by domestic demand-led growth, led by
private consumption in particular, as opposed to recovery in the past that typically was led by
external demand such as exports and production (Chart 4). In what follows, I will take up the
topic of sustainability of the resilience in private consumption and explain its background as
well as the issues I consider to be important with regard to anticipating developments in
economic recovery.
a. Improvement in consumer sentiment: rise in stock prices and improvement in the
employment and income situation
Favorable consumer sentiment is one factor that underpins private consumption. The
Consumer Confidence Index, which is a major indicator for consumer sentiment, has been
improving significantly since end-2012. It is often noted that this is attributable to the rise in
stock prices during the same period (Chart 5). Looking at developments in stock prices, their
uptrend continues on the back of the improvement in corporate profits and more
accommodative financial conditions. Some take the view that, through the improvement in
household sentiment, the rise in stock prices only boosts consumption by the wealthy and
the elderly who hold stocks. Even so, it is reasonable to say that higher stock prices have
been stimulating spending by those people who are willing to spend. It should be noted that
wealth effects for the elderly seem to spill over into the working segment of the population, as
seen in, for example, greater consumption related to grandchildren and increased demand
for three-generation family trips.2
One factor that could affect consumer sentiment more broadly is the employment and
income situation. For example, if firms offer more jobs and the number of employees rises,
the overall outlook for income improves, thereby making consumer sentiment more
favorable. An improvement in the employment and income situation could make people more
willing to borrow and spend more confidently. In fact, a strong correlation is observed
between the active job openings-to-applicants ratio - which represents the number of job
openings relative to the number of job seekers - and the Consumer Confidence Index (Chart
6). Employment conditions as suggested by the active job openings-to-applicants ratio and
the unemployment rate deteriorated in the wake of the Lehman shock, but thereafter have
been on a recovery trend. If this trend continues, consumer sentiment is likely to be
underpinned at a high level.
b. Sustainable improvement in income: rise in labor productivity
A rise in labor productivity is important in terms of providing support for improvement in
economic activity and income in the longer run, as this means strengthening the foundations
for Japan's economic growth. If prospects for a sustainable improvement in income are
widely acknowledged, private consumption will continue to be resilient. Labor productivity per
worker has been growing steadily, albeit at a moderate pace, and this trend has been firmly
taking hold despite such significant events as the Lehman shock and the Great East Japan
Earthquake (Chart 7).
Looking at a breakdown by industry, labor productivity in the nonmanufacturing sector has
been exhibiting higher growth in the past couple of years (Chart 8). The level of labor
productivity in the nonmanufacturing sector is still lower than that in the manufacturing
sector. In addition, it remains difficult to increase value-added in some segments of the
nonmanufacturing sector, due in part to various regulations. However, labor productivity in
the nonmanufacturing sector as a whole continues to show higher growth than in the past,
and has been exceeding the level seen before the Lehman shock. Developments in labor
productivity include the effects of cyclical economic recovery, but the underlying trend
reflects a pick-up in economic growth potential from a somewhat long-term perspective. For
example, reports on interviews with firms and other relevant information across regions
suggest steady progress in firms' efforts to create demand, such as for high value-added
services, and to make active fixed investment, with both being done across a wide range of
areas such as wholesaling and retailing, construction and real estate, accommodations, and
eating and drinking services.3
Recent developments in the underlying trend of labor productivity in the nonmanufacturing
sector show a strong correlation with developments in private consumption (Chart 9). There
is a possibility - although this interpretation should be taken with care - that the rise in
productivity has been boosting prospects for a sustainable improvement in income, leading
to higher growth in private consumption.
The rise in labor productivity in the nonmanufacturing sector may also be exerting upward
pressure on a broad range of prices through the growth in consumption (Chart 10). It can be
considered that this rise has exerted a positive influence on the inflation rate through an
improvement in the supply-demand balance, as its effects of increasing value-added and
demand would more than offset its effects of generating price competition through cost cuts
and subsequently exerting downward pressure on prices.4
In the manufacturing sector, the rise in labor productivity in terms of value-added in Japan
has come to a pause. However, looking at the corporate sector, firms have been steadily
enhancing their ability to make profits on a global basis. Overseas, for example, they are
increasing their production, fixed investment, and parts procurement. In the manufacturing
sector, corporate profits have recently been growing rapidly, helped in part by developments
in foreign exchange rates, and stock prices are firm, as are those in the nonmanufacturing
sector (Charts 11 and 12). It should also be noted that Japan's net income from the rest of
the world exceeds the historical peak (Chart 13). If the current account surplus is maintained
through an improvement in the income balance, the country's net assets will increase,
thereby exerting positive effects on consumption.
2. People's inflation expectations: forward-looking expectation formation
People's inflation expectations have been rising on the whole. For example, in terms of
shortterm inflation expectations such as those for fiscal 2013 or for a year ahead, many indicators
- including the results of surveys conducted on households, economists, and market
participants - show a gradual rise. Medium- to long-term inflation expectations, such as for
five and ten years ahead, are also rising, according to surveys conducted on economists
(Chart 14).
Let me elaborate on how people form expectations of future inflation rates. Generally
speaking, there are two ways to predict economic variables. One is backward-looking
expectation formation, where past results are directly used to form expectations. A typical
example is that the inflation rate for the previous period is simply assumed as the expected
future inflation rate. In this case, expectations for future inflation rates are fixed to actual past
inflation rates.
The other is forward-looking expectation formation, where future inflation rates are predicted
in line with the underlying mechanism of future developments in economic activity. As an
example, let us simply consider the Phillips curve and assume that prices rise when
economic activity improves. Given this, when prospects for a sustainable improvement in
economic activity are widely acknowledged in view of efforts to strengthen the foundations
for economic growth and the spread of policy effects, people expect a rise in prices based on
the relationship between economic activity and prices at a future point in time - in other
words, inflation expectations will rise. Meanwhile, in the corporate sector, better prospects for
economic activity and sales will enable firms to ease price competition and pass higher costs
on to selling prices. As a result, prices for the present period will likely incur upward pressure,
thereby shifting the entire observed Phillips curve upward, or making the curve steeper than
before.
In the actual formation of inflation expectations, aspects of both the backward-looking and
forward-looking formations are considered to coexist. This is called hybrid-type expectation
formation. Based on past experiences, the aspect of backward-looking expectation formation
is prominent in Japan. On the other hand, the government and the central bank have been
strongly pursuing initiatives to work on forward-looking expectations. The government has
been working to raise expectations for economic growth by increasing public spending and
promoting regulatory and institutional reforms. The Bank has set the 2 percent price stability
target and has been conducting large-scale monetary easing with the aim of achieving this
target at the earliest possible time, and thereby continues to provide strong support from the
financial side to ensure sustainable economic recovery. In the corporate sector, if there is a
continuation of nonmanufacturing firms' innovations and fixed investment that I mentioned
earlier, their labor productivity will rise further, which could lead to continuous improvement in
the income outlook.
Taken altogether, with the prospect of sustainable improvement in economic activity, it is
possible that the proportion of people who are oriented to forward-looking expectation
formation will increase. Of course, whether Japan's economy will move in line with the
scenario I mentioned earlier is uncertain, as the environment surrounding firms and
households remains severe. At the same time, however, macro data and information from
interviews with firms - both of which indicate sustainable improvement in consumption and
income - as well as the recent gradual rise in medium- to long-term inflation expectations
suggest that Japan's economy as a whole seems to be gradually moving in line with this
scenario. Taking account of this mechanism, I see some possibility that medium- to
long-term inflation expectations will rise.
II. Monetary policy
A. Conduct of Monetary Policy
Let me now explain the policy framework of quantitative and qualitative monetary easing
(QQE) introduced at the Monetary Policy Meeting held on April 3 and 4, 2013, and the state
of progress in its implementation (Charts 15 through 18).
First, the Bank conducts money market operations so that the monetary base will increase at
an annual pace of about 60-70 trillion yen. Second, it purchases Japanese government
bonds (JGBs) so that their amount outstanding will increase at an annual pace of about
50 trillion yen, and the average remaining maturity of the Bank's JGB purchases will be about
seven years. Third, it purchases exchange-traded funds (ETFs) and Japan real estate
investment trusts (J-REITs) so that their amounts outstanding will increase at an annual pace
of about 1 trillion yen and about 30 billion yen, respectively. And fourth, for CP and corporate
bonds, the Bank continues with these asset purchases until their amounts outstanding reach
2.2 trillion yen and 3.2 trillion yen, respectively, by end-2013; thereafter, it will maintain these
amounts outstanding.
The Bank will continue with QQE, which consists of the measures I have just cited, aiming to
achieve the price stability target of 2 percent, as long as it is necessary for maintaining that
target in a stable manner. It will examine both upside and downside risks to economic activity
and prices, and make adjustments as appropriate.
As a result, calculated on a stock basis, the monetary base and the amounts outstanding of
JGBs as well as ETFs will double in two years. The ratio of the monetary base to nominal
GDP is expected to increase to about 56 percent by end-2014. This not only stands above
the other advanced economies, but also is more than three times larger than the ratio before
the Lehman shock.
The amounts outstanding of the monetary base and JGBs at end-October 2013 stood at
about 189 trillion yen and about 132 trillion yen, respectively, and accumulation of the
amount outstanding of the monetary base and purchases of assets have been progressing
smoothly.
B. Issues to be considered regarding QQE
1. Policy effects of QQE
More than six months have passed since the introduction of QQE, and its effects, together
with those of the government's various economic measures, have emerged in the form of
improvement in economic activity as well as in financial market developments. In financial
markets, long-term interest rates have been stable at a low level of around 0.6 percent. Stock
prices have risen by more than 30 percent compared with at the beginning of 2013, and this
growth exceeds that in European and U.S. stock prices. Financial institutions' portfolio
rebalancing has not made marked progress yet, but households are increasingly investing in
financial assets such as investment trusts. In terms of economic activity, real GDP in Japan
registered a relatively high growth rate for two consecutive quarters through the April-June
quarter of 2013. The unemployment rate has declined to around 4 percent - a level seen
before the Lehman shock. On the price front, the year-on-year rate of change in the CPI for
all items less food and energy has improved to around 0.0 percent, and inflation expectations
appear to be rising on the whole, considering market indicators and the results of various
surveys. Given that the effects of monetary policy on economic activity and prices appear
with a time lag, these improvements in economic activity and prices can be partly attributable
to the effects produced by successive monetary easing measures implemented before the
introduction of QQE. In any case, it seems that the implementation of a large-scale monetary
easing and a commitment to continuing with it as long as it is necessary for maintaining the
2 percent price stability target in a stable manner are underpinning the improvement in
economic activity and prices.
A final assessment of the effects of QQE on economic activity and prices can be made only
after it is lifted, but I would like to explain at this point my empirical analysis on the effects of
the quantitative easing (QE) policy - adopted by the Bank during 2001-06 - on the
macroeconomy.5 The result, although tentative, showed that the QE policy had a certain
effect on economic activity (production), and that a transmission channel through asset
prices - namely, stock prices and foreign exchange rates - had been working. The QE
policy's effect on prices, however, was not as clear as that on economic activity. One
possible way of interpreting this result is that prices had been less responsive to an
improvement in economic activity brought about by the policy - that is, a slope of the Phillips
curve had been relatively flat during the period of quantitative easing.
Therefore, I think that the key issue is whether QQE will make the Phillips curve steeper than
before or shift the entire curve upward in line with the mechanism I explained earlier. As I
mentioned, inflation expectations could be more forward looking in the current phase of
economic recovery that is led mainly by private consumption. Initiatives taken by the
government and the corporate sector to achieve economic growth are likely to strengthen
such effects by enhancing confidence in sustainable improvement in economic activity. I will
continue to carefully examine efforts made by each economic entity as well as future
developments in the Phillips curve to see if there is any progress in terms of a change in the
slope or an upward shift.
2. Communication regarding the conduct of monetary policy
Central banks in advanced economies are making efforts to increase transparency, aiming at
appropriate communication to the public regarding their policy conduct. Specifically, such
efforts include the following. First, clarifying the policy target by, for example, using numerical
expressions. Second, explaining the outlook for economic activity and associated risks,
which form the basis for policy decisions. Third, making public the process of policy
formulation through release of the minutes of policy meetings and through press
conferences. And fourth, communicating to the public, as necessary, regarding the future
conduct of monetary policy and factors relevant to policy decisions, such as guidance with
regard to continuation of monetary easing. Through all these efforts, it becomes easier for
market participants and the public to predict the future course of monetary policy and utilize
such prediction in their decision-making.
On the other hand, there are in fact challenges to central banks' communication with financial
markets and the public, as uncertainties surround the economy and policy effects,
particularly in the current situation where unconventional policies are taken. In the United
States, since May 2013, given the prospects for economic recovery, the Federal Reserve
had been suggesting the possibility that it might start reducing the pace of its large-scale
asset purchases - known as "tapering", in view of the prospect that the size of asset
purchases would gradually be reduced - by end-2013. It thus enhanced communication
regarding economic conditions and economic indicators that were necessary to initiating the
tapering. In response, financial markets rapidly factored in the future normalization of policy,
thereby causing the surge in U.S. long-term interest rates.
The Federal Reserve postponed the start of tapering in September, which was the timing
initially considered most likely by the markets, due in part to the slow pace of recovery in
employment and the deadlock caused by the fiscal debate. The Federal Reserve might have
been aware of the risk that the greater-than-expected rise in interest rates would actually
impair the economic recovery. Long-term interest rates edged down thereafter but have been
at a level of around 1 percentage point higher than that seen before May.
A series of events the Federal Reserve has experienced seems to be instructive for the Bank
of Japan for the future. The Bank will continue to aim at making better communication to the
public.
Concluding remarks: the economy of Nagano prefecture
My concluding remarks will touch on the economy of Nagano Prefecture.
The postwar development of the economy of Nagano Prefecture has been supported mainly
by manufacturing, such as of electric machinery, general machinery, and transportation
equipment. However, because this is a manufacturing-oriented economy, it had been
experiencing a relatively large adverse impact from the Lehman shock and the yen's
appreciation in recent years. As for nonmanufacturing, firms had been facing a difficult
situation on the whole, mainly because public works had been declining due to the fiscal
consolidation of municipal governments and because the number of tourists had been
decreasing, reflecting a declining population of skiers. However, both the manufacturing and
nonmanufacturing sectors have recently headed toward a moderate pick-up on the back of a
recovery in exports and an increase in public works.
Indeed, Nagano Prefecture has many advantages, such as a high level of technological
capability in monozukuri, or manufacturing, and abundant resources related to tourism and
agriculture. It also is worth noting that the average life expectancies for both men and women
in the prefecture are the longest in Japan, and the employment rate of elderly people also
ranks top in the nation. This suggests that the prefecture possesses the latent strength to
maintain its economy's vitality even in the midst of such structural changes as the aging
population and declining birth rate.
With the aim of making greater use of these advantages, Nagano Prefecture has formulated
a strategic plan to promote monozukuri industry in the prefecture, encouraging cooperative
efforts among those in industry, government, and academia to improve competitiveness,
mainly in manufacturing, and to cultivate the industry's next generation of human resources.
Moreover, I heard that some financial institutions in the region have together established an
investment fund to enhance support for the business revitalization of small firms. I believe
that both of these actions are of significant importance with regard to stimulating the regional
economy.
Turning to transportation infrastructure, Nagano Prefecture is going to have two big events:
an extension of the Hokuriku Shinkansen line and the launch of the Linear Chuo Shinkansen
line. As a result, Nagano Prefecture will be linked much more closely not only with the
Hokuriku region but also with the two major metropolitan areas of Tokyo and Nagoya. This
could have an unprecedented impact on the industrial structure and demographic trends of
Nagano Prefecture. I expect that the prefecture's economy will make full use of its potential
by viewing such changes as strategic opportunities.


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