Kiyohiko G Nishimura: A tale of two programs in the early resolution of
the deflation problem
Speech by Mr Kiyohiko G Nishimura, Deputy Governor of the Bank of Japan, at a meeting
with business leaders, Niigata, 5 December 2012.
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Introduction
I am privileged and honored to be here today to exchange views with administrative and
business leaders in Niigata Prefecture. I deeply appreciate your support and cooperation in
taking part in interviews and surveys conducted by our Niigata branch. The information
from these interviews and surveys is invaluable for the Bank of Japan in grasping Japan's
financial and economic developments and conducting monetary policy. What is more, we
are delighted to share with you information - not only on what is happening in Japan but
also around the globe - on various occasions, including events at branches like the
opportunity we are enjoying today. I would like to express my sincere gratitude and also
ask for your continued cooperation.
Today I will be talking about the early resolution of the deflation problem and the Bank's
two programs. In the first half of my talk, let me outline financial and economic developments
since the summer. In the latter half, I will explain the Bank's basic thinking on monetary
policy conduct, focusing on its two programs: the Asset Purchase Program, the total amount
of which the Bank at the end of October decided to increase for the second month in a
row; and the Loan Support Program, which it decided to newly establish.
I. Developments in overseas economies
Deceleration in overseas economies becoming more severe
Looking at developments in overseas economies since the second half of 2011, the negative
impact of the European debt problem has spread globally through the effects on trade and
business sentiment. As a result, economic activity in many countries and regions, especially
in the manufacturing sector, has remained in a deceleration phase. Every April and
October, the Bank releases the Outlook for Economic Activity and Prices (hereafter, the
Outlook Report), which presents Policy Board members' assessment of economic activity
and prices based on their forecasts. In addition to the semiannual Outlook Report, the
Bank also releases interim assessments in January and July that present the Bank's
revised forecasts. The interim assessment in July 2012 listed uncertainty regarding overseas
economies as one of the risk factors for Japan's economy, and frankly speaking, my
impression is that these risks actually materialized within a short period of time since this
summer.
Specifically, risks related to the European debt problem materialized and their effects spread.
The negative impact of this problem has grown, not only in peripheral European countries
but also in the core countries, through a decline in trade within the euro area and weakening
business sentiment. Economic activity in Europe has receded slowly, with real GDP for the
euro area now having registered negative growth for four consecutive quarters. This
weakness in the European economy is affecting not only exports within the euro area but
also those bound for outside the area, and has started to affect global trade and
economic growth through global supply chain networks.
In addition, emerging economies, which had been hoped to drive global economic growth,
are lacking momentum. As for the Chinese economy, exports to Europe - which make up a
large share in China's total exports - have declined, the effects of excess investment in the
wake of the Lehman shock are starting to be felt, and inventory adjustments in a wide range
of areas, including materials industries, have been more prolonged than expected, though
some economic indicators have shown signs of improvement very recently. Partly against
the background of weakness in final demand in Europe and China, the pick-up in the NIEs
and the ASEAN economies has moderated, particularly in exports and business fixed
investment in manufacturing in the corporate sector.
Outlook for overseas economies
With regard to the outlook for overseas economies, the current deceleration phase is likely
to continue for the time being, but we expect that against the background of a sustainable
recovery in the U.S. economy and a pick-up in the Chinese economy the global economy
will gradually emerge from that phase and enter a moderate recovery thereafter. Uncertainty
about the outlook for overseas economies, however, is not insubstantial, including the timing
of economic recovery. Attention should continue to be paid to the possibility that the
European debt problem may become more serious. While the U.S. economy continues
to be on a moderate recovery trend, the momentum toward recovery warrants careful
monitoring given that uncertainty about the fiscal policy outlook, in particular with regard to
the "fiscal cliff", remains significant. As for the Chinese economy, improvement in the supply
and demand balance may require considerable time, especially in materials industries,
where there is excess production capacity. Moreover, Japan-China relations have already
started to affect a number of areas and there is concern that they may have wider
implications for Japan's economy.
Although global financial markets were unstable until this summer, since then, investors'
risk aversion triggered by the European debt problem has abated somewhat, partly owing to
the fact that European authorities have carried out a range of policy measures. Nevertheless,
particular attention needs to be paid to developments in financial markets, as fiscal and
economic structural reforms in Spain and Greece are still underway.
II. Recent developments in Japan's economy
Weakening economic activity
I will now explain recent developments in Japan's economy. In the first half of 2012,
Japan's economy registered high growth: real GDP in January-March grew at an annual
rate of 5.2 percent as domestic demand remained firm, mainly supported by both public
and private reconstruction-related demand. However, in July-September, GDP growth
turned negative for the first time since October-December 2011, showing an annual decline
of 3.5 percent.
Reflecting the deceleration in overseas economies, exports and industrial production have
decreased. This weakness in exports and industrial production has started to affect domestic
demand, which has remained firm thus far. For instance, business fixed investment in the
manufacturing sector has shown some weakness, mainly due to the deceleration in
overseas economies. Going forward, we need to remain vigilant as to whether there are
any signs of firms delaying business fixed investment. In the manufacturing sector, the
yearon-year rate of change in the number of new job offers has been negative since June
2012; moreover, overtime hours worked in the economy overall have also been decreasing
somewhat, led by a decline in the manufacturing sector. Private consumption has lost some
momentum, partly due to the decline following the expiry of subsidies for the purchase of
environmentally friendly cars.
On the whole, domestic demand is expected to remain resilient, mainly supported by
reconstruction-related demand in a broad sense, including investment related to disaster
prevention and energy. It is, however, unlikely to increase at a pace that will offset the
weakness in exports. Owing to these developments, the Bank judges that Japan's economy
as a whole has been weakening somewhat.
As for prices, the year-on-year decline in the consumer price index (CPI, all items less fresh
food) peaked at a rate of 2.4 percent in August 2009 after the Lehman shock. Since then,
the aggregate supply and demand balance - which shows the rate of utilization of labor and
fixed capital - has been improving moderately and the year-on-year rate of decline in the
CPI has been shrinking steadily since end-2009 and recently has been around 0 percent.
Outlook for Japan's economy
Based on the aforementioned developments in overseas demand, exports and
industrial production are expected to continue decreasing and Japan's economy as a whole
to remain relatively weak for the time being. With the economy weakening somewhat, the
Bank judged it appropriate to undertake additional monetary easing and at the Monetary
Policy Meeting on October 30 decided to further enhance its monetary easing for the second
month in a row, which I will elaborate on shortly with regard to the policy decisions. The
Bank believes that together with the cumulative effects of earlier policy measures and the
effects of the government's efforts to strengthen Japan's growth potential, the latest
decision to implement monetary easing will prevent the economy from deviating from its
course of returning to a sustainable growth path with price stability. As overseas economies
gradually emerge from the deceleration phase, exports and industrial production are
expected to start increasing and the economy as a whole to strengthen as spending
activity gains momentum. In the October 2012 issue of the Outlook Report, the Bank's
median projection for Japan's annual real GDP growth rate is 1.5 percent for fiscal 2012,
1.6 percent for fiscal 2013, and 0.6 percent for fiscal 2014. This projection takes into
account the front-loaded increase in demand prior to the consumption tax hike and the
subsequent decline. Excluding these effects, the projected growth rates for fiscal 2013
and 2014 would be around 1-1.5 percent.
This outlook entails a number of uncertainties and there are both upside and downside risks.
Under the current circumstances, however, we should be particularly mindful of the downside
risks. Specifically, close attention needs to be paid to the possibility that a further
prolonged deceleration in overseas economies may delay the recovery in exports and
industrial production, thus exacerbating the negative effects on domestic demand.
Next, I would like to discuss the outlook for the CPI. Excluding the direct effects of the
consumption tax hike on prices, the year-on-year rate of change in the CPI is expected to
hover around 0 percent for the time being and start rising gradually thereafter reflecting the
improvement in overall economic activity, such as increases in corporate profits and
employment as well as a pickup in wages. The median projection of the year-on-year rate of
change in the CPI in the October issue of the Outlook Report is -0.1 percent for fiscal
2012, 0.4 percent for fiscal 2013, and 0.8 percent for fiscal 2014, excluding the direct
effects of the tax hike. It thus appears likely that the year-on-year rate of change in the
CPI will move steadily closer toward the Bank's "price stability goal in the medium to long
term" for the time being of 1 percent.
Compared with the projections in the July interim assessment, these projections represent a
downward revision. The reason for the downward revision is that the improvement in the
aggregate supply and demand balance - reflecting the downward revision of the economic
outlook - is expected to be delayed and that crude oil prices were corrected downward.
Nevertheless, despite the downward revision, the Bank's CPI projections are still higher
than those of economists in the private sector.
In my view, the difference between the Bank's projections and private sector economists'
projections is due to differences in the extent to which prices are seen to respond to
changes in the aggregate supply and demand balance. The projections by private sector
economists tend to strongly reflect developments in the mid-2000s, when prices failed
to respond commensurately with the improvements in the aggregate balance. In fact, even
though the economy registered moderate growth during this period, the inflation rate hardly
picked up. This was a period when the excesses in production capacity remained
unresolved, price competition among firms was even severer against the backdrop of
subdued growth in the domestic market reflecting the aging of and decline in the
population, and there was a substantial increase in cheap imports - from emerging
economies such as China - that competed with domestic products. Increases in goods
prices were also constrained by efforts by firms to restrain wages against the backdrop of
an increase in global competition. Furthermore, property prices continued to decline at a
rapid pace, and rents - which make up about 20 percent of the CPI components (all items
less fresh food) - started to decline, keeping a lid on any upward pressure on overall CPI
inflation.
In contrast with that period, cheap imports from China today are not so conspicuous as to
exert sizable downward price pressure and the resolution of excess production capacity,
even if only at a gradual pace, is also making progress. Moreover, it is increasingly
possible to see cases where firms have succeeded in differentiating their goods and
services in response to the aging of and decline in the population and customers are
showing interest in high value-added goods with relatively high prices; thus, there are
forces that make it relatively easier for firms to raise prices. In addition, the declining trend
in property prices has finally come to a halt and rents are expected to do the same, albeit
with some lag.
Taking recent changes into account, the year-on-year rate of change in the CPI in the
baseline scenario in the Outlook Report is expected to start rising gradually as the aggregate
supply and demand balance improves. However, it is also important to note that the
changes that I mentioned are not that strong yet and remain vulnerable to external shocks.
We therefore continue to remain vigilant to the downside risks.
III. First program: asset purchase program
The two stages of the transmission mechanism of monetary easing
Let me now move on to the Bank of Japan's conduct of monetary policy.
The Bank recognizes that Japan's economy faces the critical challenge of overcoming
deflation as early as possible and returning to a sustainable growth path with price stability.
Based on this recognition, the Bank has been pursuing aggressive monetary easing. The
transmission of monetary easing can be divided into two stages. The first stage is the
transmission of monetary easing effects from the realm of monetary policy to the financial
environment in which firms and households can raise sufficient funds at low interest rates.
The second stage is the transmission of effects from the financial conditions to economic
activity and prices; in other words, the extent to which firms and households actually take
advantage of the accommodative financial conditions to actively increase their investment
and spending. In the following, I will discuss the role of the Bank's two programs in terms of
these two stages.
Accommodative financial conditions
In its Monetary Policy Meeting on October 30, the Bank decided to increase the size of the
Asset Purchase Program substantially. This increase is a step that targets the first stage of
the transmission mechanism. The Program was introduced in October 2010, starting off
with a size of about 35 trillion yen, and the increased purchases were scheduled to be
completed at the end of 2011. Since then, the size of the Program has been increased
repeatedly and the timeframe has also been extended. In September and October 2012, the
Bank took bold steps to further increase the size of the Program - each time by about
10 trillion yen respectively. Consequently, the Program has reached the substantial amount
of about 91 trillion yen, and the timeframe has been extended to the end of 2013. The aim of
the Program was to generate accommodative financial conditions in a situation where the
Bank's target rate was already at virtually zero percent, by encouraging a decline in
longerterm market interest rates and a reduction in risk premiums through the purchase of not
only Japanese government bonds (JGBs) and treasury discount bills (T-Bills) but also of
various types of risk assets, including CP, corporate bonds, exchange-traded funds (ETFs),
and Japan real estate investment trusts (J-REITs).
Since the introduction of the Asset Purchase Program, financial conditions in Japan have
become extremely accommodative both in historical and international comparison. In this
sense, we believe that the Program has already achieved its intended effects. To be specific,
in terms of firms' funding costs, both short-term and long-term average interest rates on
new loan contracts have hit 1 percent - an unprecedented level. In terms of
households' borrowing costs, 35-year fixed mortgage rates have fallen below 2 percent.
Moreover, financial institutions' lending attitude remains accommodative, issuing conditions
for CP and corporate bonds are also generally favorable, and, overall, an environment has
been maintained in which households and firms can feel secure that they can gain access
to funds. Moreover, the Bank's aggressive easing has mitigated the negative effects
stemming from the appreciation of the yen and has fended off an even greater
appreciation. Against the strong headwinds generated by the Great East Japan
Earthquake and the European debt problem, extremely accommodative financial conditions
have been firmly maintained.
As part of the Asset Purchase Program, the Bank has stated its commitment to maintaining
powerful monetary easing to achieve so-called policy duration effects. Specifically, the
Bank has clarified that for the time being it aims to achieve the goal of 1 percent inflation in
terms of the year-on-year rate of increase in the CPI through the pursuit of powerful
monetary easing, conducting its virtually zero interest rate policy and implementing the
Program mainly through the purchase of financial assets. The Bank is determined to
continue with this powerful monetary easing until it judges the 1 percent goal to be in sight.
As I mentioned, the October issue of the Outlook Report notes that in fiscal 2014 it appears
likely that the year-on-year rate of increase in the CPI will move steadily closer toward the
Bank's "price stability goal in the medium to long term" for the time being of 1 percent.
So far, however, we have not come to the conclusion that the 1 percent goal is in sight.
While the Program's intended timescale for completing the increase is currently set for the
end of 2013, given the commitment it has made, the Bank will continue to operate the
Program beyond that date.
IV. Second program: loan support program
Making use of accommodative financial conditions
While the creation of accommodative financial conditions represents the first stage of the
transmission of monetary easing, the second stage consists of the extent to which a wide
range of economic entities actually make use of such accommodative financial conditions.
At present, the average interest rate paid by firms has fallen to nearly 1.5 percent. This is
extremely low compared with firms' return on assets (ROA), which has been around
3 percent. Firms are in a position to raise ample funds at interest rates substantially below
their rates of return. Thus, at first glance, it seems as though firms only need to borrow
some funds and invest them in order to make a profit; yet, this is not necessarily the case.
Rather, they are faced with a situation where they have little confidence that if they do
borrow funds they will actually be able to sell their products or services and make sufficient
profits. Put differently, stagnant growth expectations have been preventing firms from
being more aggressive in their business activities, and under these circumstances the
accommodative financial conditions are not fully made use of.
In order to overcome this sense of stagnation, we need to make efforts to strengthen the
growth potential of Japan's economy. As such efforts proceed and growth expectations
pick up, firms' profit prospects will improve, the expected rates of return on new investments
will increase, and firms will become more proactive in their spending such as on
investment. Once such a virtuous circle has taken hold, the accommodative financial
conditions will have even stronger effects, and the virtuous circle will become more
sustainable. This is what we aim to achieve at the second stage of the transmission
mechanism of monetary easing.
In terms of creating a favorable business environment, the government also plays an
important role. On October 30, 2012, the government and the Bank of Japan released a
joint statement with the title "Measures Aimed at Overcoming Deflation" in order to state
clearly the shared understanding of their respective roles to overcome deflation. This
statement reconfirms the importance of the government's role in creating a favorable
business environment. The Bank strongly expects the government to generate new demand
by vigorously promoting measures - including decisive regulatory reform - for
strengthening Japan's growth potential, based on the government's recognition that
reforming the economic structure predisposed to deflation is essential in order to overcome
deflation.
Establishment of the framework for the "stimulating bank lending facility"
From the perspective of boosting the second stage of the transmission mechanism of
monetary easing, the Bank in 2010 introduced the Fund-Provisioning Measure to Support
Strengthening the Foundations for Economic Growth (I called it the Growth Foundation
Strengthening Facility or GFSF in my previous speeches) in order to make its utmost
contribution as the central bank. This facility enables the Bank to provide long-term funds at
a low interest rate to financial institutions carrying out lending and investment that
contribute to Japan's economic growth. Moreover, for a central bank, this is an extraordinary
measure in the sense that it directly influences the lending activity of financial institutions.
However, because the intention of the policy has been widely understood, I believe that
the facility has been able to generate some successful outcomes. It is also heartening
that this facility has served as a trigger for a wide recognition of the importance of
strengthening the economy's growth potential.
Further to the introduction of this facility, the Bank on October 30, 2012 decided to establish
the framework for the Fund-Provisioning Measure to Stimulate Bank Lending (I will call it
the Stimulating Bank Lending Facility or SBLF hereafter) with a view to promoting
aggressive action by financial institutions and helping to stimulate proactive credit
demand by firms and households. Under this facility, the Bank will provide long-term
yen-denominated funds at a low cost to financial institutions, at their request, up to an
amount equivalent to the net increase in their lending. The total amount of funds provided
by the Bank will be "unlimited" - that is, there shall be no upper limit. Financial institutions'
lending eligible under the SBLF can be either yen-denominated or foreign
currencydenominated. With economic globalization continuing, the growth potential of financial
institutions and firms is closely linked to their overseas activities. The Bank therefore
judged that encouraging lending by financial institutions - irrespective of the currency
involved - would be an effective means to boost the growth of Japan's economy, and that
strengthening financial institutions' overseas activities would help to support Japanese firms
with growth potential from the financial side. Moreover, increasing lending will enhance the
profit base of financial institutions themselves in the medium to long term and thus is
consistent with what they should be aiming for. In fact, partly because they have shown
steady achievements in their business matching activities, the outstanding amount of
financial institutions' loans has recently been increasing at a moderate pace.
Both the newly-introduced SBLF and the existing GFSF aim to encourage further use of
accommodative financial conditions in Japan by supporting financial institutions' efforts. In
that sense, the two facilities are complementary to each other. Specifically, the SBLF
intends to support the economy overall from the financial side by encouraging financial
institutions to increase their lending and firms and households to increase their borrowing to
engage in proactive economic activities. On the other hand, the GFSF mainly aims at
playing a catalytic role in encouraging firms and financial institutions to proceed with
efforts to strengthen the economy's growth potential.
The Bank decided to call the combination of the SBLF and the GFSF the "Loan Support
Program". Under the Loan Support Program, it aims at strengthening the second stage of
the transmission mechanism of monetary easing by letting the two facilities achieve their
intended consequences. Furthermore, it expects that coupled with the stimulative effects of
the Asset Purchase Program the effects of monetary easing as a whole will be amplified.
Looking at the last 12 months, the amount of lending by those banks and shinkin banks
holding current accounts at the Bank that saw a rise in their lending increased by a total of
approximately 15 trillion yen. This implies that under the new facility, the SBLF, those
banks are entitled to receive funds of up to approximately 15 trillion yen from the Bank.
Together with the 5.5 trillion yen from the GFSF, the total size of the Loan Support Program
will be approximately 20 trillion yen. If financial institutions manage to increase their
lending more aggressively, the total size of the Program will exceed 20 trillion yen.
Furthermore, adding the Asset Purchase Program and the Loan Support Program
together, the total size of these programs will easily exceed 110 trillion yen. Given that
Japan's nominal GDP in 2011 was 468 trillion yen, the size of these programs is
equivalent to almost a quarter of GDP. This shows that the monetary easing undertaken by
the Bank at present has reached a level unprecedented in the past.
We strongly expect that financial institutions' efforts to increase their lending will lead to an
expansion of the total amount of fresh funds supplied to the economy. To this end, the
Bank is currently in the process of working out the details of the new facility, the SBLF, to
make it easy for financial institutions to use. We expect to release the details before the
end of the year and start operation of the facility as soon as possible.
Because of time constraints, I discussed the Bank's monetary policy focusing on these two
programs. The message that I wish to emphasize once again is that the Bank has been and
will always be ready to take appropriate and decisive action when the economy strays too
far from the baseline scenario of the outlook for economic activity and prices or when risks
to that scenario materialize. Going forward, in order to achieve its price stability goal for the
time being, the Bank is determined to pursue its aggressive monetary easing, making full
use of the new policy measures.
Concluding remarks
Let me conclude my speech today by touching on the economy of Niigata Prefecture.
In my speech, I stressed repeatedly the importance of making efforts to strengthen the
economy's growth potential in order to overcome deflation. Looking at firms based in
Niigata, there are many locations where skills to make top products have been nurtured and
accumulated over the years. Even in the midst of fierce competition with overseas firms,
many firms have succeeded in maintaining leading market shares either at home or abroad
on the back of these skills and using know-how on how to expand sales channels. This
shows that firms have been making incessant efforts toward strengthening growth potential
in the face of adversity such as the global financial crisis. I have full respect for these
efforts.
In addition, while Niigata is one of the most natural resource abundant regions in Japan -
for example in terms of oil and natural gas deposits - it has long been involved in promoting
renewable sources of energy. Initiatives aimed at commercializing solar power generation
on a large scale at solar parks in the "snow country", where daylight hours in winter are
short, have started to bear fruit and power generation has commenced. Reflecting the
experience after the Great East Japan Earthquake last year, the utilization of renewable
energy and the use of environmentally friendly cars and home appliances have been
accelerating on a national basis. Given that other countries in the world are likely to face
energy constraints in the future, Niigata's experience and accumulated know-how in this
field should stand it in good stead to benefit from the first mover advantage.
Looking back at the past year, a major piece of national news was that for the first time in
36 years, crested ibis chicks hatched in the wild on Sado Island in Niigata Prefecture. The
crested ibis is registered as a special natural treasure in Japan and the hatching of the chicks
is happy news. It is hoped that such happy news can also soon be heard on the economic
front. The Bank will continue to make every effort as a central bank and do its utmost to help
your initiatives.
Thank you.