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, Oita, 5 June 2014.
* * *
I. Introduction
Thank you for giving me this opportunity to exchange views with people representing the
political, economic, and financial arena of Oita Prefecture. I would like to take this opportunity
to express my sincere gratitude for your cooperation with the activities of the Bank of Japan's
Oita 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 Oita Prefecture. 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. Recent economic and financial developments in Japan and abroad
A. Developments in Japan's economic activity and prices following the
consumption tax hike
Regarding recent developments in Japan's economy, although statistics relating to
production and sales for April 2014 indicate a reactionary decline in domestic private demand
following the consumption tax hike, the economy seems to remain resilient as a trend. It
should be noted that (1) some sentiment indicators are weak, although this was expected,
and (2) a reactionary decline in demand following the front-loaded increase prior to the tax
hike is somewhat hard to gauge due to supply-side constraints. Let me follow up on this latter
point. In the automobile industry, for example, it is considered that a production decrease as
a whole caused by the decline in demand will come to a halt in the July-September quarter of
2014. Nevertheless, according to anecdotal information, there are some concerns about a
possible decline in that quarter and thereafter, because production for the April-June quarter
is not expected to be much affected by the decline in demand following the front-loaded
increase, as backlog orders from the January-March quarter had piled up due to supply-side
constraints. This suggests that we need to remain cautious about this decline in demand,
although there are many views that recent developments have generally been as expected.
From a somewhat longer-term perspective, I consider the critical point to be the extent to
which positive effects on the employment and income situation - such as the recent rise in
base pay - will be able to offset negative effects of the decline in real disposable income that
is caused by the tax hike.
In this regard, the recent employee income situation can be understood as follows. On the
one hand, the rate of increase in nominal wages has remained weak at around 0 percent on a
year-on-year basis, given that scheduled cash earnings are depressed - reflecting the recent
rise in the number of non-regular employees whose working hours are relatively short - despite
the increases in non-scheduled cash earnings and special cash earnings. On the other hand,
the total number of employees is boosted by the increase in non-regular employees;
consequently, nominal employee income - which is calculated by multiplying nominal wages
by the number of employees - has been increasing moderately at around 1 percent on a
year-on-year basis (Chart 1). Considering that the recent movements toward raising base
pay will likely increase scheduled cash earnings from this summer, and that a rise in base
pay, should it be realized, will positively affect non-scheduled cash earnings and special cash
earnings, it is natural to think that nominal employee income will increase at a somewhat
accelerated pace. In my view, with this employment and income situation acting as a
tailwind, Japan's economy will remain resilient against the consumption tax hike.
The consumer price index (CPI) figures since the consumption tax hike show that, excluding
the effects of the tax hike, the year-on-year rate of increase in the CPI for all items less fresh
food, or the core CPI, was generally around the previous month's level, and this is also a
supporting factor for the assessment of the underlying trend that I just mentioned (Chart 2).
Prior to the release of the CPI figures, there was a lot of conflicting anecdotal information -
such as price hikes exceeding the rise in consumption tax and price cuts through discount
sales. It turned out, however, that the rise in consumption tax alone has basically been
passed on to consumers. From another perspective, consumer demand can be regarded as
having been resilient enough to accept the passing on of the rise in tax. Japan's economy is
expected to return to a moderate recovery trend from the summer, as the subsequent decline
in demand following the front-loaded increase wanes.
B. Understanding of coexistence of the weaker-than-expected economic growth
rate and higher-than-expected prices
Japan's economy has decelerated from a high annual growth rate of around 4 percent in the
first half of 2013 to around 1 percent in the second half (Chart 3). This is partly due to
sluggish exports despite the yen's depreciation, but a significant increase in imports should
also be noted. Imports surged due to firm domestic demand as well as the front-loaded
increase in demand prior to the consumption tax hike, thereby pushing down the headline
GDP growth rate. However, focusing on domestic demand excluding net external demand,
the economy did not see much of a slowdown given that this demand kept growing at around
3 percent on an annual basis throughout the calendar year. As GDP growth for the second
half of 2013 was weaker than expected, this will have a smaller carry-over effect on GDP
growth for fiscal 2014. Partly reflecting this technical factor, the median of the Policy Board
members' forecasts for 2014 presented in the April 2014 Outlook for Economic Activity and
Prices (hereafter the Outlook Report) was revised downward, and there was also a
downward revision to forecasts for fiscal 2013. However, the mechanism of economic
recovery will be maintained in a situation where exports recover and domestic demand
remains resilient as a trend (Chart 4). Regarding the April-June quarter of 2014, the
contribution of net external demand to GDP growth is expected to turn positive, reflecting a
decline in imports, and this will in turn act as a buffer against a decline in domestic private
demand. As I will describe shortly, recovery of overseas economies - especially the U.S.
economy, which is getting over the effects of the unusually severe winter weather and has
started to return to a recovery trend - is expected to act as a tailwind for Japan's economy.
In the meantime, the core CPI for fiscal 2013, which was revised upward from the median of
the Policy Board members' forecasts in the January 2014 interim assessment of the Outlook
Report, registered 0.8 percent on a year-on-year basis. The fundamental reason behind this
upward revision to prices despite the downward revision to the GDP growth rate will be
explained later. In what follows, I highlight the role of imports in this context.
One factor contributing to the rise in the CPI is a rise in energy prices stemming from the
yen's depreciation. However, it is also the case that the year-on-year rate of increase in the
CPI for all items less food and energy, or the core-core CPI, for April 2014 excluding the
effects of the consumption tax hike registered 0.8 percent, which shows that prices other
than those of energy have also been rising. In terms of price hikes for items other than
energy and related goods, I am focusing on the price changes in digital appliances
(Chart 5).1
The CPI for digital appliances has risen by around 30 percentage points, from the range of
minus 22-23 percent for February 2012 to the range of 6-7 percent for February 2014 on a
year-on-year basis. This had an indispensable effect on the rise in the core-core CPI. As the
background to this, it can be pointed out that prices of digital appliances had fallen to the
bottom and fierce price competition in the household electrical appliances industry came to
an end. It should not be overlooked that the halt in the price decline of digital appliances is
attributable to the fact that prices of these products had become more susceptible to the
effects of the yen's depreciation with the increased import penetration ratio. A decline in
competitiveness and pricing power in the industry in Japan can be pointed out as a reason
behind such susceptibility. However, the CPI for digital appliances became more or less flat
on a year-on-year basis in the March-April period of 2014 excluding the effects of the
consumption tax hike as the yen's depreciation paused, and the core-core CPI for the
Kuarea of Tokyo in May declined by 0.2 percentage point from the previous month on the same
basis. The effects of the halt to the yen's depreciation trend on future developments in prices
should be monitored carefully.
C. Overseas economic and financial developments
As I just mentioned, Japan's economy is expected to continue growing at a pace above its
potential as a trend due to the ongoing firm domestic demand, while it will be affected by the
front-loaded increase and subsequent decline in demand prior to and after the consumption
tax hike. The probability of this scenario will be enhanced by the moderate increase in
exports led by the recovery of overseas economies, particularly advanced economies. In this
regard, recent developments in overseas economies will support Japan's economy through
exports; for example, the U.S. economy has been recovering moderately, led by private
demand, with the recovery becoming more widespread, and the euro area economy is also
recovering moderately (Chart 6).
With regard to the U.S. economy, the pace of recovery will accelerate gradually, mainly in
private consumption, as the improvement in households' balance sheets makes progress
supported by the ongoing recovery trend of housing prices as a whole, and as the effects of
fiscal drag fade. These positive effects will likely continue spreading to firms' production
activity, and thus the recovery trend of business fixed investment is likely to become more
evident (Chart 7). Of course, the Federal Reserve's (Fed's) policy developments and their
subsequent effects on global financial markets should be monitored as downside risks. In
this regard, the end in autumn 2014 to the Fed's asset purchase program has broadly been
incorporated into the markets at this point. In addition, the statement by the Federal Open
Market Committee (FOMC) has clarified the view that "it likely will be appropriate to maintain
the current target range for the federal funds rate for a considerable time after the asset
purchase program ends." My understanding is that the Fed will communicate carefully with
market participants in order to avoid bringing instability to financial markets.
Regarding the euro area economy, there are various adjustment pressures associated with
the excess debt problems in the public and private sectors. However, the economy is
expected to continue recovering moderately supported by ongoing recovery in domestic
demand, reflecting improvement in various economic entities' sentiment (Chart 8).
As just described, advanced economies are likely to recover moderately, led by the U.S.
economy. Meanwhile, emerging and commodity-exporting economies will likely continue to
lack growth momentum for the time being, especially in those economies that are restraining
aggregate demand, such as by raising interest rates.
Looking at the Chinese economy, domestic demand is likely to continue facing downside
pressure amid ongoing progress in structural reforms. However, since the authorities have
formulated concrete policy measures to underpin economic activity and external demand is
expected to continue picking up, the economy is likely to maintain stable growth in general at
around the current pace.
From a somewhat longer-term perspective, however, there are concerns about the Chinese
economy due to factors such as demographic changes (Chart 9). Labor supply and demand
conditions seem to be tight, although the growth rate has fallen from double digits to the
range of 7-8 percent. This implies the possibility that China's potential growth rate is
declining considerably. While the authorities have set the growth target at around
7.5 percent, some of them have said that some downward deviation from 7.5 percent is
within the target range. It is better to take a conservative view that China's growth rate is
likely to be around 7.5 percent at its highest, despite the government's measures to underpin
economic activity.
D. Risks to overseas economies
The outlook for overseas economies that I have explained is subject to both upside and
downside risks. Geopolitical risks such as the recent situation in Ukraine should be carefully
monitored in the short run. In addition, I am personally concerned about the possibility of a
disinflationary trend and decline in potential growth rates in Europe and the United States in
the medium to long run (Chart 10).
The euro area in particular should be carefully monitored as the disinflationary trend might be
prolonged, mainly in peripheral countries. Several peripheral countries in particular are
expected to continue facing downward pressure on wages in order to retain competitiveness
under the appreciation of the euro, and the European Commission and the European Central
Bank (ECB) have revised down their inflation forecasts for both this year and the next.
Medium- to long-term inflation expectations both in Europe and the United States have been
stable at around 2 percent, which is one of the reasons why the policy authorities in the euro
area have taken the view that it will not enter stagnant deflation like Japan (Chart 11).
However, Japan's experience suggests the possibility that low inflation continuing for a long
time changed people's inflation expectations in a backward-looking manner, and thus
medium- to long-term inflation expectations also lowered adaptively. In fact, as the
disinflationary trend continues, short- and medium-term inflation expectations by economic
entities and the markets have already started to decline somewhat in the euro area as well.
If the stability in medium- to long-term inflation expectations is undermined, various policy
actions are expected to be taken. The ECB has already revealed its policy stance that it will
not hesitate to make use of unconventional measures to address the risk of prolonged
disinflation, and I therefore am keeping a watchful eye on its future conduct of monetary
policy. It should also continue to be noted that the financial system is still somewhat fragile in
the euro area.
In the United States, deflationary concerns have not been observed so far, and instead
shortterm inflation expectations in the private sector have been revised upward. However, the
inflation rate has recently been lower than the Fed's forecast, partly reflecting the stable
energy prices brought about by the shale revolution. Therefore, I feel it necessary to take into
account the risk that the inflation rate will remain lower than the optimal level from a
somewhat longer-term perspective.
It also should be noted that an argument that raises concerns about secular stagnation of the
global economy has attracted somewhat more attention. Lawrence Summers, for example,
has argued that there is a possibility that the level of equilibrium real interest rate - or, the
natural rate of interest - that is consistent with full employment has declined to the range of
minus 2-3 percent in the United States since the late 2000s, as there has not been excess
demand in the economy before and after the financial crisis, and because prices have been
stable, with the actual GDP rate continuing to be far below the potential one.2 The argument
regarding secular stagnation after the crisis seems reasonable, considering the experience in
Japan - namely, that it continued to be difficult to boost demand, in part reflecting the
financial crisis in the late 1990s and demographic changes since the 2000s. Paul Krugman
previously noted that Japan's equilibrium real interest rate had temporarily declined to
around minus 4 percent.3 What is new about the arguments of Summers is that the
equilibrium real interest rate has been declining for a long time, not temporarily, on a global
scale, against the background of, for example, excess savings in countries with a current
account surplus and the decrease in the nominal investment amount arising from declining
capital goods prices.
Leaving aside the question of whether the equilibrium real interest rate has actually been
declining in negative territory for a long time, it seems plausible that growth momentum in the
global economy has declined somewhat more than in a typical cyclical pattern, reflecting the
prolonged downturn in demand, the deceleration in labor input, and the slowdown in
technological innovation. As a background to this, for example, the forecast for global growth
by the International Monetary Fund (IMF) has been consistently revised down, and growth
rates in emerging economies are far lower than those before the Lehman shock. Assuming
that the equilibrium real interest rate has declined due in part to the slowdown in the potential
growth rate, and that weak growth in demand has started to become chronic in this situation,
it becomes easier to understand the current disinflationary trend in advanced economies and
the downward trend in inflation rates in emerging economies.
However, we should avoid making a hasty conclusion. It is not easy to grasp the situation of
the potential growth rate and the slack in the economy.4 There are various arguments over
whether the decline in the inflation rate is solely attributable to a cyclical factor or is rooted in
a structural one, as described earlier. It also is often difficult to distinguish a cyclical factor
from a structural one. If the potential inflation rate has not declined much, the current
disinflationary trend could simply reflect the slack in capital stock and in the labor market,
and it is possible that disinflationary pressure will ease as the slack dissipates. As just
described, the inflation outlook and its implication for macroeconomic policy could change
depending on how to understand the current potential growth rate. Thus, I will continue to
carefully monitor this matter.
III. The conduct of monetary policy for the immediate future
A. Interim review on quantitative and qualitative monetary easing
Fourteen months have passed since the Bank introduced quantitative and qualitative
monetary easing (QQE) in April 2013. Looking at economic and price developments over this
period, as mentioned earlier, economic growth has turned out to be somewhat lower than the
Bank's projection, due to developments in exports and imports, and prices have been higher
than projected. Economic and price developments so far have been in line with the Bank's
projection on the whole. Thus, the Bank summarized in the April 2014 Outlook Report that
QQE has been exerting its intended effects. The Bank's Policy Board has judged it
appropriate to steadily pursue QQE under its current guidelines.
However, although prices are higher than projected, the transmission mechanism of QQE,
such as progress in the so-called portfolio rebalancing and a rise in medium- to long-term
inflation expectations, has not yet been observed to the extent the Bank initially intended. Of
course, I have no intention of denying that the mechanism is working. In fact, some marginal
changes have been observed; for example, financial institutions are gradually taking a more
active risk-taking stance. However, the current price hike seems to be affected not only by
the yen's depreciation and the rise in energy prices but also by the fact that the economy
- mainly on the employment front - is starting to reach the upper limit of supply capacity
sooner than expected, as the economic recovery is led mainly by nonmanufacturing, for
which labor productivity is lower than that in manufacturing. In what follows, I explain this
matter.
B. Mechanism of price hikes
In the April 2014 Outlook Report, the mechanism of price hikes is explained as follows: the
output gap, which shows the utilization of labor and capital, has been improving mainly on
the labor front, reflecting firm domestic demand, which tends to have large stimulative effects
on employment, and it appears to have reached around the past long-term average of about
zero; in this situation, upward pressure on wages and prices due to the tightening of supply
and demand conditions is likely to steadily increase. Actually, the bottleneck caused by the
labor shortage can be observed widely, and its effects are reflected in the hourly pay of
nonregular employees such as part-time workers. The effects of wage hikes easily penetrate
prices, particularly in the services sector - which is relatively labor intensive - and such
effects seem to have already appeared in services prices, such as for meals outside the
home (Chart 5).
Let me note that there are various approaches to estimating the output gap, and estimates
are subject to a margin of error. However, in light of the overall macroeconomic information -
such as tightness of the current labor conditions and the reduction in excess production
capacity shown in the March 2014 Tankan (Short-Term Economic Survey of Enterprises in
Japan) - it could be considered that the output gap, regardless of whether it has or has not
reached about zero, has already narrowed to a considerable degree. This narrowing seems
to be affecting prices to some extent. Nevertheless, it should be noted that this situation
seems to reflect not only the demand-side pick-up but also supply-side constraints, and
therefore attention needs to be paid to the possibility that the mechanism of economic and
price recovery could be different from what the Bank initially aimed for.
In other words, it is possible that the potential growth rate of Japan's economy has declined,
especially after the Lehman shock. This is because manufacturers' stagnant fixed investment
in Japan led to a slowdown in accumulation of capital stock, which in turn decreased labor
productivity. Tight labor conditions, due to the recovery led mainly by nonmanufacturing,
seem to be affected by lower labor productivity in nonmanufacturing compared to
manufacturing (Chart 12).
It is true that wage increases induced by tight labor conditions are a profit-squeezing factor
and thus not preferable for firms. If corporate profits are constrained by labor costs, business
fixed investment will be restricted and stock prices will be affected, and consequently wage
hikes will not be sustainable. It is desirable to see wage increases that are in line with growth
in labor productivity. In this regard, in achieving sustainable wage increases, it is
indispensable to have a boost in labor productivity in nonmanufacturing, such as through
investment aimed at labor saving. If such efforts toward improvement in labor productivity in
nonmanufacturing feed back into manufacturing and a virtuous cycle in the overall economy
is generated, the growth potential will be raised, thereby enhancing the probability of
achieving the price stability target of 2 percent in the medium to long term. Currently, in my
view, people's perception of labor conditions is tighter than what is suggested by statistics,
as labor shortages are being reported widely. It can be considered that Japan's economy is
at a critical point in terms of whether its growth will slow due to supply-side constraints or it
steps up to a new stage of growth by leveraging such constraints as a driving force to further
improve its labor productivity.
C. Importance of flexibility in the conduct of monetary policy
When the price stability target was introduced in January 2013, the Bank clearly stipulated
that the conduct of monetary policy has to be flexible by examining various risk factors,
including those related to financial imbalances, in addition to the assessment of current
developments and outlook for economic activity and prices, from the perspective of achieving
sustainable growth with price stability.
The importance of flexibility in monetary policy is what I have been focusing on to date.
Monetary policy requires long and variable time lags before its effects permeate the
economy, and thereafter prices. Therefore, to achieve a sustainable growth path in the
context of price stability, monetary policy needs to be flexible, taking into account future
prospects. In other words, the Bank examines the current conditions and the outlook for
economic activity and prices, and also analyzes various risk factors including the
accumulation of financial imbalances.
In addition, the Bank clearly commits to continuing with QQE, 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 my understanding, the timeframe for "maintaining that target in a stable manner"
should be assessed on a forecast basis.
In this regard, the price stability target is by no means a rigid and superficial framework that
simply aims to raise the inflation rate to reach 2 percent temporarily. Rather, it is a flexible
and practical framework that accommodates the needs arising from economic developments.
As described in the minutes of the Monetary Policy Meeting held on April 30, 2014, my own
view on the outlook for prices is somewhat more cautious than the majority view of the
Bank's Policy Board members. However, this does not mean that I am skeptical of QQE's
effects, nor does it mean that I deny the effectiveness of the QQE's transmission
mechanism. My understanding is that the price stability target is not a framework that calls
for the inflation rate to reach 2 percent with surgical precision, but rather that it represents a
flexible policy framework in which some degree of latitude - both upside and downside -
should be accommodated. Based on this understanding, I see some flexibility with regard to
the achievement of the 2 percent price stability target.
On this point, what the price stability target aims to achieve is not a situation in which only
prices will rise. Rather, it aims to achieve an environment in which the improvement of the
overall economy results in higher wages and then higher prices in a well-balanced manner. It
is necessary to avoid any misunderstanding that the Bank has been solely pursuing a
pickup in prices without due attention to the economy.
Let me turn to price indicators that are referred to in assessing the achievement of the price
stability target. It is sometimes misunderstood that the degree of such achievement is merely
assessed by using the core CPI, given that forecasts of the Policy Board members are made
in terms of the CPI on this basis. In fact, the price stability target is set based on the CPI for
all items, not the core CPI. However, this does not mean that the degree of achievement of
the target is assessed only by using the CPI for all items.
To evaluate price developments, it is necessary to appropriately understand the underlying
trend of price changes by excluding temporary destabilizing factors. In doing so, the indicator
that appropriately assesses price developments depends on each country's economic
structure. The Bank puts emphasis on the core CPI that excludes fresh food, which
fluctuates largely due to such factors as the weather. This CPI is used for Policy Board
members' forecasts in the Outlook Report. To understand the underlying trend in prices,
however, a wide range of indicators should be monitored carefully while fully taking into
account characteristics of each indicator. Such indicators include not only the CPI for all
items, the core CPI, and the core-core CPI, but also the CPI for all items less imputed
rents - which represents a concept similar to the cost of living - as well as those relating to
wages. It is important to note that monetary policy is not tied to specific indicators (Chart 13).
D. Developments in long-term interest rates
Next, I would like to talk about developments in long-term interest rates. Market participants'
price outlook has been lower than the Bank's baseline scenario to date, and as a matter of
fact, long-term interest rates have been stable at low levels partly due to asset purchases by
the Bank. Future developments in long-term interest rates depend on market participants'
economic and price outlook, but I am paying close attention to whether the price situation
and nominal long-term interest rates will develop in a consistent manner in a situation where
the rate of increase in the core CPI excluding the effects of the consumption tax hike has
been around 11⁄4 percent on a year-on-year basis for six consecutive months.
Here, let me recap how QQE will work on nominal long-term interest rates through its
transmission mechanism. Nominal long-term interest rates combine two elements: one is the
average of future short-term rates and the other is premiums (Chart 14). Based on this
understanding, the Bank has specified its forward guidance - namely, that it will continue
with the QQE, aiming to achieve the price stability target, as long as it is necessary for
maintaining that target in a stable manner. This in effect will exert downward pressure on the
average of expected future short-term rates. In addition, premiums will be prevented from
widening through the Bank's massive purchases of JGBs with relatively longer maturities.
However, under such unconventional policy, nominal interest rates are likely to face upward
pressure as the effects of the policy start to appear, preceding the improvement in the
economy and prices. Referring to the elements that I have just explained, expected future
short-term rates are likely to rise if market participants judge that an exit from current easing
policy is at hand.
In the case of a rise in nominal long-term interest rates, even when a central bank increases
its purchases of government bonds, or otherwise is put under pressure to increase such
purchases, in order to suppress the government's borrowing costs, the premiums might
possibly rise if it is judged by market participants that the central bank's purchases will
weaken fiscal discipline. This is because, when the level of long-term interest rates is
formulated, it is the market's judgment that matters rather than a central bank's intention.
These arguments are hypothetical and can be regarded as simply the result of brain storming
at this point. However, as the economy heads toward overcoming deflation, the effects will
start to spread to long-term interest rates. At that point, the Bank's monetary policy, including
the process through which it will eventually exit from the current easing policy, should not be
decided by giving consideration to fiscal sustainability, but instead be decided solely from the
standpoint of achieving the 2 percent price stability target. In that sense, I would like to
reemphasize that the government's commitment to medium- to long-term fiscal consolidation
plays an important role in ensuring the ultimate success of QQE.
IV. Concluding remarks: economic activity in Oita Prefecture
Economic activity in Oita Prefecture is somewhat more sluggish than that in Japan as a
whole, which has been showing clear recovery. The share of manufacturing in this prefecture
is larger than that in the country overall. Electronic parts and devices - which face a decline
in orders due to increased competition with foreign manufacturers and to sluggish sales of
final products - account for a large share of manufacturing in the prefecture. Accordingly, the
industrial production index for this prefecture has been below that for the whole country as a
trend, albeit with some fluctuations due to the front-loaded increase in demand prior to the
consumption tax hike (Chart 15). Considering that Japan's current economic recovery is
characterized as being led mainly by nonmanufacturing, the large share of manufacturing in
the prefecture's industrial structure might be the reason for the sluggish recovery compared
with that of the country as a whole.
It also should be noted that positive developments have been spreading. Anecdotal
information suggests that, although private consumption - mainly apparel, high-end goods,
furniture, and household electrical appliances - has been affected by the reactionary decline
in demand following