Yoshihisa Morimoto: Economic activity and prices in Japan and
monetary policy
Speech by Mr Yoshihisa Morimoto, Member of the Policy Board of the Bank of Japan, at a
meeting with business leaders, Ishikawa, 2 August 2012.
* * *
I. Recent financial and economic developments
A. Global financial markets and overseas economies
1. Global financial markets
I would like to start with developments in global financial markets and overseas economies,
which affect Japan's economy.
Global financial markets have recently been characterized by a repetitive pattern of rising
and declining pessimism reflecting developments in the European debt problem. From the
middle of 2011 toward the end of the year, strains in markets increased due to concerns over
the sustainability of public finances in peripheral countries. From the turn of 2012 toward
early spring, there were phases of easing strains due to the introduction of measures to
strengthen fiscal discipline in the member states of the European Union (EU), the decision on
the second financial support program for Greece by the euro area member states and the
International Monetary Fund (IMF), and the agreement to raise the lending capacity of the
European Financial Stability Facility (EFSF) and the European Stability Mechanism (ESM).
Nevertheless, markets became nervous again from early spring: there was talk of a euro
crisis due to the turmoil in the domestic political situation in Greece, and in Spain yields on
10-year government bonds temporarily rose above 7 percent due to concerns about the
stability of its financial system.
Subsequently, a new government was inaugurated in Greece, and the EU and eurozone
summits at the end of June emphasized the need to strengthen growth and agreed to take
steps to establish a single supervisory body for eurozone banks with a view to making it
possible for the ESM to recapitalize banks directly. These decisions raised hopes that the
vicious circle between uncertainty over Spain's financial system and increasing government
debt would be broken, and markets temporarily regained stability. This situation, however,
did not last long. At present, yields on 10-year Spanish government bonds are hovering at
around 7 percent. On the other hand, interbank funding markets have generally been stable
since the beginning of 2012 due to the abundant liquidity provision by the European Central
Bank (ECB). It appears, however, that it will take some more time until uncertainties are
dispelled over the fiscal and economic structural reforms as well as over measures regarding
the financial system in Europe. Thus, developments in the European debt problem continue
to warrant careful attention.
2. Overseas economies
Under these circumstances, overseas economies have shown some improvement, albeit
moderate, but on the whole they have not emerged from a deceleration phase. By region,
economic activity in the euro area continues to be sluggish, despite signs of a pick-up in
exports, because domestic demand in the area has been stagnant. Peripheral countries in
particular have fallen into a vicious circle, in which the downturn in economic activity due to
fiscal austerity measures and the deterioration in financial conditions lead to a further
worsening of the financial conditions of governments and financial institutions. As a result,
disparities between economic sentiment in core countries such as Germany and in peripheral
countries are widening. For example, the unemployment rate in Germany stands at around
5 percent, which is a historical low since the reunification of East and West Germany, while
in Spain it has reached well over 20 percent and the youth unemployment rate is in excess of
50 percent. Moreover, the deterioration in the economies of peripheral countries is affecting
business sentiment in core countries, and thus the European economy is likely to remain
sluggish for the time being.
Next, the U.S. economy is generally continuing to recover at a moderate pace. Private
consumption has been firm due in part to an increase in real purchasing power reflecting the
decline in gasoline prices, and the housing market has shown some signs of picking up.
Business fixed investment has recently maintained its uptrend against the background of
solid corporate profits. However, signs of weakness have been observed in business
sentiment, and the momentum of growth in employment has recently been slowing.
Furthermore, amid persisting strains from balance-sheet adjustments, households and firms
are not likely to increase their spending due to concerns over the adverse impact of the
European debt problem as well as uncertainty regarding the "fiscal cliff," that is, fiscal
spending cuts scheduled to be implemented at the beginning of 2013 and the handling of tax
cuts set to expire at the end of 2012. Taking these factors into account, the U.S. economy is
likely to recover at only a moderate pace.
Emerging and commodity-exporting economies still have not emerged from a phase of
sluggishness, but on the whole these economies have maintained relatively high growth
backed by firm domestic demand. The pace of growth in the Chinese economy has slowed
reflecting the deceleration in private real estate investment as a result of monetary tightening
earlier, but there are also signs that the slowdown is bottoming out, such as the increasing
trend in exports and bank lending. The Chinese government has accelerated approvals for
infrastructure investment and introduced subsidies for energy-saving electrical appliances
and other goods. With the pace of consumer price inflation decelerating, the authorities have
also started stimulating the economy on the monetary front, lowering the benchmark lending
rates for two consecutive months. Looking ahead, the growth rate of the Chinese economy is
unlikely to reach dramatic levels, but it is likely to rise gradually as these policy measures
start producing effects. In the NIEs and the ASEAN economies, exports have been affected
by the slowdown in Europe and China, but domestic demand has been firm on the whole,
and production has been recovering moderately. As for the outlook, including other emerging
economies such as Brazil, the growth rate of emerging and commodity-exporting economies
will likely increase gradually reflecting accommodative financial conditions and a recovery in
real purchasing power following a decline in inflation rates.
B. Japan's Economy
1. Economic activity
I will now explain the current state of, and outlook for, Japan's economy based on the
overseas economic developments I have just outlined. Until the beginning of autumn 2011,
Japan's economy picked up steadily following the plunge caused by the Great East Japan
Earthquake, which struck just as the economy was recovering from the Lehman shock.
Thereafter, however, it remained more or less flat on the whole until around the early spring
of 2012 mainly due to the adverse effects of the slowdown in overseas economies and the
appreciation of the yen. More recently, with domestic demand remaining firm - led by
reconstruction-related demand and private consumption - and exports continuing to show
signs of picking-up, economic activity on the whole has started picking up moderately.
The firmness in domestic demand is attributable to the following factors. Demand for
restoration and reconstruction of social infrastructure and of disaster-stricken facilities and
homes has led to increases in public investment, business fixed investment, and housing
investment. Reconstruction-related demand has also been underpinned by changes in the
behavior of firms and households triggered by the disaster. Examples are efforts to
strengthen the earthquake resistance of buildings and facilities and to bolster business
continuity systems, investment in the area of new energy sources, and the purchase of
energy-saving products. Meanwhile, private consumption has been boosted by pent-up
demand, that is, a recovery in demand following the temporary restraint due to the effects of
the disaster, and by policy measures such as subsidies for purchasers of environmentally
friendly cars. Private consumption has also been pushed up by an increase in spending on
products and services provided by businesses targeting the elderly reflecting firms' efforts to
enhance their line-up in this area.
Although considerable uncertainty remains regarding the outlook, Japan's economy, with
domestic demand remaining firm and overseas economies emerging from their phase of
deceleration, is expected to return to a moderate recovery path, as also shown in the
June 2012 Tankan (Short-Term Economic Survey of Enterprises in Japan) and the Regional
Economic Report.
Given this situation in demand at home and abroad, the economy is likely
to register a relatively high rate of growth in fiscal 2012, supported by a gradually increasing
momentum in the virtuous circle of growth in production, income, and spending. In fiscal
2013, with overseas economies continuing to see relatively high growth on the whole, the
economy is expected to be firm, although the growth rate is expected to be somewhat lower
than that in fiscal 2012, because the positive effects from reconstruction-related demand will
gradually diminish. In the Bank of Japan's projection released in July 2012, the median of the
Policy Board members' forecasts for Japan's real GDP growth rate is 2.2 percent for fiscal
2012 and 1.7 percent for fiscal 2013.
2. Prices
Next, I will talk about price developments. International commodity prices softened somewhat
from autumn 2011, reflecting the slowdown in the global economy. After a slight rise in early
spring of 2012, especially in crude oil prices against the backdrop of heightened geopolitical
risk, they then fell back again through June 2012, and remained more or less flat thereafter.
Most recently, prices of crude oil have bottomed out, while those of grains have risen due to
unseasonable weather. As for the outlook, international commodity prices as a whole are
expected to rise at a moderate pace in line with the growth in overseas economies. Under
these circumstances, the year-on-year rate of change in the domestic corporate goods price
index (CGPI) has recently been negative. The CGPI is expected to decline moderately for
the time being and then start to rise slowly reflecting the expected moderate increase in
international commodity prices and the improvement in the negative output gap.
Turning to the consumer price index (CPI) for all items less fresh food, the year-on-year rate
of change since summer 2011 has been around 0 percent and is expected to stay at this
level for the time being. Assuming that medium- to long-term inflation expectations remain
stable, the year-on-year rate of change in the CPI is expected to gradually rise to a range of
above 0.5 percent and less than 1 percent in fiscal 2013 as the negative output gap
improves. Thereafter, it will likely be not too long before the rate reaches the Bank's current
"price stability goal in the medium to long term" of 1 percent. In the Bank's projection
released in July 2012, the median of the Policy Board member's forecasts for the
year-on-year rate of increase in the CPI (all items less fresh food) is 0.2 percent for fiscal
2012 and 0.7 percent for fiscal 2013.
C. Risks to the baseline scenario
The baseline scenario for Japan's economy described thus far is subject to both upside and
downside risks. By far the most important risk is uncertainty regarding the outlook for
overseas economies, and particularly the European debt problem. Although concerns about
the stability of Spain's financial system had temporarily subsided thanks mainly to the
agreement reached at the EU and eurozone summits, in order to fundamentally resolve the
debt problem it is nevertheless necessary in Europe to break the underlying negative
feedback loop among fiscal balances, the financial system, and economic activity. At the
same time, it is crucial that countries on the European periphery, whose international
competitiveness has declined, steadily work on fiscal and economic structural reforms.
Moreover, as part of the efforts toward deeper integration in the euro area, discussions are
ongoing within the EU with the aim of establishing a banking union and a fiscal union, and I
believe it is important to press ahead with these steps. In this situation, if reforms make
steady progress, this would strengthen market confidence, which in turn would push up
global economic growth. However, in core countries such as Germany, there are concerns
that the financial burden of providing support to peripheral countries through, for example,
greater fiscal integration would increase. Hammering out concrete steps, therefore, is likely
to involve a great deal of complication. If in the meantime the European debt problem
worsens, or the considerable sense of uncertainty continues for a prolonged period, this
could weigh on the economic recovery in other areas such as the United States and China.
External demand for Japan's exports is expected to once again become the driving force of
Japan's economy after the earthquake-related reconstruction demand peaks out, but if
exports remain sluggish, a virtuous circle may not take hold. For this reason, overseas
economic developments warrant close attention.
Next, risks stemming from domestic factors include uncertainty with regard to
reconstruction-related demand as well as both upside and downside risks in how medium- to
long-term growth expectations will be affected by the supply and demand balance of
electricity and by innovation in energy-related technology. Another issue is the sustainability
of Japan's public finances, concerns over which restrain consumer spending due to anxiety
about the future and affect long-term interest rates. Given that social security spending will
continue to exert upward pressure on fiscal expenditure, it is necessary to push ahead with
structural reform of public finances on both the expenditure and the revenue side and
maintain the public's confidence in fiscal discipline. Efforts to restore Japan's public finances
are underway and are something that I will keep a close eye on. Both upside and downside
risks persist also in import prices, particularly international commodity prices.
II. Monetary policy
Next, I would like to turn to the Bank's conduct of monetary policy under the current
economic situation.
In order for Japan's economy to overcome deflation and return to a sustainable growth path
with price stability, efforts to strengthen the economy's growth potential and support from the
financial side are of the utmost importance. Based on this recognition, the Bank is currently
providing support to raise Japan's growth potential through its fund-provisioning measure to
support strengthening the foundations for economic growth, while at the same time pursuing
powerful monetary easing continuously by steadily providing funds through, for example,
purchasing financial assets. Moreover, the Bank is doing its utmost also to ensure stability in
financial markets.
In what follows, I will explain the Bank's measures in greater detail.
A. Pursuit of powerful monetary easing
I will begin with the Bank's pursuit of powerful monetary easing. In October 2010, the Bank
introduced the comprehensive monetary easing policy, and has been easing financial
conditions continuously since then. The comprehensive monetary easing policy consists of
three measures: the implementation of a virtually zero interest rate policy by setting the
target for the policy rate, the uncollateralized overnight call rate, at around 0 to 0.1 percent;
the purchase of financial assets and funds-supplying operation through the Asset Purchase
Program (hereafter the Program); and the clarification of the policy time horizon, that is, the
clarification that these measures will remain in place until the Bank judges that price stability
is in sight.
In this context, financial conditions in Japan have continued to ease. The overnight call rate
has been below the 0.1 percent level. With regard to long-term interest rates, yields on
Japanese government bonds (JGBs) with a remaining maturity of three years or less are
0.1 percent, and those on 10-year government bonds are at the lowest level in about nine
years. Firms' funding costs have also declined moderately, as shown, for example, by the
fact that the average contracted interest rate on new loans and discounts is in the region of
only 1 percent.
1. Clarification of the policy time horizon based on "the price stability goal in the
medium to long term"
At the Monetary Policy Meeting held in February this year, the Bank introduced "the price
stability goal in the medium to long term" as a part of its efforts to further clarify its
determination to overcome deflation. "The price stability goal in the medium to long term" is
the inflation rate judged by the Bank to be consistent with price stability sustainable over the
medium to long term. At present, the Bank judges "the price stability goal in the medium to
long term" to be within a positive range of 2 percent or lower in terms of the year-on-year rate
of change in the CPI and, more specifically, sets a goal of 1 percent for the time being. On
this basis, the Bank has stated that for the time being it will aim 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, which I mentioned earlier. As you can see, by presenting its
commitment regarding the policy time horizon, the Bank has further clarified its determination
to pursue monetary easing.
2. Expansion of the Asset Purchase Program
The Program currently implemented by the Bank was established to further enhance
monetary easing by encouraging a decline in longer-term interest rates and various risk
premiums in a situation where there was little room for a further decline in short-term interest
rates. Established on the Bank's balance sheet, the Program is used to purchase various
financial assets - such as government securities, CP, corporate bonds, exchange-traded
funds (ETFs), and Japan real estate investment trusts (J-REITs) - and to conduct fixed-rate
funds-supplying operation. Since the establishment of the Program, the Bank has expanded
its size successively, including in February and April of this year, so that the outstanding
amount of asset purchases would reach about 65 trillion yen by around the end of 2012 and
about 70 trillion yen by around the end of June 2013, thereby contributing to the pursuit of
powerful monetary easing.
Furthermore, in April, in order to encourage a decline in longer-term interest rates, the Bank
decided to extend the remaining maturities of JGBs and corporate bonds to be purchased
under the Program from "one to two years" to "one to three years." And in July, the Bank
decided to remove the minimum bidding yields for outright purchases of treasury discount
bills (T-bills) - which had previously been 0.1 percent per annum - and of CP in order to
ensure that the outstanding amount of asset purchases under the Program would reach the
planned amount. For the same reason, the Bank also revised the categories of assets
purchased and loans provided through the Program. The outstanding amount of the Program
stood at 53 trillion yen as of July 20, and the Bank will continue to proceed with powerful
monetary easing by steadily increasing the outstanding amount of the Program by about
17 trillion yen by around end-June 2013. It is expected that the effects of the continuing
purchases of financial assets under the Program will strengthen further as the economy
recovers.
B. The Bank's efforts to support strengthening the foundations for economic
growth
I will now talk about the fund-provisioning measure to support strengthening the foundations
for economic growth (hereafter the Growth-Supporting Funding Facility).
The Bank introduced this measure in June 2010 to support strengthening the foundations for
economic growth for the purpose of providing support for the critical challenge of enhancing
the growth potential of Japan's economy, and has been providing long-term funds at a low
interest rate to financial institutions in accordance with their efforts in terms of lending and
investment for strengthening the foundations for economic growth. The maximum duration of
loans is four years, and the loan rate is currently set at 0.1 percent. The initial ceiling of the
outstanding amount of loans was set at 3 trillion yen. Subsequently, in June 2011, the Bank
introduced a new lending arrangement of 500 billion yen for the measure, through which it
extends loans to financial institutions for their equity investments and asset-based lending
(ABL). The loans for ABL allow financial institutions to use their expertise to identify and lend
to potential growth firms without conventional collateral or guarantees.
In March 2012, the Bank decided to further enhance the Growth-Supporting Funding Facility
by (1) increasing the ceiling for the outstanding amount of loans from 3 trillion yen to
3.5 trillion yen; (2) establishing special rules for another new lending arrangement of
500 billion yen for small-lot investments and loans; and (3) establishing special rules for a
new U.S. dollar lending arrangement of 12 billion U.S. dollars - equivalent to
1 trillion yen - using the U.S. dollar reserves already held by the Bank, for foreign
currency-denominated investments and loans.
The outstanding balance of the total loans disbursed by the Bank, including those extended
under the special rules, stood at approximately 3.2 trillion yen as of the beginning of June.
The first disbursement of U.S. dollar loans under the special rules is to take place in
September. A breakdown of financial institutions' individual investment and lending for
strengthening the foundations for economic growth in the period April 2010-March 2012 by
designated business area shows that almost 30 percent of the total funds was provided to
"environment and energy business" and almost 20 percent was provided to "medical, nursing
care, and other health-related business," but funds were also provided to business areas
falling under the category of "others," such as lending or investment to revitalize local
industries. A wide range of financial institutions have been making a variety of efforts
targeting their specific customer base or the region they serve, such as establishing new
dedicated funds to support economic growth, so that the amount of lending and investment
actually provided by financial institutions using the Growth-Supporting Funding Facility
greatly exceeds the amount of loans disbursed by the Bank. The Bank, with its steady
disbursement of loans, will continue to support the flow of funds to growth areas in order to
contribute as much as possible as the central bank of Japan toward strengthening the
foundations for economic growth.
C. Measures to ensure financial market stability
In addition to pursuing the measures just described, the Bank has been doing its utmost to
ensure financial market stability by making use of various funds-supplying operations.
Immediately after the earthquake in March 2011, the Bank provided ample funds on an
unprecedented scale, exceeding the amount provided immediately following the Lehman
shock. When the European debt problem worsened at the end of November 2011, the Bank
lowered interest rates on U.S. dollar funds-supplying operations as part of coordinated
measures among six major central banks in order to ensure stability in financial markets. At
the same time, the central banks agreed to establish bilateral swap arrangements enabling
the provision of liquidity in any of their currencies in addition to the already available
U.S. dollar.
III. Issues related to strengthening the growth potential of Japan's economy
A. The importance of strengthening the growth potential to overcome deflation
Earlier, I touched on the Bank's efforts to support strengthening the growth potential of
Japan's economy. Let me elaborate on the challenges we face in strengthening the growth
potential. Japan's economic growth rate has been trending down due to the effects of the low
birth rate and the aging of the population as well as to a decline in its international
competitiveness. Consumption and investment have been restrained as a result of a decline
in households' and firms' growth expectations, so that aggregate domestic demand has
remained below the aggregate supply capacity of the economy for a prolonged period,
exerting downward pressure on prices. With economic activity picking up,
the output gap - that is, the difference between aggregate supply capacity and aggregate
demand - has recently been narrowing. Nevertheless, aggregate demand continues to fall
short of aggregate supply capacity by about 2 percent. While price developments are subject
to various factors, including developments in international commodity prices, in order for
Japan's economy to overcome deflation it is important to address the problem of insufficient
demand, which is the key factor underlying deflation in Japan. At the same time, in order to
achieve sustainable economic growth amid the low birth rate and aging of the population, it is
important to maintain sufficient supply capacity to meet new sources of demand.
B. Capturing global demand and creating demand through innovation
To resolve the problem of insufficient demand, it is essential to capture global demand,
including demand from emerging economies, and to tap latent demand both at home and
abroad.
With respect to capturing global demand to overcome the shortage of demand at home, in
addition to making efforts to increase exports it is important to increase income from
overseas investment. While income from foreign direct investment is not included in GDP, it
does contribute to gross national income (GNI). Moreover, advances in the international
division of labor likely contribute to strengthening the economy's growth potential through the
associated increase in exports of related goods and the shift of the domestic labor force into
areas with growth potential.
Tapping latent demand, the other essential element in addressing insufficient demand, also
requires efforts on a continuous basis. Markets for new types of goods and services usually
grow only slowly at the initial stage. They then enter a phase of rapid growth until demand is
saturated and growth slows again. In order to maintain the growth potential of the economy
as a whole, it is therefore important to continuously secure demand both at home and
abroad. To this end, it is necessary to accelerate innovation that taps latent demand for
goods and services and consequently creates demand, which will give depth to areas with
growth potential. The demographic change resulting from the low birth rate and the aging of
the population is also prompting changes in the demand structure. For example,
consumption expenditure by households headed by a person aged 60 years or older,
including the baby-boomer generation, now accounts for more than 40 percent of total
private consumption. Therefore, an important challenge is to supply goods and services that
meet the needs of this generation in a timely manner.
Corporate profits and business sentiment at Japanese firms have been on an improving
trend recently. This reflects not only the positive effects of subsidies and earthquake-related
reconstruction demand, but in my view also shows that firms' active efforts to tap latent
demand and address social challenges are paying off. Examples are businesses targeted at
the elderly and in the areas of information and telecommunications as well as environment
and energy, where challenges in terms of energy creation, energy saving, and energy
storage need to be addressed with urgency. For example, in the automobile industry,
environmentally friendly cars - such as hybrid cars with better environmental efficiency
- have been selling briskly, and it is expected that related markets, such as those for
rechargeable batteries, will also expand. In the field of information and telecommunications,
smartphones are coming into widespread use, providing the infrastructure for not only the
distribution of digital books and music but also a whole range of new services. One example
is the use of the Internet and the Global Positioning System (GPS) to provide services such
as giving information on cafes and restaurants in the vicinity and guiding smartphone users
there. In the convenience store industry, the number of stores was said to be near saturation
at one time. However, by expanding the range of products and services aimed at women and
the elderly, such as introducing home deliveries, convenience stores have been able to
increase their sales per store. Looking ahead, it is extremely important that efforts toward
innovation do not come in spurts but are sustained across a wide range of fields.
C. Maintaining the labor supply and improving productivity
In order to strengthen Japan's growth potential, it is also important to ensure that supply
capacity is commensurate with demand. While the recent employment situation has been on
an improving trend, labor supply still exceeds demand. There still remain problems that need
to be solved, such as the extremely severe employment conditions for the young. However,
Japan's working age population will continue to decline, and in the medium to long term labor
supply may fall short of demand. Economic growth can be decomposed into two
components: the rate of growth in the number of workers and that in productivity per worker.
Assuming that the labor force participation rate remains unchanged, the negative growth
contribution of the decline in the number of workers is forecast to increase to around
1.0-1.5 percent by the 2030s. Meanwhile, the average annual increase in labor productivity
has been around 1 percent in recent years, so if things remain the same, Japan's potential
growth rate will fall into negative territory.
In order to mitigate the impact of these developments as much as possible, with regard to the
labor force, it is important to increase labor market flexibility to allow workers to change
industries more easily and to boost labor market participation of the elderly and of women
who wish to work but are not currently working. On the other hand, regarding labor
productivity growth, this is actually quite high in Japan when compared with other major
countries and may be difficult to raise further. However, since labor productivity is the ratio of
aggregate value added to labor input costs, productivity growth could be improved if growth
areas provide sufficient opportunities for the creation of high-value-added goods and
services, so that firms can generate sufficient profits. This could then produce forward
momentum through generating income, thus mitigating the impact of the decline in the
working-age population.
Given that Japan has a low birth rate and the fastest aging population in the world, achieving
such a strengthening of the growth potential is extremely difficult and represents a challenge
that requires the efforts of the nation as a whole, since it requires raising demand, labor
supply, and productivity to the limits of Japan's potential. Based on this perspective, the
Japanese government has compiled the "Strategy for Rebirth of Japan" to create an
environment allowing firms to meet the challenges of the task. The strategy places priority on
eleven areas. These areas include "green innovations," which focuses on Japan's aim to
lead the world in the energy revolution and create new industries and employment related to
this field; "life innovations" with the aim of turning businesses related to medical services and
nursing care into growth industries, fostering new related industries and markets, and
developing markets overseas; human resources development; and turning Japan into a
tourism nation. In order to boost the efforts undertaken by firms, support from the financial
side is essential, in addition to the creation of the right environment. With this in mind, the
Bank will continue exerting itself in its role together with firms, financial institutions, and the
government.