Kiyohiko G Nishimura: Recent economic and financial developments and
the conduct of monetary policy
Speech by Mr Kiyohiko G Nishimura, Deputy Governor of the Bank of Japan, at a Meeting
with Business Leaders, Tochigi, 29 January 2009.
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Introduction
The Bank of Japan regularly holds a meeting of this kind in various regions where a member
of the Policy Board explains developments in Japan's economy and the thinking behind the
conduct of monetary policy, and exchanges opinions with business leaders in the region.
Today, I am much honored to have my first opportunity to visit Tochigi Prefecture and speak
before business leaders here.
I understand that our staff in the Research and Statistics Department and the Financial
Systems and Bank Examination Department visit you frequently to collect information on the
economic and financial situation of the region. The information is very valuable for accurately
understanding Japan's economic and financial situation as well as for formulating the
conduct of monetary policy. I would like to take this opportunity to thank you for your
cooperation.
Today, I would first like to explain the Bank's view on Japan's economic and financial
situation and our thinking behind the conduct of monetary policy.
The Bank publishes semiannually, in April and October, a document called Outlook for
Economic Activity and Prices, which explains the Bank's economic outlook and its thinking
behind the conduct of monetary policy, and three months after its publication, in July and
January, mid-term assessments of the projections are conducted. We just conducted a
midterm assessment at the Monetary Policy Meeting (MPM) held last week, and revised the
projected growth rates and inflation rates significantly downward. To explain the reasons for
this downward revision, I must begin by discussing the financial crises in the United States
and Western Europe as well as the deceleration in overseas economies, which are major
factors responsible for the deterioration in Japan's economic conditions. Then I would like to
proceed to Japan's financial conditions, the current situation of and outlook for Japan's
economy, and the Bank's policy responses.
I. The U.S. and Western European financial crises and the deceleration in
overseas economies
The turmoil in global financial markets stemming from the subprime mortgage problem in the
United States was exacerbated by the bankruptcy of Lehman Brothers in September 2008.
The turmoil has advanced to become a financial crisis where not only U.S. but Western
European financial institutions either failed or faced severe difficulties. Currently, the
influence of the financial crisis is spreading to emerging economies in regions such as
Central and Eastern Europe and Latin America. As a result, economic conditions are
deteriorating globally: emerging economies that had continued to show high growth are
experiencing a decline in exports reflecting the deterioration in the U.S. and Western
European economies, and the impact of the financial crisis is taking its toll on internal
demand in emerging economies, leading to a clear deceleration in economic activity. Another
distinctive feature of the current deceleration is the speed with which financial crises spread
and economic conditions deteriorate. Since the world economy has never experienced such
sudden changes before, this is further increasing future uncertainty and has led to a further
deterioration in economic conditions.
The largest factor contributing to this rapid and simultaneous deterioration in world economic
conditions is the progress of globalization in financial and economic activity. The widespread
use and popularization of advanced technology in information and communications have
supported globalization through increased speed of transactions, reductions in the
interregional information gap, and a global network of transactions. Paradoxically, one
cannot deny that once financial transactions and economic activity supported by these
advanced information and communications technologies decrease, this causes a sudden
unwinding.
With respect to financial activity, financial institutions around the world are currently utilizing
these advanced information and communications technologies to carry out a large volume of
cross-border financial transactions and invest in a variety of financial assets. The direct
causes of the U.S. subprime loan problem leading to balance-sheet constraints and failures
of Western European financial institutions were their large investment in securitized products
backed by U.S. subprime mortgage loans and their commitment to provide backstop liquidity,
just as in the case of U.S. institutions. While the deterioration of economic conditions in the
United States and Western Europe and the increase in bad assets were gradually
proceeding, Lehman Brothers went bankrupt, triggering a sharp decline of confidence in U.S.
and European financial institutions, which are mutually involved in a web of complex trade,
and this led to a chain of failures and poor performance of financial institutions in the United
States and Western Europe. In addition, these financial institutions had an important role
channeling funds to emerging economies in regions such as Central and Eastern Europe and
in Latin America. With the outbreak of financial crises in the United States and Western
Europe, these institutions suddenly scaled back their exposures to emerging economies,
creating problems for these economies too.
With respect to economic activity, the progress of globalization increased the role of
emerging economies not only as production bases for the leading economies but also as a
huge market for the latter's own products. Given this increased presence in the global
marketplace, emerging economies are now faced with a marked decrease in internal
demand due to declining exports reflecting a downturn in the U.S. and Western European
economies and downward pressure from the financial side as a consequence of financial
crises in the United States and Western Europe. With the widespread use and popularization
of advanced information and communications technologies, these developments are taking
place at a speed not imaginable in the past. As a manager of a manufacturing firm has
stated, "Demand has evaporated in a market where, until recently, supply could not keep up
with the increase in demand." With the clear deceleration in growth of emerging economies,
exports to them from the United States and Western Europe are decreasing, adding further
downward pressure on economic activity there. And this is causing in turn a further decline in
exports from emerging economies, subsequently decreasing internal demand in these
economies. Currently, there are two adverse feedback loops operating globally and leading
to a sharp deterioration in world economic conditions: one where a decrease in production,
income, and expenditure takes place in a spiral with a decrease in exports as a starting point,
and another where negative developments in financial and economic activity mutually
reinforce each other.
Confronted with a sharp global deterioration in financial and economic conditions,
governments and central banks have taken various measures. To alleviate the economic
downturn, considerable monetary easing and fiscal stimulus have been enacted in many
countries. To alleviate the financial crisis, central banks in various countries are providing
funds not only in their own currency but in U.S. dollars as a concerted action. Governments
are placing troubled financial institutions under their control, injecting public funds, expanding
their deposit insurance schemes, and insuring the liabilities of financial institutions.
In spite of these successive expeditious measures taken by governments and central banks,
there are still uncertainties as to how the financial crises in the United States and Western
Europe will be resolved and how the world economy will recover. With the adverse feedback
loop operating between financial and economic activity, losses incurred by financial
institutions and the amounts of capital that need to be raised tend to increase as time
passes, and it is not clear whether the actions taken so far are sufficient to deal with the
problem. For the financial system to regain stability, the amount of losses that financial
institutions will incur needs to be clarified and the institutions need to be sure that the amount
of capital they hold is enough to cover these losses. Since it is not clear that these conditions
are met, a high level of uncertainty remains regarding how the financial crises will be
resolved.
With regard to the recovery of the world economy, a turning point will arrive when
adjustments in asset prices proceed in major economies, recovery in total demand is
foreseen, and pressures acting to depress economic activity from the financial side dissipate
with the progress in stabilizing the financial system. Although we expect these signs of
recovery to emerge by the latter half of this fiscal year, the timing of recovery in the world
economy remains highly uncertain since it is unclear how financial crises will be resolved.
II. Financial conditions
Japan's economy, until recently, was not burdened by excesses in production capacity and
labor, and the financial system remained relatively stable. Therefore, it was thought to be
resilient against supply and demand shocks as long as they remained local. However, with
multiple shocks hitting the world economy like tidal waves since last autumn, Japan's
economic conditions have deteriorated sharply. In the last several years, Japan has
developed a growth mechanism based on increases in global demand - especially for
automobiles and capital equipment - but decreases in exports of these goods, due to a
sharp deterioration in world economic conditions, have led to a substantial decline in
production, income, and labor. The decline was also augmented by increased tightness in
Japan's financial conditions.
With regard to firms' funding costs, while bank lending rates have decreased somewhat
owing in part to the reductions in the policy interest rate, credit spreads on CP and corporate
bonds remain elevated reflecting strong risk aversion worldwide among investors. As a
result, funding costs of firms as a whole have remained mostly unchanged. With regard to
the amount of funds available, the amount outstanding of CP and corporate bonds issued is
currently substantially less than a year ago due to the deterioration in issuing conditions, and
demand for bank lending is rising sharply due to firms' strong desire for ample liquidity to
hoard in view of increased future uncertainty. Financial institutions, while examining
borrowers' creditworthiness and past business relations with them, have been attentive to
these funding needs. In addition, an increasing number of financial institutions are utilizing
the emergency guarantee scheme introduced by the government to provide lending to small
firms with growing funding needs due to deterioration in their business conditions. Bank
lending, therefore, rose through the end of last year to exceed, in November and December,
the highest year-on-year rate of increase recorded since the publication of such statistics
began.
With stock prices remaining low and economic conditions deteriorating sharply, financial
institutions are becoming increasingly conscious of future rises in credit costs as well as their
capital constraints. This is further worsening the severity of financial institutions' lending
attitudes. Also in the area of trade credits, small firms are facing tighter settlement conditions.
With the tightening of financial conditions and the decline in corporate profits, an increasing
number of firms are indicating that their funding conditions are severe, and are scaling down
their fixed investment plans. In this sense, an adverse feedback loop between economic and
financial activity is starting to operate in Japan.
In addition to the state of the financial crises in the United States and Western Europe and
the degree of recovery in the world economy, the appropriateness of the level of capital held
by Japanese financial institutions will also be important in judging how financial conditions
will change and whether the adverse feedback loop between financial and economic activity
will intensify.
In Japan, bank lending accounts for the majority of corporate funding. Banks also serve an
important role in direct financing, since they underwrite a large proportion of CP and
corporate bonds issued by firms. Therefore, the amount of risk that banks can assume
becomes an important issue. In other words, given that banks' capacity to take on risk is
determined by the level of capital they hold, whether that level is sufficient has an important
bearing on developments in corporate financing.
This could be conceptually summarized as follows. Even if the business condition of banks
deteriorates and losses expand, the financial intermediary function of banks will not be
harmed as long as losses can be sufficiently absorbed by capital. In other words, capital
serves as a buffer in the financial intermediary function. If, however, the ratio of losses to
capital exceeds a certain critical point, there is a possibility that the financial intermediary
function will become significantly impaired; in other words, the relationship between the scale
of capital and the financial intermediary function is nonlinear. This was observed after the
economic bubble burst in Japan. For several years, the workings of the financial intermediary
function did not become an issue, although increases in nonperforming loans were
recognized as a big problem. However, in the latter half of the 1990s, a credit crunch
materialized where lending could not be increased due to capital constraints.
With regard to the current situation of the financial system in Japan, the level of capital held
by financial institutions, or their capital strength, remains adequate on the whole. This is very
different from the situation in the United States and Western Europe, where large-scale
capital injection of public funds into a wide range of financial institutions became necessary.
Also, the situation in Japan is currently quite different from that in a credit crunch, where
financial intermediation becomes largely dysfunctional. Having said this, global financial
markets still remain under significant strain and this is gradually affecting Japanese financial
institutions as well as their financial intermediary function through declines in stock prices
and increases in credit costs, although the degree may differ with the institution. This
reinforces the argument for strengthening the capital base of financial institutions and is the
background against which an institutional framework embodied in the Act on Special
Measures for Strengthening Financial Functions is being prepared. The Bank will be closely
monitoring the capital conditions of financial institutions and developments in the financial
intermediary function.
III. Outlook for Japan's economy
I will now turn to the outlook for Japan's economy. As I said earlier, economic conditions in
Japan have deteriorated significantly due to a substantial decrease in exports, reflecting a
slowdown in overseas economies and the resultant adverse effects on domestic demand,
and also to tighter financial conditions, and they are likely to continue deteriorating for the
time being.
Uncertainty about the prospects for Japan's economy continues to be extremely high, but the
Bank's baseline scenario is that the economy will start recovering as global financial markets
regain stability and overseas economies move out of their deceleration phase. The timing of
recovery, however, is likely to be no sooner than the latter half of fiscal 2009. Based on the
interim assessment made at the MPM held on January 21 and 22, 2009, the growth rate of
real GDP on a fiscal-year basis is projected to be negative for two consecutive years,
recording minus 1.8 percent in fiscal 2008 and minus 2.0 percent in fiscal 2009. The growth
rate is unlikely to recover to its potential until fiscal 2010.
The outlook for Japan's economy relies heavily on the recovery of overseas economies, the
stability of global financial markets, firms' medium- to long-term growth expectations, and
financial conditions in Japan. Depending on developments in financial conditions worldwide,
overseas economies, medium- to long-term inflation expectations, or Japanese financial
conditions, growth rates may turn out lower than expected.
With regard to inflation, the consumer price index (CPI) inflation rate, which had been around
0 percent since around 2003, rose at a rapid pace from around the end of 2007 reflecting
increases in the prices of petroleum products and food due to the surge in commodity prices,
and reached 2.4 percent last summer. Thereafter, it began to decline at a rapid pace
reflecting a significant drop in commodity prices, and recorded 1.0 percent in November
2008. Looking ahead, it is expected to continue its sharp downtrend and turn negative due to
increasing slackness in domestic supply and demand conditions in addition to the declines in
the prices of petroleum products and the stabilization of food prices. The CPI inflation rate is
projected to record a decline of around 1 percent in fiscal 2009. Thereafter, the rate of
decline is expected to diminish gradually through fiscal 2010 as the economy returns to a
sustainable growth path.
Given that the CPI inflation rate will likely remain negative through fiscal 2010, one question
that may be raised is whether this decline in prices will lead to a deflationary spiral - a
situation in which a decline in prices induces a further decline, thereby accelerating the pace
of decline and at the same time adversely affecting economic activity. If households expect
wide-ranging price declines, they will reduce consumption, and this in turn will accelerate the
decrease in demand. If firms expect their competitors to reduce prices on a broad range of
products, they have no choice but to reduce their prices, and this may decrease firms'
profitability further. However, the most important factor in assessing whether a deflationary
spiral will materialize is not the short-term inflation expectations, which have been affected by
the rapid changes in commodity prices, but developments in the medium- to long-term
inflation expectations of households and firms. During the last twelve months, they have
remained mostly unchanged, little affected by last year's rise or the recent rapid decline in
the inflation rate. If the inflation rate remains negative for a protracted period, however, there
is a risk of a gradual decline in medium- to long-term inflation expectations. Future
developments in medium- to long-term inflation expectations should therefore continue to be
monitored closely.
IV. Conduct of monetary policy
Next, I will talk about the Bank's conduct of monetary policy.
As I said earlier, economic conditions in Japan have deteriorated significantly. In response to
the economic situation and its weaker prospects, the Bank reduced its policy interest rate to
0.3 percent from 0.5 percent at the end of October 2008, and reduced it again to 0.1 percent
in December. To produce maximal effects of reductions in the policy interest rate, it is a
necessary precondition that markets function in a stable and smooth manner. From this
viewpoint, the Bank has been taking various policy actions. The first is to ensure stability in
money markets by providing liquidity. In addition to the substantial provision of liquidity in
yen, the Bank has been providing liquidity in U.S. dollars without limitation on the amount, as
long as it is within the value of collateral, under an internationally coordinated framework.
Furthermore, in December 2008 the Bank increased its outright purchases of Japanese
government bonds (JGBs) from 14.4 trillion yen per year to 16.8 trillion yen per year. In order
to supply funds more smoothly, provision of longer-term funds is desirable rather than
providing short-term funds through frequent operations. Hence, the Bank decided to increase
its outright purchases of JGBs, which provide longer-term funds.
The second policy action comprises measures to facilitate corporate financing. Since last fall,
when financial conditions began to tighten, the Bank has been taking various measures with
a view to making it easier for firms to obtain funds.
The Bank has for some time been conducting purchases of CP under repurchase
agreements, and these have been significantly increased in terms of frequency and size to
support the better functioning of the CP market. In addition, with a view to facilitating
corporate financing during the run-up to the calendar and fiscal year-ends, the range of
corporate bonds and loans on deeds accepted as eligible collateral was expanded in early
December 2008 and it was decided, as a temporary measure, to include BBB-rated
corporate bonds and loans on deeds in eligible collateral. Furthermore, a decision was made
to introduce a special operation to facilitate corporate financing, starting in early January.
This special operation enables financial institutions to obtain funds over the fiscal year-end
with no explicit ceiling on the total funds available, although the maximum loan available to
an individual financial institution will not exceed the value of the corporate debt it has pledged
as collateral. In addition, the interest rate on these funds is set lower than the corresponding
market interest rates. With these measures, the Bank is aiming to support, in terms of the
availability and cost of funds, the lending activity of financial institutions and transactions on
the CP and corporate bond markets.
In addition, given that the environment surrounding corporate financing had deteriorated and
the tightness in corporate financing might increase further during the run-up to the end of the
fiscal year, the Bank decided, in mid-December 2008, to introduce outright purchases of CP
from financial institutions, and to investigate additional measures. However, since these
measures involve taking on the credit risks of individual firms, they represent an exceptional
step for a central bank, and when taking such a step, a central bank should of course
implement measures that have maximal effects in terms of facilitating corporate financing. At
the same time, however, it should also consider possible actions to be taken should losses
occur, so that the Bank's financial health and confidence in the currency and in monetary
policy are not impaired. After close investigation of the present environment surrounding
corporate financing and careful examination of the range of CP to be accepted under this
exceptional measure and the measure's duration, the Bank decided, at the MPM held on
January 21 and 22, 2009, to introduce outright purchases of CP and asset-backed CP
(ABCP) for a total outstanding amount not exceeding 3 trillion yen until the end of March
2009. If the Bank purchases CP from financial institutions, this gives them additional capacity
to accept more CP, which would improve the functioning of the CP market, or to increase
lending, including that to small firms. The underlying assets of ABCP are mainly credit
receivables, loans, and bills, and the Bank's outright purchases of ABCP are therefore
expected to contribute to facilitating corporate financing, especially among small firms. The
Bank also decided to accept, when providing funds to financial institutions, bonds, such as
J-REIT bonds, issued by real estate investment corporations as collateral. Through this
measure, the Bank expects the market liquidity of these products to increase, leading to
better functioning of the real estate securitization market.
In addition to the measures just described, the Bank decided to examine practical ways to
introduce outright purchases of corporate bonds. Corporate bonds are debts with longer
maturities than CP, and thus outright purchases by a central bank involve taking on the credit
risks of individual firms for a longer term than in the case of CP. In order to prevent outright
purchases of corporate bonds from adversely affecting long-term resource allocation in
individual firms and avoid prolonging markets' dependence on the central bank as a buyer, a
central bank should only purchase corporate bonds with a short residual maturity and
purchase them from financial institutions that are counterparties of the central bank instead
of purchasing directly from the issuers. Bearing these factors in mind, the Bank intends to
purchase corporate bonds with a residual maturity of up to one year, and will decide on the
specifics of this measure as swiftly as possible after careful examination.
As I mentioned earlier, to deal with increasing demand for funds during the run-up to the
calendar and fiscal year-ends, the Bank has been providing substantial liquidity to stabilize
financial markets. And to deal with tighter conditions in corporate financing, the Bank
implemented various measures, including the introduction of a new operation, to facilitate
corporate funding, and to exert influence upon the formation of longer-term interest rates,
which are the actual interest rates that apply when funds are acquired. The Bank will
continue to carefully assess economic and financial conditions and do its utmost as a central
bank by introducing the monetary policy measures that it judges most effective.
Closing remarks: toward a new path of growth for Japan's economy
You may have the impression that newspaper articles and television news and even my
speech today communicate nothing but the severity of the current economic and financial
conditions. In a situation like the current one, where changes in global financial markets and
in overseas economies come flooding in all at once like tidal waves, one tends to lose sight
of the broad picture and focus only on recent events. In closing, therefore, I would like to give
my brief overview of the current situation.
As I mentioned at the beginning of my speech, innovation in information and communications
technology made great strides from the latter half of the 20th century through the early 21st
century, and globalization progressed based on the rapid entry of a growing number of
emerging economies into the world of market economies made possible by these advances.
As a result, the supply of goods increased due to the added production in regions newly
integrated in the world of market economies, and at the same time, economic development in
these regions increased demand for goods and financial assets. This generated increased
business opportunities in the markets for goods and financial assets, and accelerated the
growth of the world economy. However, such an environment is likely to invite an
accumulation of various excesses and imbalances. Thus, the situation we are currently
facing can be explained as a sudden reversal of a rapid growth process that depended
heavily on excesses and imbalances.
Looking back, while overseas economies had been increasing their growth rates by taking
advantage of globalization, Japan's economy was still suffering from the aftereffects of the
bubble economy of the 1980s. Japanese industries, with the exception of exporting
industries, were not able to benefit from the growth mechanism based on the progress of
globalization. This means, however, that excesses and imbalances inherent in Japan's
economy are small relative to those of the economies that fully enjoyed the benefits of
globalization, and they require only moderate adjustments. If Japan can redefine its area of
comparative advantage and implement measures to strengthen these areas, Japan's
economy is likely to show its true worth when overseas economies return to a recovery path.
There are two requirements for this to be realized. First, Japan should protect and strengthen
the areas where it has an advantage. Japan has an edge in manufacturing in a broad sense,
especially where coordination is necessary. For example, in the process of producing an
automobile, parts makers and the assembler discuss various ideas and techniques to make
improvements. The quality of the final product is thus improved and at the same time
productivity is increased to reduce costs. Demanding that parts makers reduce costs without
providing any support in increasing productivity would just be forcing them to bear an
additional burden. This is not the way Japanese manufacturers increase the value of
products. Increasing the value of products is important in non-manufacturing industries too.
For example, I was informed by a retailer that, with a slight change of focus in its sales
strategy, it came up with the idea of selling goods that were easy for the elderly to use and
that these became big sellers. This made me realize the importance of going back to the
basic idea that value is created by a continuous accumulation of improvements. I believe that
such strenuous efforts will be rewarded when the world economy returns to a recovery path.
Second, Japan should directly confront and tackle current problems. Although the problems
are numerous, it can be said that this is due to the fact that Japan is one of the world's
leading economies. Solving the problems will bring about technological innovation that will
give Japan's manufacturing industry a more prominent place in the world economy. Japan
has an aging population, and there must be a need for innovative new products that turn this
to advantage, such as automobiles with increased safety so that the elderly, with decreased
physical functioning, can drive them safely and easily. Japan also faces environmental
problems such as global warming as well as water and air pollution. Technological innovation
that contributes to solving these problems will definitely help to increase Japanese firms'
competitiveness.
Tochigi Prefecture has a history of achievement in manufacturing, and the prefecture's
strength in manufacturing has been supporting an expansion into a wide range of fields.
Many firms in the prefecture have the top market share in Japan in technologically advanced
products, for example, medical and optical equipment, and I am aware of efforts to further
develop and strengthen these fields through cooperation between industry, government, and
academia. I hope that these efforts will bear fruit, and lead to a recovery of Japan's economy
and positive new developments in the future.
The Bank is determined to support these movements through appropriate conduct of
monetary policy.
Thank you very much for your kind attention.