Sayuri Shirai: Monetary policy and forward guidance in Japan
Speech by Ms Sayuri Shirai, Member of the Policy Board of the Bank of Japan, at the
International Monetary Fund, Washington DC, 19 September 2013, and at the Board of
Governors of the Federal Reserve System, Washington DC, 20 September 2013.
* * *
I. Introduction
It is a great honor to have this opportunity to address you today on Japan's economy and its
monetary policy. Since April 2013, when the Bank of Japan introduced quantitative and
qualitative monetary easing (QQE) that further strengthened existing monetary easing, nearly
six months have passed. In these six months, a number of positive outcomes have
materialized: these also reflect stimulus measures taken by the Japanese government.
Compared with last year, stock prices have been higher; more active transactions are taking
place in the financial and real estate sectors; the yen's exchange rate has been at more
depreciated levels; and funding costs for firms and households in the loan and bond markets
remain very accommodative.
Most importantly, the growth momentum of Japan's economy is gaining traction - this is
evidenced by the positive economic growth rates seen in the last three consecutive quarters
(with an annualized real GDP growth rate of 3.8 percent in the second quarter of 2013). The
unemployment rate dropped to 3.8 percent in July 2013, approaching the lowest level in
recent years of 3.6 percent recorded in July 2007, before the financial crisis. There are some
signs of the economy moving out of deflation with the year-on-year rate of change in the
consumer price index (CPI) for all items less fresh food, or the core CPI, turning positive at
0.4 percent in June and 0.7 percent in July.
Given the amount of global media attention being paid to QQE, it appears that its content is
becoming increasingly familiar to many experts and market participants. For this reason, I
would rather talk today about QQE from a somewhat different perspective, namely from the
standpoint of "forward guidance" - a topic that has been hotly debated globally in recent
years. In general, forward guidance refers to communication strategy undertaken by a central
bank to provide information to the markets and the public (households and firms) on its future
monetary policy stance. Forward guidance is currently used by some central banks in
advanced economies facing the zero lower bound on short-term interest rates (hereafter
called the zero lower bound) as an accommodative monetary policy.
I will begin my speech by explaining why forward guidance is important for Japan in Section
II. Section III will focus on general issues related to forward guidance. I will then give my
viewpoint on the current practice of monetary policy as adopted by the Bank, compare it with
previous monetary policy practices, and highlight some of the ways the practice differs in
Japan compared with other economies. Section IV will review QQE progress to date through
an overview of current price performance and its outlook, followed by an overview of
economic activity.
II. Why is forward guidance so important for Japan?
I want to first address the question of why forward guidance is so important for Japan. As you
know, the Bank is attempting to overcome the mild deflation that has lasted in Japan for
nearly 15 years since 1998 and to achieve the 2 percent price stability target adopted in
January 2013. The rate of price changes since 1998 is averaged at minus 0.3 percent.
Before proceeding with my speech, let me pause here for a moment. I would like to bring up
a question that I often encounter abroad. That is What is the problem with having mild
deflation in Japan when the unemployment rate has remained so low even throughout the
global financial crisis?
Long-standing mild deflation
It is a legitimate question. It is true that Japan's unemployment rate has been much lower
than that of other economies: the highest level it reached so far during the global financial
crisis was only 5.5 percent in July 2009. Certainly, deflation is persistent, but it is mild and
has avoided a deflationary spiral. On the surface, therefore, it may be difficult to comprehend
Japan's fundamental problems.
My response is normally provided as follows. Mild deflation has been exerting adverse
effects on Japan's economy because it reflects a long-standing negative output gap (chronic
demand shortage), low expectations of future economic and market growth by firms, as well
as sluggish expectations of future income growth by households (Chart 1). Deflation is also
closely associated with the long-term yen appreciation trend that adds to the pessimism of
firms already struggling to maintain price competitiveness. These phenomena - together with
a decline in total population, the rapid pace of aging of the population, and the slow pace of
structural reforms - have discouraged firms from actively engaging in business fixed
investment and innovative activities, have led to households saving more because of growing
concerns about the future, and have prompted financial institutions to undertake risk-averse
investment strategies.
In this environment, households take the lower prices of goods and services for granted as
they develop a deflation-oriented mindset and thus believe that prices will not increase. In
addition, firms follow a deflation-oriented pricing behavior and hence use the sales prices of
their rivals and the purchasing behavior of customers to set their prices, even when the
supply-demand balance improves. Moreover, financial institutions become increasingly
deflation-oriented investment strategies,
accustomed to and shift their investments from risk
assets (such as stocks, corporate bonds, mutual funds, loans, real estate, and foreign
securities) to safer assets (such as Japanese government bonds [JGBs], deposits, and
cash).
Why was the 2 percent target adopted?
As I mentioned earlier, in January of this year the Bank established a target of 2 percent to
achieve price stability. I would like to explain here why this course was decided on. In
essence, Japan's economy had been quite depressed and gradually eroding for some time.
Given this background the reason for setting the 2 percent target, in my view, is the belief
that deflation is more harmful to an economy than inflation, and that it is important to achieve
a comparable level of (mild) inflation to that of major advanced economies.1 The Bank's aim
of achieving the 2 percent price stability target is particularly challenging. It implies that the
medium- to long-term inflation expectations of both the markets and the public need to be
increased and anchored at around the 2 percent level. No other major economies have ever
had to face such an undertaking. In more formal economic terms, the important point is that
by raising inflation expectations toward 2 percent, the Phillips curve shifts upward and its
slope steepens, thereby enhancing the responsiveness of price changes to the
supplydemand balance (Chart 2).
Forward guidance used for anchoring inflation expectations
I stress that "forward guidance" is essential to anchor inflation expectations, particularly in the
case of Japan, with its requirement to firmly establish 2 percent medium- to long-term
inflation expectations in the minds of the markets and the public. We should note here that
the Bank needs to undertake an accommodative monetary policy with two main aims:
(1) achieving economic recovery, and (2) anchoring inflation expectations at the target level.
Contrast this with the situation of other economies' central banks. Their inflation expectations
are already well-anchored at the target level of inflation, and thus, their primary aim is
achieving economic recovery (see Section III). In Japan, the second aim of anchoring
inflation expectations requires the Bank to first help transform the deflation-oriented behavior
of all entities and then to steadily raise their inflation expectations. In this context, the Bank's
task can be considered more challenging than in other economies, and its forward guidance
operates under different circumstances. It needs to particularly target price movements and
have a stronger commitment regarding monetary easing policies.
III. General issues on forward guidance and its implementation in Japan
Forward guidance is now a popular topic among the central banks of advanced economies;
however, it has been practiced in Japan for some time. Indeed, the Bank was the pioneer in
using forward guidance as an accommodative monetary policy tool in the face of the zero
lower bound, initiating the practice as early as 1999 when the zero interest rate policy was
adopted (Chart 3). Since then, the Bank has come up with various forms of forward guidance
at each monetary easing period, as I will later discuss. Moreover, since the onset of the
global financial crisis, forward guidance has attracted global attention mainly as a result of its
active use by the Federal Reserve under the zero lower bound. It has also recently been
implemented as a tool by the European Central Bank (ECB) and the Bank of England (BOE),
which is discussed in the Appendix to my speech.
A. General issues relating to forward guidance
The term "forward guidance" is now frequently used by a number of central banks and
experts but it appears to have different meanings under different contexts. For clarity here, I
assume that forward guidance simply refers to the provision of information by a central bank
about future monetary policy to the markets and the public, regardless of whether or not the
central bank calls it forward guidance. For example, the Bank does not officially use the term
"forward guidance" to describe its communication strategy, but it could be regarded as such.
Essentially, forward guidance is aimed at enhancing the effectiveness of monetary policy. It
can be classified into two types depending on the objective. The first objective is to clarify a
normal monetary policy reaction function (or the conduct of normal monetary policy)
envisaged by a central bank. By contrast, the second objective commits to the continuation
of a more accommodative policy under the zero lower bound than would otherwise have
been anticipated with the normal policy reaction function. I will further explain these
objectives shortly, but one difference between them is that the impacts on financial markets
- such as generating downward pressure on long-term interest rates (and raising asset
prices) - are not necessarily intentional and present in the case of the first objective, but are
always deliberately pursued as a result of the unconventional monetary policy tool in the
case of the second objective. While forward guidance has attracted recent attention for the
role it takes in formulating exit strategies from monetary accommodation, as is the case in
the United States, my speech today focuses instead on its role in introducing and maintaining
a monetary stimulus.
Forward guidance to clarify a normal monetary policy stance
Forward guidance with the first objective may be regarded as communication strategy by a
central bank to inform the markets and the public about the normal policy reaction function of
the monetary policy (such as the Taylor rule). This can be classified as "Delphic forward
guidance" according to Campbell et al. (2012).2 Forward guidance in this instance can take
the form of (1) indirect signals about a future monetary policy stance (for example, about a
future policy interest rate path) through publishing comments and projections on the outlook
for prices and economic activity with risk balance assessments, or it can take the form of
(2) direct signals through releasing the future policy interest rate numerical projections. In
any case, the future policy stance of a central bank is a forecast based on the currently
available information and the normal reaction function. This forecast is updated as new
information becomes available. The important point here is that the central bank makes no
commitment on its future monetary policy.
Generally, this type of guidance is used to enhance transparency and predictability for the
markets and the public, so it does not necessarily affect financial markets. Nonetheless,
there are some cases where this guidance may favorably influence financial markets. An
example of this would be a case where forward guidance results in a clearer understanding
by the markets and the public of a central bank's policy reaction function. They thus adjust
their expectations accordingly, even if the central bank's monetary policy stance is constant.
There may also be cases where their better understanding contributes to lowering the degree
of uncertainty, and may result in, for example, reducing the volatility of the bond market and
term premiums. Finally, there may be instances where the markets and the public believe
that a central bank has superior information that can be used for assessing future prices and
economic activity.
Forward guidance used to signal a more accommodative policy stance
The second objective of forward guidance is to signal a more accommodative policy stance.
In this instance, it is used as communication strategy for a central bank at the zero lower
bound and also as a deliberate additional monetary easing measure, by shifting from the
et al.
normal policy reaction function. Campbell refer to this type of guidance as "Odyssean
forward guidance." Here the central bank commits to a longer duration of accommodative
monetary policy than is generally anticipated by the markets and the public. This commitment
to a longer accommodative monetary policy is needed to compensate for the period
constrained by the zero lower bound. There has been gradual accumulation of theoretical
and empirical analyses on this perspective in the last decade.3 Its most extreme form is an
"unconditional commitment" to continue the current monetary easing policy in the future. In
other words, a central bank will maintain its already-promised accommodative stance even
after economic recovery strengthens and whatever shocks take place in the future.
The lower the degree of conditionality, the more effective monetary policy is. However, there
is a trade-off between greater effectiveness and higher flexibility regarding the conduct of
future monetary policy. In practice, it is not realistic for a central bank to make an extreme
unconditional commitment because of the time-inconsistency issues. It is difficult for a central
bank to commit to a current accommodative monetary policy in the long term without taking
any consideration of the fact that an excessive rise in inflation may dis-anchor medium- to
long-term inflation expectations. A similar concern is often raised in relation to the impacts on
excessive financial instability and asset price bubbles when a policy of low interest rates is
sustained for too long. Therefore, "conditional commitment" or the use of expressions that
reduces the degree of commitment is a form generally undertaken by central banks.
Open-ended, calendar-based, and state-contingent forward guidance
Forward guidance can take various forms. For example, it can be applied solely to the policy
interest rate or to a broader set of monetary stimulus measures including the policy rate and
asset purchases. It can be categorized as open-ended, calendar-based, or state-contingent
(or threshold-based).4 Open-ended guidance can refer to an abstract description of the
monetary easing policy duration (such as "a considerable period" or "an extended period") or
of the economic conditions under which the accommodative policy will be maintained (such
as "until deflationary concerns are dispelled"). Calendar-based guidance uses specific date
expressions for monetary easing, such as "over the next six months." Some people consider
that calendar-based forward guidance is superior to open-ended forward guidance from a
transparency and effectiveness perspective.
State-contingent guidance provides a clear description of the economic conditions under
which the accommodative policy will be maintained by using, for example, a threshold on the
inflation outlook. When comparing calendar-based and state-contingent forward guidance,
the state-contingent approach is regarded as being superior for two reasons. First, it provides
assurance of a central bank's intention to maintain its accommodative monetary policy even
after economic recovery strengthens by introducing such specific expressions in the
guidance. Second, a clear description of the relationship between the conduct of future
monetary policy and the economic conditions contributes to enhancing transparency and
predictability in the eyes of the markets and the public. The major drawback of the
calendarbased approach is the difficulty in distinguishing whether an extension of the period for
maintaining the current accommodative monetary policy is, for example, (1) the result of
more pessimistic forecasts by a central bank on prices and economic activity or (2) the result
of a more accommodative policy. The former may discourage aggregate demand while the
latter may promote aggregate demand. The state-contingent approach may help to
distinguish between these two cases.
In relation to economic conditions (or thresholds), forward guidance can focus solely on
prices or can include a wide set of economic variables (e.g., the unemployment rate). The
different forms here reflect (1) the presence of other mandates given to the central bank,
such as the dual mandate in the case of the Federal Reserve; (2) the specific environment
surrounding monetary policy at the time (e.g., whether current inflation trends are above or
below the inflation target); and (3) the detailed measures adopted (e.g., policy interest rate,
asset purchases, or a combination of both). The most important point I wish to highlight here
is that the degree of details contained in the description of forward guidance can vary over
time. It can be refined over time as economic recovery becomes firm, by giving more specific
information about the duration of monetary accommodation or the economic conditions.
B. Forward guidance in Japan
Let me now focus on forward guidance in Japan. The Bank has a long history of practicing
communication strategy to generate monetary easing under the zero lower bound. There are
a number of empirical analyses pointing to the effectiveness of this policy in Japan,
particularly in regard to the impacts on financial markets.5 Forward guidance also constitutes
an important element of QQE. I will first explain the forward guidance used under the current
QQE, then provide my personal views on the rationale for its structure, followed by a
comparison with past measures and other countries' experiences.
Forward Guidance under the Current QQE
The Bank released a statement on April 4, 2013, with the introduction of QQE, containing the
following two descriptions regarding the time span of monetary accommodation:
(1) The Bank will achieve the price stability target of 2 percent . . . at the earliest possible
time, with a time horizon of about two years (I will call this "the first set of forward
guidance").
(2) The Bank will continue 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. It will examine both
upside and downside risks to economic activity and prices, and make adjustments as
appropriate (I will call this
"the second set of forward guidance").
You might wonder what the relationship between these two descriptions is. In answer to this,
Bank of Japan Governor Haruhiko Kuroda explained in his speech on April 12, 2013, that
QQE included all the necessary measures to achieve the 2 percent target with a time horizon
of approximately two years. He stressed, however, that because there is uncertainty in any
economy and there is always a degree of latitude in people's expectations, it was appropriate
to state that the Bank would continue with monetary easing as long as it was necessary to
achieve the 2 percent target in a stable manner so that everyone was convinced that
sufficient monetary easing would be implemented. Thus, these two descriptions are closely
connected to reinforce the credibility of the Bank's commitment to achieving its stated target.
I would like to further elaborate on this with my personal view, which does not necessarily
reflect the consensus among the Bank's Policy Board members, focusing on the respective
roles of both parts of the released statement as forward guidance. In essence, this unique
structure of providing two sets of forward guidance is attributable to the Bank's challenging
tasks of transforming the deflationary mindset and of increasing inflation expectations to
anchor around the 2 percent level.
The first set of forward guidance was included in the first part of the released statement and
was positioned as the rationale for introducing "a new phase of monetary easing both in
terms of quantity and quality" (Chart 4). To implement this bold new monetary policy, the
Bank decided to shift the main operating target for money market operations from the
uncollateralized overnight call rate to the monetary base. Decisions were also made to
double the monetary base and the amounts outstanding of JGBs and exchange-traded funds
(ETFs) in two years by end-2014, as well as to more than double the average remaining
maturity of JGB purchases (from less than three years to about seven years). On an annual
basis, the monetary base will be increased by about 60-70 trillion yen, JGBs (including those
with maturities of up to 40 years) by about 50 trillion yen and ETFs by about 1 trillion yen
(Chart 5). In addition, Japan real estate investment trusts (J-REITs) will be purchased at an
annual pace of about 30 billion yen over the same period.6
The purpose of this first set of forward guidance was to signal to the markets and the public
the Bank's strong determination to achieve its 2 percent target within a time horizon of about
two years, normally pursued by other central banks under the inflation targeting framework.
The guidance combines both calendar-based (i.e., about two years) and state-contingent
(i.e., 2 percent) features. The calendar-based feature was considered to be essential to gain
the confidence of the markets and the public in both the Bank's intention and the possibility
of achieving 2 percent at the earliest possible time. An improvement in confidence may
accelerate the pace of increasing the medium- to long-term inflation expectations and may
enhance the responsiveness of price changes to the supply-demand balance.
The second set of forward guidance was placed under the subheading "the continuation of
QQE" in the mid part of the statement. It is a conditional commitment, because the
continuation of monetary easing is subject to the examination of upside and downside risk
factors (Chart 4). It is also a state-contingent one, linking to the continuation of QQE, and
plays a greater role than the first set of forward guidance in stabilizing medium- to long-term
inflation expectations at around 2 percent.
As a related issue, the expression "in a stable manner" described in the Bank's second set of
forward guidance may give the impression of a broad description of the conditions. However,
I view this expression to be appropriate at present, because the formation of medium- to
long-term inflation expectations entails uncertainty. In my opinion, this is especially true when
the Bank attempts to raise inflation expectations and subjective judgment by the Policy Board
members is unavoidable on whether medium- to long-term inflation expectations will be
stabilized at around 2 percent, and when. Additionally, there is no example in other countries
where central banks raised inflation expectations, for the Bank to use as a reference. Some
measurement constraints also exist, including the fact that (1) there are no precise indicators
measuring the inflation expectations of households and firms; (2) statistical bias is included in
some survey data - for example, households' inflation expectations tend to be
upwardbiased in Japan, while the diffusion index (DI) for expected sales prices in the Tankan
(ShortTerm Economic Survey of Enterprises in Japan) tends to be downward-biased; (3) in terms
of market-based indicators, the impact of the Bank's JGB purchases needs to be taken into
account; and (4) the breakeven inflation rate (BEI) indicator also reflects the differences in
liquidity between fixed-rate and inflation-indexed bonds.
Nevertheless, as prices and economic activity firmly improve and as the process of
increasing inflation expectations becomes clearer, I personally feel that, in the longer-term
view points, there may be an opportunity to refine the second set of guidance with more
specific information.
These two sets of forward guidance are not mutually exclusive, as the first set of guidance
can be considered as the "necessary condition" for achieving the second, whereas the
second set of forward guidance shows a strong commitment to continue QQE for as long as
necessary to stably achieve the 2 percent target (Chart 4). Therefore, while the time horizon
of these two sets of guidance overlaps, the second set of guidance may imply a somewhat
longer time horizon. In addition, the second set of guidance plays an essential role in
reducing volatility of long-term interest rates, and in preventing them from overshooting.
In my view, this second set of guidance warrants any necessary actions by the Bank beyond
the two-year horizon, if it judges it necessary to do so in light of stably achieving 2 percent. It
also suggests that the Bank will not consider an exit from monetary easing before this
statecontingent guidance is achieved.
Is the bank's forward guidance open-ended?
The BOE referred to the Bank of Japan's second set of forward guidance under QQE as
"open-ended" in its report released August 2013.7 Based on my earlier arguments, this
classification is not consistent with my assessment, although I fully respect the BOE's
judgment and analysis. When the two sets of forward guidance are viewed together, my
opinion is that the Bank's forward guidance is multi-layered, largely state-contingent, and
focuses on the 2 percent price stability target with a strong (conditional) commitment. The
BOE's conclusion may have been drawn from the fact that only the second set of forward
guidance was referred to in the Bank of Japan's April 2013 statement under the subheading
"The continuation of QQE" and that the expression "in a stable manner" may have appeared
qualitative and vague. However, as described above, I feel that the expression "in a stable
manner" is appropriate considering the circumstances.
C. Clearer and stronger commitments compared with past practices
The forward guidance used by the Bank for the current QQE reflects clearer and stronger
commitments compared with previous guidance. In the past, the Bank adopted forward
guidance at each period of monetary easing: (1) the zero interest rate policy (February 1999-
quantitative easing policy
August 2000); (2) the (March 2001-March 2006); and
(3) comprehensive monetary easing (October 2010-March 2013), as summarized in
Charts 6 and 7.
First round of forward guidance: 1999-2000
The first round of forward guidance adopted in 1999 was transmitted to the markets and the
public in the form of a declaration - rather than a statement - by the then Bank of Japan
Governor Masaru Hayami, at a press conference in April 1999, two months after the adoption
of the zero interest rate policy. He indicated that he thinks the Bank will maintain the zero
interest rate policy until deflationary concerns are dispelled. This could be classified as
openended forward guidance, linking to the continuation of the zero interest rate policy.
However, it has been pointed out that the expression "deflationary concerns" was vague
without providing any clear definition of deflation. As a result, this allowed for a wide range of
interpretations of and judgments on the exit timing, thereby making it difficult for Policy Board
members to make a collective judgment and for the markets and the public to be adequately
convinced. For example, while industrial production and exports did improve, the rate of
change in the (headline and core) CPI remained negative. Nonetheless, the Bank terminated
this policy in August 2000 and raised the uncollateralized overnight call rate to an average of
around 0.25 percent, claiming that downward pressure on prices stemming from weak
demand had markedly receded. A number of external commentators have expressed the
view that the exit timing was too early.
Second round of forward guidance: 2001-2006
The second round of forward guidance was adopted when the quantitative easing policy was
initiated in March 2001, after the policy rate was lowered to an average of around
0.15 percent in the previous month. Under the policy framework, the Bank shifted the main
operating target for money market operations from the uncollateralized overnight call rate to
the current account balances held by financial institutions at the Bank. The target amount of
the balances was raised nine times from the initial 5 trillion yen (which was higher than the
required reserve level of 4 trillion yen) to approximately 30-35 trillion yen in January 2004.
The reserve targeting was achieved mainly through relatively short-term money market
operations with some purchases of long-term JGBs. The Bank decided that the economic
conditions warranted drastic monetary easing. It issued a statement in March 2001 stating
that monetary easing would continue to be in place until the core CPI registers stably zero
percent or an increase year on year. This was state-contingent guidance, linking to the
continuation of the quantitative easing policy. It should be noted that the economic condition
actual
used in the guidance was based on the performance of the core CPI and was thus
clearer than in the earlier zero interest rate policy case.
In October 2003, the Bank provided further detailed information on the expression "stably
zero percent or an increase" to clarify its commitment for continuing the quantitative easing
policy. It refined the expression so that (1) not only that the most recently published core
CPI should register zero percent or above, but also that such tendency should be
and (2) the prospective
confirmed over a few months, core CPI will not be expected to
register below zero percent. These conditions were regarded as necessary to terminate
the quantitative easing policy, and it was assumed that there might be cases where
quantitative easing would be continued even if these conditions were fulfilled. This refined
state-contingent guidance applied economic conditions based on both actual and projected
price performance.
In this circumstance, the core CPI growth rate turned positive in November 2005 (that of the
headline CPI turned positive in January 2006). Judging that all the conditions were fulfilled,
the Bank terminated the policy in March 2006 by reintroducing the uncollateralized overnight
call rate as a money market operations operating target (initially at effectively zero percent).
However, these CPI figures were retroactively revised downward and the previously positive
figures fell into negative territory in August 2006, when the CPI base year was shifted from
2000 to 2005. The scale of the downward revision was greater than in previous cases and
was thus larger than projected. Partly because of this downward revision, there were a
number of external views that the exit timing was too early.
Third round of forward guidance: 2010-March 2013
The third round of forward guidance was adopted in October 2010, when comprehensive
monetary easing was introduced through a virtually zero interest rate policy and the Asset
Purchase Program (hereafter the Program). The type of assets purchased under the
Program covered JGBs (with remaining maturity from one to three years), treasury discount
bills (T-Bills), CP, corporate bonds, ETFs, and J-REITs. The total amount outstanding of the
Program was increased gradually from an initial 35 trillion yen to 65 trillion yen at the end of
2012. The amount was scheduled to further expand to 101 trillion yen by the end of 2013 and
to 111 trillion yen by the end of 2014. Thereafter, the amount of 111 trillion yen was to be
maintained for an undefined period of time. The forward guidance statement indicated that
will maintain the virtually zero interest ra