Masaaki Shirakawa: Toward stronger growth - challenges facing Japan's
economy
Speech by Mr Masaaki Shirakawa, Governor of the Bank of Japan, at a meeting held by the
Yomiuri International Economic Society, Tokyo, 6 September 2012.
* * *
Introduction
It is a great honor to be invited to this meeting hosted by the Yomiuri International Economic
Society today.
Both the global economy and Japan's economy currently face mounting challenges. Looking
back, it has already been six years since U.S. housing prices peaked, five years since the
subprime mortgage problem surfaced in the form of what has come to be known as the
Paribas shock, and about four years since the Lehman shock. Thanks to aggressive policy
implementation by authorities and other measures following the Lehman shock, the global
economy succeeded in avoiding a downturn as significant as the Great Depression in the
1930s. Nevertheless, the pace of recovery in advanced economies thereafter has remained
very sluggish, unlike anything they have experienced since World War II.
Taking the year 2007 - that is, prior to the Lehman shock - and setting the level of GDP at
100, the current level stands at 113 for the global economy as a whole and 102 for advanced
economies (Chart 1). While these latest figures correspond to those seen in the mid-1990s,
in terms of timing when compared with Japan's post-bubble period, the pace of recovery in
real GDP for the United States and Europe is either comparable to or even worse than that
for Japan in the period leading up to the mid-1990s (Chart 2). Moreover, the emergence of
such a situation, regardless of the advanced economies' highly aggressive policy conduct,
suggests the severity of the situation we face today.
As for fiscal policy in advanced economies, the amount outstanding of government debt has
been increasing substantially against the background of massive fiscal deficit. Turning to
monetary policy, central banks continue to implement extraordinary measures, including the
zero interest rate policy, a commitment to maintaining low interest rates, the significant
expansion of central bank balance sheets, and purchases of risk assets. The long-term
interest rates of advanced economies are at historically low levels. Meanwhile, the
coexistence of the sovereign and financial crises continues in the euro area. These types of
crises used to be widely regarded as phenomena unique to developing or emerging
economies during the post-war period. Such a conventional view, however, has been
overturned.
In retrospect, considering that the period leading up to the mid-2000s had been referred to as
the age of "Great Moderation" for its continued high growth, low inflation, and low interest
rates, times have certainly changed. And now, reflecting on the past quarter-century with a
fresh eye, bubbles and financial crises have been emerging more frequently worldwide over
time, with Japan's economic bubble in the late 1980s, the Asian financial crisis in the late
1990s, and the global financial crisis in the 2000s, to name a few.
Against these backgrounds, historical precedents have been drawing increasing attention as
topics for economic debate in recent years. This trend appears to reflect the growing sense
of awareness that the global economy and financial conditions are in the midst of drastic
changes. If this really were the case for the era we live in, it might be a sign that adopting
historical as well as medium- to long-term perspectives is key to taking appropriate action in
response to problems facing the economy. Time has revealed that the decline in Japan's
economic growth rate over the past two decades is the result of the delay in the post-bubble
disposal of nonperforming loans as well as the delayed responses to rapid globalization and
the aging and declining population. If the gravity of such problems had been recognized at an
earlier stage, allowing for swifter responses, the developments that followed might have
turned out differently from what we find today. The most powerful lesson Japan has learnt in
the past 20 years is that we must act on the basis of medium- to long-term perspectives in
order for the economy to grow at a sustainable pace. In view of this, my address to you today
is entitled "Toward Stronger Growth: Challenges facing Japan's Economy", and this will take
into account medium- to long-term perspectives.
I. Recent developments in Japan's economy
As the starting point of my talk, let me kick off with the recent developments and the outlook
for Japan's economy. In its Monetary Policy Meeting held last month, the Bank of Japan
judged that Japan's economic activity had started picking up moderately as domestic
demand remained firm, mainly supported by reconstruction-related demand, while overseas
economies had not yet emerged from a deceleration phase and overseas demand had been
somewhat weak. The real GDP growth rate was 5.5 percent and 1.4 percent year on year in
the first and second quarter of 2012. Among the G7 economies, Japan registered much
faster growth in the first half of this year. Looking ahead, the economy is expected to return
to a moderate recovery path as domestic demand remains firm and overseas economies
emerge from the deceleration phase. This outlook rests on whether domestic demand
remains firm while overseas economies emerge from the deceleration phase.
As for domestic demand, there are factors on the one hand that will eventually subside, such
as effects stemming from subsidies for purchasing environmentally-friendly cars. On the
other hand, there are factors that are more fundamental to maintaining firmness in domestic
demand, such as creating new business to meet demand associated with the aging of the
population. In terms of reconstruction-related demand, this is not just a matter of repairing
facilities and housing damaged by the earthquake or tsunami, together with the pent-up
demand following the disaster. It is more broad-based and includes the demand associated
with consumers' conscious will to prevent disaster, as well as firms' increased needs for
building disaster prevention centers or business continuity centers and shifting their
resources to renewable sources of power. As such, we would expect firmness in domestic
demand to continue for some time to come, although there is evidence of certain factors that
require attention, such as weak bonuses this summer.
In overseas economies, deceleration has continued for somewhat longer than expected and,
reflecting such developments overseas, exports and industrial production both appear to be
somewhat weak. Against this background, we downgraded our assessment in the Monetary
Policy Meeting last month by saying that "the pick-up in exports has moderated, and the
recent reading on production has been relatively weak". Subsequent readings showed that
real exports and industrial production in July were somewhat weak. On the whole, there is a
wide range of uncertainties about the outlook for the economy. As I recently talked about the
short-term outlook for economic developments, I wish to pick up today on some underlying
factors that are essential to assessing the outlook for economic activity and prices, and to
conducting policy, while taking into account the medium- to long-term perspectives.
There are six topics on which I wish to elaborate: the first is the mechanism of Japan's
economic growth before the Lehman shock; the second is the recent development and
outlook for overseas economies; the third is the growth potential of Japan's economy; the
fourth is deflation; the fifth is a stronger yen; and, the sixth is the fiscal situation in Japan.
After covering all these topics, I will explain the recent conduct of the Bank's monetary policy.
II. Mechanism for economic recovery in Japan before the Lehman shock
Let me start with the first topic - namely, the background explanation of economic recovery
in Japan before the Lehman shock. The reason I chose to open with this topic is that there
are several clues to draw from when formulating a process for generating economic recovery
after the Lehman shock. Looking at the turning points of economic expansion and recession,
as announced by the Cabinet Office, the previous economic recovery started in January
2002 and ended in February 2008. While the average growth rate during these years was not
high, compared with those in the past, the duration of economic expansion lasted six years
and a month, the longest period of economic expansion in the post-war era, longer than the
"Izanagi Boom" (Chart 3). There are three reasons behind this.
The first is that the balance-sheet adjustment, which had weighed on Japan's economy after
the bursting of the bubble, ended. In particular, the completion of resolving excess debts at
the beginning of the 2000s had a non-negligible impact.
The second reason is the long-lasting high economic growth in the global economy (Chart 4).
The average growth rate of the global economy from 2004 to 2007 was 5.0 percent, which
was much higher than the average rate of 3.0 percent in the 1990s. These periods were
often referred to as the "Great Moderation", where inflation remained low. Under such
circumstances, optimism about the economic outlook prevailed around the globe, and a
boom in the real estate market and a rise in durable goods consumption took place in the
United States and Europe. On the financial front, financial institutions increasingly favored
taking risk, and a rapid expansion of leverage - i.e., the accelerated expansion of credit -
occurred. In retrospect, the high economic growth in the global economy during those
periods was largely sustained by the creation of credit bubbles.
The third reason is the increase in exports under a depreciating yen. The yen appreciated
somewhat in the first half of the periods under quantitative easing, but subsequently
depreciated after 2005 - in particular, from 2006, when the quantitative easing was lifted, to
2007 (Chart 5). This reflects active carry trades against the background of continued
extremely low interest rates in Japan, while interest rates started to rise in overseas
economies due to high growth rates. Supported by the continued weaker yen, exports
increased markedly, particularly in the automobile-related area and in capital goods and
equipment (Chart 6).
After the Lehman shock, two out of three factors - namely, high growth in overseas
economies and the yen's depreciation - no longer hold. Setting the level of real GDP in 2007
(i.e., a year before the Lehman shock) at 100 and looking at its development since then, the
present level of Japan's economy is 99. This falls short of the pre-Lehman level. In an
international context, the present level is 97 for Great Britain, 99 for the euro area, and
102 for the United States; hence, Japan stands somewhere in the middle of the advanced
economies (Chart 7). In terms of per capita GDP, the picture is somewhat different. The level
of economic activity falls short of those before the Lehman shock in any country or region.
Amongst all, Japan has registered the smallest decline. Furthermore, in terms of real GDP
per working-age person, only Japan exceeds the level seen before the Lehman shock. This
reflects the effect of the rapid aging of the population, but I will come back to this topic later
on.
III. Overseas economies
Let me now move on to the second topic, i.e., the recent development and outlook for
overseas economies. This is the major factor that could change the course of Japan's
economy. Overseas economies started decelerating since the second half of last year,
mainly due to the European debt problem, and still have not emerged from a deceleration
phase. Accommodative financial conditions are an important factor for sustaining economic
recovery, but there is a wide range of uncertainties, including when those economies might
emerge from the deceleration phase.
Current situation and outlook for the overseas economies
As for the U.S. economy, borrowing the terminology from Chairman Bernanke's recent
speech, there are three "headwinds" that are restraining economic activity. Specifically, these
are the headwinds coming from the housing market, the fiscal situation, and the European
debt problem. Among the three, it is heartening that the adjustment in the housing market is
making progress at a gradual pace, though it still weighs on the economy. Concerning the
fiscal situation, the "fiscal cliff" is a problem; hence, the pace of economic recovery entails a
wide range of uncertainties.
The European economy continued to be stagnant in the midst of the sovereign debt crisis.
After 2010, not only did Greece, Ireland, and Portugal receive support from the EU and the
IMF, but the fiscal problems are now spreading to the larger southern European economies
of Spain and Italy. Yields on government bonds in those countries rose, or, in other words,
bond prices fell. The assets of financial institutions deteriorated, generating instability in their
respective financial systems. As a result, firms' and households' confidence and financial
conditions deteriorated substantially, exerting downward pressure on the real economy. The
slowdown in the real economy and the instability in financial systems created an adverse
feedback loop on the fiscal problem by reducing revenues and increasing the burden of
bailing out financial institutions. As such, Europe currently faces a difficult situation as a
result of the adverse feedback loop among the fiscal situation, the financial system, and
economic activity.
Lastly, as for China, its economy has gone through a somewhat longer deceleration phase.
While there are signs of improvement in domestic demand, such as investment in
infrastructure and real estate sales, we should maintain a vigilant watch on whether it can
make a smooth transition towards a sustainable growth path. In terms of the future for the
Chinese economy, its exports to Europe, which have a large weight, require attention.
Another important issue is the evaluation of rising real income as a result of a number of
policy measures - such as monetary easing, the advanced execution of building
infrastructure, and the stimulus consumption package - as well as declining inflation rates.
From a somewhat long-term perspective, the most important point is whether China would
succeed in making a smooth transition from high economic growth to moderate growth. The
high-growth period in Japan started in the middle of the 1950s and ended at the beginning of
the 1970s. The average growth rate between these periods was 9.7 percent, nearly identical
to the 10.1 percent registered by the Chinese economy since the 1990s (Chart 8). As was
the case in Japan, the transition from high economic growth to stable growth will not be an
easy path.
From such a perspective, in comparing recent indicators between Japan and China, per
capita GDP in China is approximately 5,500 U.S. dollars, almost the same as that in Japan in
the middle of the 1970s. The share of business fixed investment relative to GDP in China is
significantly higher than that of Japan during the high-growth era. As for labor or
demographic changes, the "Lewisian Turning Point" - that is, when the excess labor surplus
in rural areas eventually disappears - and demographic changes in the working-age
population are important issues (Chart 9). Once the "Lewisian Turning Point" occurs, it will
increase upward pressure on wages, and the pick-up in labor productivity is likely to
decelerate. While the jury is still out on whether the Chinese economy has passed this point,
the working-age population will start to decrease around 2015 and the aging of the
population will proceed at a rapid pace. In Japan, there was a time lag of about 30 years
from the "Lewisian Turning Point" to a decrease in the working-age population; it might be
that China will experience such changes in relatively short periods of time (Chart 10).
Effect of the bursting of the credit bubble on the overseas economies
As I explained so far, the U.S., European, and Chinese economies fluctuate by their intrinsic
factors. On the other hand, they are also driven by a common factor. In this regard, it is
useful to examine the global economy from a broad perspective. On this point, the impact felt
around the globe from the bursting of the credit bubble in the mid-2000s is an important point
to consider. As for the headwinds against the U.S. economy, the collapse of the housing
market was caused by the bursting of the bubble, and the problem associated with the "fiscal
cliff" is largely regarded as an aftereffect caused by the bursting of the bubble.
European financial institutions suffered massive losses from the U.S. subprime loan problem.
At the same time, the bubbles in the real estate markets of some peripheral countries burst,
creating grave damage to the balance sheets of the respective governments and financial
institutions. Let me come back to the European debt problem later, when I will talk about
monetary unions, which are unique elements in Europe that have made it more difficult and
complex to address the bursting of bubbles. Emerging economies have grown at the
potential rate, in large part due to their intrinsic factors. However, they are not immune from
the aftereffects of the bursting of the bubbles in advanced economies (Chart 11).
As we have seen, problems emerge in different ways between advanced economies and
emerging economies. From the perspective of the effect of the bursting of the bubble, which
is the common factor surrounding the global economy, what should we expect in terms of
policy-making and business management? The research done by Professors Reinhart and
Rogoff, who analyzed the financial crisis, is worth noting.1 These two professors looked back
at the episodes of serious financial crises in 14 countries after World War II, including the
experience of the Japanese bubble, the Nordic banking crisis, and the Asian currency crisis.
They showed that per capita real GDP had declined from its peak to the bottom in almost two
years. Furthermore, they showed that it had taken 4.4 years on average to recover the
pre-crisis level of economic activity.
Taking into account these past episodes and ongoing events - namely, the large bubbles
burst in the United States and Europe - and given that it takes time to establish a new
growth model in economies including Japan and emerging countries, it is important to realize
that the situation of subdued growth in the global economy is going to last for some time.
Under such circumstances where the subdued growth is less than satisfactory according to
the previous criteria, excessive policy measures intended to engender higher growth may
end up failing to achieve such policy goals, and we may be left with a number of distortions.
The common challenge facing each country after the Lehman shock is to make the utmost
efforts to achieve sustainable growth by conducting macro-policies subject to the structure of
each economy at the time, and to proceed with economic and fiscal reforms in each country
and region in order to raise economic growth in the medium to long term. On this front, the
challenge differs from one country to the next. Emerging economies should aim to achieve
balanced growth by cultivating domestic demand, which has the potential to grow while
relying less on overseas demand. Moreover, while the speed of aging may differ, Japan,
advanced economies, and some emerging countries in Asia face the challenge of addressing
their aging populations. Lastly, innovation in the area of natural resources and energy is a
challenge that needs to be tackled through the collective wisdom of all human beings in order
for the global economy to achieve sustainable growth.
European debt problem and its challenges
The key to understanding the current state of the global economy is the adjustment after the
bursting of bubbles. Let me now describe the European debt problem, which goes well
beyond the post-bubble adjustment.
Since the introduction of a single currency - the euro - in 1999, some countries were able to
raise funds at lower rates than those justified by their economic strength, and this led to rapid
accumulation of external debts. In those countries, wages have risen at a faster pace than
productivity growth, and consequently the competitiveness of industries has declined.
Nonetheless, as a result of the euro area having adopted a single currency, there is no
option to recover balances or mitigate severe adjustment pressure by depreciating its own
currency. This makes it even more difficult to resolve the problem in the area.
Against such a background, the European Central Bank (ECB) undertook two longer-term
refinancing operations (LTROs) with a maturity of 36 months, which provided virtually
unlimited liquidity in the euro area. In addition, central banks including the Bank of Japan
arranged the coordinated U.S. dollar fund-supplying action. Owing to these policy measures,
financial chaos - as we saw at the time of the Lehman shock - has been avoided so far.
The liquidity provision by central banks can only provide a temporary reprieve - in other
words, it is a measure to "mitigate the pain" or "buy time", so to speak. Central banks' actions
themselves will not solve the problem. Thus, two things are necessary to stop the adverse
feedback loop among the fiscal situation, the financial system, and the real economy.
First, economies with fiscal problems must proceed with drastic fiscal reforms as well as
economic structural reforms, such as reforming the labor market and maintaining and
strengthening the soundness of financial systems.
Second, Europe as a whole must set out clearly the future of economic integration and
reconstruct a sustainable single currency zone. Europe, as part of its process of creating a
European banking union, is considering the establishment of a single supervisory
mechanism. Conditional on the establishment of such a mechanism, a principle is currently
being discussed that allows the European Stability Mechanism (ESM) to inject capital directly
into financial institutions. In addition, in order to strengthen the fiscal consolidation of the
respective countries in the region, the European authorities are in the process of drafting a
road map that sets out the deadline for achieving such a target.
These are the challenges - that have been recognized by the public - beyond a "monetary
union", and European authorities share a broad sense of the necessary direction to follow. At
the same time, these are essential and difficult tasks that will define the future of Europe's
economy, society, and politics. For that reason, there are a number of issues that ought to be
resolved, and it will be difficult to form consensus in such a short time.
While a difficult task, the European monetary union has progressed over the years under the
grand vision to realize peace, prosperity, and stability in the region through political and
economic integration. In order to realize this vision, a strong political will is imperative. I
sincerely hope that the European authorities - by taking advantage of the responsiveness
that has been nurtured and the mutual trust that has been established through the course of
history in Europe - will take bold measures to address the fundamental problem.
IV. Growth potential
Japan's growth potential
So far, I have addressed the issue of overseas economies. I would now like to change the
subject to the domestic economy and present the third topic: Japan's growth potential, or
potential growth rate.
To have some idea of where the potential growth rate lies is vital both in terms of making
policies and managing firms. This is because the output gap of Japan's economy has
tightened to about -2 percent at present, and the economic growth rate over the next 10 or
20 years is largely underpinned by the potential growth rate. Both monetary policy and fiscal
policy are aimed at stimulating demand by closing the output gap, and neither is quite able to
raise potential growth.
To understand potential growth, let us look back at the long time-series of real GDP growth
rates in Japan. While it was around 4.4 percent in the 1980s, real GDP declined gradually,
reaching around 1.5 percent in the 1990s and around 0.6 percent in the 2000s (Chart 12).
The real GDP growth rate can be decomposed into the growth rate of the workforce and the
growth rate of real per capita GDP, i.e., the growth rate of value-added productivity. The
decline in real GDP from the 1980s to the 1990s owes much to the declining growth rate of
value-added productivity (Chart 13). This is mainly due to the remnants of the bubble; in
other words, economic activity stagnated during the course of removing excesses in terms of
business equipment and debts that had accumulated during the bubble period. However, its
decline from the 1990s to the 2000s owes much to the fact that the working-age population
started to decrease, rather than increase, while the growth rate of value-added productivity
stopped declining. The decline in the workforce reflects the rapid aging of the population that
is in progress.
What is going to happen in the next 10 years? Assuming that the labor participation of
male/female workers and that of different age groups remain constant, the future course of
the working-age population can be calculated with great accuracy. In the 2010s and 2020s, it
is expected to decline by 0.6 percent and 0.8 percent, respectively. Meanwhile, value-added
productivity for the last 20 years is 0.9 percent on average. Taking the average between
2000 and 2008 - excluding the 1990s when the aftereffects of the bursting of the bubble still
remained - value-added productivity becomes 1.4 percent. Assuming that it will grow at
1.0-1.5 percent, the economic growth rate will be 0.4-0.9 percent and 0.2-0.7 percent in the
2010s and 2020s, respectively.
This computation is mechanical, and I do not place absolute significance on these numbers.
Nevertheless, I still believe that they are useful in terms of being able to grasp future
economic growth in a situation where no efforts were made to change the status quo.
Measures to raise Japan's growth potential
Between the two components that constitute economic growth, the way in which value-added
productivity is assumed warrants further discussion. Value-added productivity per
workingage person in Japan is at a level comparable to other major economies. In fact, it is even
higher than some other countries. While it is lower than emerging economies, this reflects the
difference in economic structure between the economies that are in the process of catching
up and those that have matured. It is rather unrealistic to expect that value-added
productivity in Japan will pick up at a rate similar to those in the high-growth era. It may
sound as though I am trying to emphasize that we should accept low growth as fate. This is
not my intention.
Changing the demographic trend itself, were it possible, would take a long time. Thus, we
must face the reality that aging will proceed anyway, and make efforts to carry out structural
reforms in view of the aging society. This is the only way to reinvigorate Japan. It is not only
the declining population or aging itself that lies behind the low growth rate. The lack of
advancing structural reforms to create higher value-added in response to demographic
changes is at its core. When thinking in such a way, it becomes clear where we should be
headed in order to raise economic growth.
The first move would be to increase labor participation, or to increase the share of those who
actually work relative to the working-age population. In order to do so, it is necessary to
make serious efforts to lay the foundation for allowing more females and the elderly to
participate in the labor market. Leaving the current labor participation as it is, the
workingage population would decline by 0.6 percent in the next 10 years. If the labor participation of
female workers became as high as that in Sweden, for instance, the working-age population
would rise, rather than decline.2
The second is to exert efforts to raise or at least stop a further decline in value-added
productivity. The emphasis here is on productivity that requires efforts to raise it. If firms raise
their profitability by cutting wages and suppressing input prices, this will only end up
suppressing household income and the profit base of suppliers; hence, the value-added in
the economy as a whole will not increase. Therefore, in order to raise value-added
productivity, one has to develop new goods and services that meet the potential needs at
home and abroad, initiate successful business models, and raise value-added productivity.
Here, the spirit of challenge on the part of firms plays an important role. There are two ways
in which firms can make a maximum contribution: the first is to generate highly value-added
goods and services by capturing overseas demand and cultivating domestic demand; and
the second is to shift their human, commodity, and financial resources to areas that have the
potential to increase demand. In order to encourage firms to demonstrate their spirit of
challenge, it is necessary to lay the foundation through initiatives such as deregulation.
Turning areas where potential demand has not been cultivated due to existing regulation into
growing markets may well be a big opportunity for Japan's economy. At the same time, the
society's willingness to accept such challenges is also important.
V. Deflation
When I talk about the importance of raising the growth potential, the likely response might be
that overcoming deflation is also important. Indeed, this is an important issue, but we need to
think carefully about what it means to overcome deflation. Next, I would like to present the
results of the Opinion Survey on the General Public's Views and Behavior. The Bank
conducts this survey on a quarterly basis, based on the responses collected from individuals
who are chosen through a stratified two-stage random sampling method. This survey is an
opinion poll designed to gain insight into the general public's perceptions on their household
circumstances, including questions with regard to the perception of price levels (Chart 14).
According to recent survey results, among the respondents who felt that prices have gone
up, more than 80 percent viewed the price rise as "rather unfavorable". In contrast, among
the respondents who felt that prices have gone down, about one third of them deemed the
price decline as "rather favorable". While the exact number changes from one survey to the
next, the responses have tended to be rather stable.
Reading the newspaper, in contrast, one often comes across an article stressing the
necessity to overcome deflation and representing this as the voice of the general public in
Japan. Given that deflation is a state in which prices keep declining, these two outcomes are
inconsistent with each other. How can we reconcile these outcomes? In my view, the answer
lies in the fact that "deflation" means different things to different people. Some use this
terminology in the context of consecutive declines in prices, while others believe it means
deteriorating economic activity and the rest view it as declining wages. There are even those
who use deflation in the context of falling asset prices.
According to the opinion survey that I have just mentioned, most Japanese people are not
hoping that prices would simply rise. If prices rise while real GDP remains stagnant, this will
lead to higher nominal GDP, which represents a situation where costs rise in a number of
items and cost-push inflation prevails. This does not lead to a higher living standard. In the
minds of most people, overcoming deflation is not simply a state in which prices rise in
general, but rather one where better economic conditions are realized by increasing
corporate profits, employment, and income. In economists' jargon, it represents a rise in the
real GDP growth rate. When the real GDP growth rate rises, the demand and supply balance
improves, generating upward pressure on prices and wiping out deflation. The question is
how to raise the real GDP growth rate. There is a combination of forces that needs to be
addressed: first, strengthening the economy's growth potential; and second, providing
support from the financial side.
VI. Stronger yen
Recent developments in foreign exchange rate and its background
Related to the current economic developments, I would now like to talk about the problem
asso