Yukitoshi Funo: Economic activity, prices, and monetary policy in
Japan
Speech by Mr Yukitoshi Funo, Member of the Policy Board of the Bank of Japan, at a meeting
with business leaders, Hiroshima, 3 July 2019.
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I. Recent Economic and Price Developments
A. Overseas Developments
I would like to begin by talking about overseas economies, which have been growing moderately
on the whole, although slowdowns have been observed. Uncertainty regarding the outlook has
been heightening, due in part to protectionist moves, but private consumption has been firm on
the whole, partly supported by a favorable employment and income situation. In terms of the
outlook, slowdowns are likely to continue for the time being; thereafter, however, overseas
economies are expected to grow moderately on the whole with their growth rates rising
somewhat.
Looking at developments by major region, the U.S. economy has been expanding moderately,
whereas the European economy has been decelerating. The Chinese economy has continued to
see stable growth on the whole, but some weakness has been observed in the manufacturing
sector. Other emerging and commodity-exporting economies have been recovering moderately
on the whole, mainly on the back of the effects of those economies' stimulus measures. As for
the outlook, the U.S. economy is expected to maintain its moderate expansion and the European
economy is projected to gradually move out of its deceleration phase. The Chinese economy is
likely to broadly follow a stable growth path as authorities conduct fiscal and monetary policies in
a timely manner. Other emerging and commodity-exporting economies are likely to continue to
see moderate recovery on the whole.
Risk factors to the overseas economic outlook are wide ranging and likely to be significant, as
exemplified by (1) the U.S. macroeconomic policies and their impact on global financial markets,
(2) the consequences of protectionist moves, including those observed in U.S.-China trade
negotiations and their effects, (3) developments in emerging and commodity-exporting
economies, (4) the progress in global adjustments in IT-related goods, (5) negotiations on the
United Kingdom's exit from the European Union (EU) and their effects, and (6) geopolitical risks.
As it can be said that there is uncertainty surrounding overseas economies, it is necessary to
stay vigilant regarding these risk factors, including their impact on firms' and households'
sentiment in Japan.
B. Japan's Economy and Prices
1. Economic activity
I will now discuss the economic situation in Japan. The economy has been on a moderate
expanding trend, with a virtuous cycle from income to spending operating, although exports and
production have been affected by the slowdown in overseas economies. It has continued to grow
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at a pace above its potential growth rate. This is evidenced by the real GDP growth rate having
registered 1.8 percent for the October-December quarter of 2018 on an annualized
quarter-onquarter basis, and 2.2 percent for the January-March quarter of 2019. According to the Bank of
Japan's June 2019 Tankan (Short-Term Economic Survey of Enterprises in Japan) released at
the beginning of July, the diffusion index (DI) for business conditions for all industries and
enterprises has remained positive despite being affected by the slowdown in overseas
economies and other factors.
Meanwhile, after enduring the severe damage caused by the heavy rain, which mainly affected
western Japan in July 2018, Hiroshima Prefecture has seen steady progress in its restoration
and reconstruction, owing to the efforts of those involved. To give an example, although firms'
production activities had become stagnant due to damage to production facilities, a water cutoff,
and disruptions to traffic infrastructure, these effects have more or less dissipated. Moreover,
such inviting locations as the two World Heritage Sites of Hiroshima - the Atomic Bomb Dome
and the Itsukushima Shrine - as well as the beauty of the archipelago in the Setouchi region are
attracting tourists from home and abroad once again, making up for the past slowdown.
With regard to the outlook, Japan's economy is likely to continue growing at about the same pace
as its potential on average and continue on an expanding trend, despite being affected by the
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slowdown in overseas economies for the time being. Specifically, for now, exports are projected
to show some weakness and business fixed investment also is likely to decelerate somewhat,
reflecting the effects of the slowdown in overseas economies. Meanwhile, private consumption is
expected to continue increasing as the employment and income situation continues to improve.
Thereafter, Japan's exports are projected to return to their moderate increasing trend, with
overseas economies expected to grow moderately on the whole. Domestic demand is likely to
follow an uptrend, with a virtuous cycle from income to spending being maintained in both the
corporate and household sectors, mainly against the background of highly accommodative
financial conditions and the underpinnings through government spending, despite being affected
by such factors as the scheduled consumption tax hike. In terms of specific figures for the
economic growth rate, as provided in the April 2019 Outlook for Economic Activity and Prices
(Outlook Report) released by the Bank, the medians of the Policy Board members' forecasts are
0.8 percent for fiscal 2019, 0.9 percent for fiscal 2020, and 1.2 percent for fiscal 2021.
1. Under a specific methodology, Japan's potential growth rate is estimated to be in the range
of 0.5-1.0 percent recently. However, the estimate of the potential growth rate varies
depending on the methodologies employed and could be revised as the sample period
becomes longer over time. Thus, it should be regarded as being subject to a considerable
margin of error.
2. It is assumed that the consumption tax will be raised to 10 percent in October 2019 and that
a reduced tax rate will be applied to food and beverages - excluding alcohol and dining out
- and newspapers.
2. Prices
Let me now explain price developments. The year-on-year rate of change in the consumer price
index (CPI) for all items less fresh food is in the range of 0.5-1.0 percent and at around 0.5
percent excluding the effects of energy prices, together suggesting that it has continued to show
relatively weak developments compared to the economic expansion and labor market tightening.
With regard to the outlook, medium- to long-term inflation expectations are projected to rise
gradually as firms' stance is likely to gradually shift toward further raising wages and prices with
the output gap remaining positive. As a result, the year-on-year rate of change in the CPI (all
items less fresh food) is likely to increase gradually over time. In terms of specific figures, the
medians of the Policy Board members' forecasts of the year-on-year rate of change presented in
the April 2019 Outlook Report are 1.1 percent for fiscal 2019, 1.4 percent for fiscal 2020, and 1.6
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percent for fiscal 2021.
1. 3The forecasts assume the following: (1) the consumption tax will be raised to 10 percent in
October 2019 and a reduced tax rate will be applied to food and beverages - excluding
alcohol and dining out - and newspapers, and (2) with regard to policies concerning the
provision of free education, measures for free early childhood education as well as other
measures including free higher education will be introduced in October 2019 and April 2020,
respectively.
II. Keys to Assessing the Outlook for Economic Activity and Prices
In what follows, I would like to discuss several points that I think deserve particular attention in
terms of realizing the outlook for economic activity and prices that I mentioned earlier.
A. Employment and Income Situation
Let me first talk about the employment and income situation. As the economy has continued its
moderate expansion, the output gap has remained clearly positive, and supply-demand
conditions in the labor market have continued to tighten steadily. The Labour Force
Surveybased number of employees has continued to increase firmly when smoothing out fluctuations,
and the active job openings-to-applicants ratio has been at a high level that exceeds the peak
marked during the bubble period. In addition, the unemployment rate has remained at a low level.
These indicators of supply-demand conditions in the labor market show that the degree of labor
market tightness has been at the level last seen in the first half of the 1990s or in the first half of
the 1970s.
Amid such supply-demand conditions in the labor market, the latest rate of base pay increase for
fiscal 2019 is about the same as the actual rate for fiscal 2018. The year-on-year rate of increase
in scheduled cash earnings of full-time employees is in the range of 0.5-1.0 percent. In addition,
that in hourly scheduled cash earnings of part-time employees, which are responsive to
supplydemand conditions in the labor market, has registered relatively high growth at around 2 percent.
As a result, although total cash earnings per employee have been increasing moderately, albeit
with fluctuations, the increases have remained relatively weak compared to the labor market
tightening, partly due to the high wage elasticity of labor supply in recent years, mainly among
women and seniors.
As Japan's economy is likely to continue on an expanding trend, it is expected that the number of
employees will keep increasing and supply-demand conditions in the labor market will continue to
tighten steadily. I therefore expect the rate of increase in total cash earnings per employee to
gradually accelerate.
B. Prices
Next, I will turn to price developments, taking into account the employment and income situation.
The year-on-year rate of change in the CPI (all items less fresh food and energy) has remained
at around 0.5 percent. The relatively weak developments compared to such factors as the labor
market tightening are attributable to the mindset and behavior based on the assumption that
wages and prices will not increase easily, which have been deeply entrenched among firms and
households, due mainly to the experience of prolonged low growth and deflation. In addition,
room for raising productivity and progress in information technology in recent years, for example,
have allowed firms to absorb an increase in costs and thereby maintain their cautious stance
toward raising prices.
While affected by various factors, I view the underlying trend in prices as being determined by the
aggregate supply-demand balance. In other words, a positive output gap leads to a rise in the
inflation rate through a virtuous cycle from income to spending. In the case of households, for
example, a tightening of labor market conditions encourages an increase in private consumption
through a rise in wages, thereby leading to an increase in the year-on-year rate of change in the
CPI.
In this regard, looking at annual price changes across all CPI items less fresh food, the share of
price-increasing items minus the share of price-decreasing items has been rising on average
recently. In this situation, I believe various changes are spreading throughout the economy. For
example, in terms of private consumption, firms have developed and supplied new products to
tap potential demand in view of the increasing variation in consumer needs. My impression is that
consumers, in response, are tolerant of the prices set for products and services that are not
necessarily inexpensive, as long as they are unique and have high value-added, like travel
packages that offer a new life experience in return.
As for the outlook, it is projected that, with the output gap remaining positive, firms' stance
gradually will shift toward further raising wages and households' tolerance of price rises will
increase. In this situation, further price rises are likely to be observed widely and medium- to
long-term inflation expectations are projected to rise gradually. As a consequence, it can be said
that the year-on-year rate of change in the CPI is likely to increase gradually. Conversely,
attention should be paid to the fact that a change in the mindset and behavior of firms and
households does not occur overnight and may in fact take a considerable amount of time.
III. Conduct of Monetary Policy
Let me now turn to the Bank's monetary policy.
The Bank has set the price stability target at 2 percent in terms of the year-on-year rate of
change in the CPI and has been conducting monetary policy to achieve this target at the earliest
possible time. To this end, the Bank has been pursuing powerful monetary easing, considering
developments in economic activity and prices, as well as financial conditions, under the
framework of Quantitative and Qualitative Monetary Easing (QQE) with Yield Curve Control. The
Bank, under this framework, has been conducting yield curve control, in which it controls
shortand long-term interest rates. Specifically, at present, according to the guideline for market
operations, the Bank sets the short-term policy interest rate at minus 0.1 percent and purchases
Japanese government bonds (JGBs) so that 10-year JGB yields will remain at around 0 percent.
By conducting this operation, short- and long-term interest rates have been stable at low levels,
and I consider that the highly accommodative financial conditions, brought about by yield curve
control, have stimulated firms' and households' spending activities.
Meanwhile, prices have continued to show relatively weak developments compared to the
economic expansion and labor market tightening, with Policy Board members' forecasts
presented in the April 2019 Outlook Report indicating that it likely would still take time to achieve
the price stability target. As part of its efforts to do so, at the Monetary Policy Meeting (MPM) held
on April 24 and 25, the Bank decided to clarify forward guidance for policy rates. Specifically, the
description of the existing guidance was partially revised, thereby making clear that the Bank
would "maintain the current extremely low levels of short- and long-term interest rates for an
extended period of time, at least through around spring 2020, taking into account uncertainties
regarding economic activity and prices including developments in overseas economies and the
effects of the scheduled consumption tax hike." By doing so, the Bank clarified its unchanged
policy stance to persistently continue with the current powerful monetary easing. What I would
like to call attention to here is that the current extremely low levels of short- and long-term interest
rates will be maintained "for an extended period of time" and that the inclusion of "at least" in the
description regarding the time frame of the guidance indicates a fair possibility that the current
low interest rates will be maintained beyond "around spring 2020." In other words, "for an
extended period of time" does not denote "through around spring 2020"; rather, it implies an
open-ended period even beyond that.
The Bank also decided at the April MPM to implement measures contributing to the continuation
of powerful monetary easing. Specifically, the Bank decided to (1) expand the scope of eligible
collateral for its provision of credit for such purposes as the Bank's lending to financial
institutions, (2) improve the use of the Fund-Provisioning Measure to Support Strengthening the
Foundations for Economic Growth, (3) relax the terms and conditions for the facility of
temporarily lending Japanese government securities (JGSs) held by the Bank, and (4) consider
introducing an exchange-traded fund (ETF) lending facility, which would make it possible to lend
its ETFs to market participants. These measures are aimed at strengthening policy durability in
order for the Bank to continue with powerful monetary easing through its smooth
fundprovisioning and securing of market functioning.
Given the current situation, where prices and inflation expectations have not risen easily, it is
necessary to maintain a positive output gap for as long as possible by keeping interest rates at
sufficiently low levels for a prolonged time, in order to achieve the price stability target. I believe
that the clarification of forward guidance and the aforementioned four measures will bolster
confidence in the Bank's continuation of powerful monetary easing and further ensure
achievement of the price stability target. With a view to achieving the target, the Bank will
continue conducting monetary policy in an appropriate manner, taking account of developments
in economic activity and prices as well as financial conditions.
IV. Challenges for Japan's Economy
I now would like to express my thoughts regarding the current situation for Japan's economy
from a longer-term perspective.
According to the Bank's estimates, the potential growth rate has been in the range of 0.5-1.0
percent recently. Although the rate has risen compared to around 2010, it can be said that
Japan's growth potential has been sluggish. This is also an indication of the various challenges
that Japan faces in achieving a rise in productivity. With regard to corporate activities, for
example, firms' utilization of resources to achieve the intended goals should be minimized, and
the achievement process needs to be managed by means of effective corporate governance.
Unless this way of thinking is widely accepted by firms, however, excessive resources -
including labor - tend to be allocated in order to produce results that are more impressive than
necessary, regardless of the marginal benefit. This tendency, prevalent across professions and
industries, seemingly is encouraged by Japan's employment practices and bottom-up approach
to management.
In spite of these trends, going forward, I see the potential growth rate rising through an
improvement in productivity as a wide range of entities continue with initiatives concerning
structural reforms and growth strategies. Take recent developments for instance; namely, the
output gap being positive and labor market conditions remaining considerably tight, as evidenced
by the existing labor shortage. Such underlying developments seem to have given rise to
changes in employment practices, including increased mobility in the labor market brought about
by the efficient allocation of excess labor resources from sectors with low productivity to those
with high productivity. Alongside this, progress in working-style reforms and other initiatives
suggests a deepening awareness among both workers and managers of the need to raise
productivity. Pursuing structural reforms and growth strategies is not an easy task and a fairly
extensive process. Nonetheless, it is safe to say that the necessary conditions for a rise in
productivity, which will bring about a boost in Japan's growth potential, gradually are being
fulfilled.
I believe these developments will play a role in underpinning the virtuous cycle from income to
spending. Specifically, a rise in productivity will act as a starting point of such cycle, stimulating
price rises through increases in wages and private consumption. Effects of monetary policy are
not directly transmitted to economic entities - namely, individual firms and households - and
thus may take time to materialize in the form of backing up their efforts. However, they should be
able to support various initiatives as the Bank's conduct of monetary policy stimulates aggregate
demand and suitably tight supply-demand conditions are maintained. Therefore, with a view to
achieving its price stability target and realizing sustainable economic growth in a coordinated
manner, the Bank needs to persistently continue with its powerful monetary easing and
consistently provide support for the initiatives of a wide range of economic entities.