Hirohide Yamaguchi: Economic slowdown and monetary easing
Speech by Mr Hirohide Yamaguchi, Deputy Governor of the Bank of Japan, at the Asian
Affairs Research Council, Tokyo, 24 September 2012.
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Introduction
Thank you for giving me an opportunity to speak at the Asian Affairs Research Council
special lecture in front of distinguished members who are active in a wide range of areas.
For half a century since 1964, the Council has been, through its various kinds of research
and studies about the Asia and Pacific region, contributing to the deepening of mutual
understanding and harmonious development of the region. The year 1964 was when the
Tokyo Olympics were held and when Japan joined the Organisation for Economic
Co-operation and Development. Japan's trade balance turned into a clear surplus from that
year and continued to be in surplus for 47 years up to 2010. The year 1964 could be said
as a milestone for Japan's economy.
In September 1964, the Annual Meetings of the International Monetary Fund (IMF) and the
World Bank Group were held in Tokyo. Half a century since then, Japan's economy has
grown significantly and, amid globalization, a linkage between Japan and the rest of the
world has been further closely interrelated. In the week after next, from Tuesday, October
9, the Annual Meetings of the IMF and the World Bank Group will be held in Tokyo for the
second time. The Bank of Japan, together with the Ministry of Finance, is preparing for the
Meetings as a host country. About 20 thousand participants and concerned parties from
all over the world are expected to join, and many conferences and seminars on the
global economy, financial systems and other various issues are to be held. In order to let
people know further about Japan's economy, the best way is to let them actually see Japan.
I believe many of you are already planning to participate, and hope that you will seize the
opportunity for a lively exchange of views.
Today I will talk under the theme of the "Economic Slowdown and Monetary Easing." In the
first half, I will present an overview of the current state and outlook for the global
economy and Japan's economy. In the second half, based on such things about the
economies at home and abroad, I will explain the Bank of Japan's conduct of monetary
policy. To summarize the thrust of my speech in advance, there are five points. First,
looking at overseas economies, due to the effects of the European debt problem,
business sentiment has become cautious in many countries and regions, mainly in the
manufacturing sector, and the economies have moved somewhat deeper into a deceleration
phase. Future uncertainty remains high. Second, in considering the background to the
slowdown in overseas economies, it might be better not to focus only on the effects of the
European debt problem, but to view from a broader perspective. Namely, we need to have
the following big picture in mind. During the period up to the mid-2000s of the so-called Great
Moderation, a bubble was generated in advanced countries and they are still suffering from
the balance-sheet adjustments after the burst of the bubble. In emerging economies, as an
excess supply capacity of a low cost labor force, which was a factor in supporting the Great
Moderation, becoming low, it has become difficult to simultaneously achieve economic
growth and price stability. Third, Japan's economy registered relatively high growth in the first
half of 2012, but the pick-up in economic activity has come to a pause, reflecting the weak
developments in overseas economies. Economic activity is expected to level off more or
less for the time being. Fourth, in response to a weaker outlook for economic activity, the
Bank of Japan further enhanced monetary easing at the Monetary Policy Meeting held last
week so that the future economy will not deviate from the orbit of "returning to the
sustainable growth path with price stability." Fifth, in order for Japan's economy to
overcome deflation, in addition to such support from the financial side, it is important to
make efforts to strengthen growth potential and take advantage of accommodative financial
conditions. After explaining those issues, I will answer to some of the questions raised about
this time's monetary easing.
I. Current state and outlook for overseas economies
Let me start with the current state of the global economy. Overseas economies have
moved somewhat deeper into a deceleration phase. While the global economy has been on
a deceleration phase, it seems that the extent of deceleration has recently increased
mainly in manufacturers in many countries and regions.
Current state of the European economy
The European economy is currently in a deceleration phase. Three years have already
passed since concern over the government debt was recognized in international financial
and capital markets, and, at present, the problem has not been limited to Greece, Portugal,
and Ireland, which have already been receiving support from the European Union (EU) and
the IMF but also spread over to major southern European countries, including Spain and
Italy. In those countries, due to a rise in government bond yields, namely, a decline in
government bond prices, financial institutions' assets have deteriorated, which has led to a
rise in funding costs and instability of financial positions. As a result, financial conditions
surrounding firms and households have worsened, posing pressure to suppress
economic activity. Such deterioration in the real economy and concern over the financial
systems have been fed back to the fiscal problem through a decline in revenue and an
increase in support for financial institutions. In such a way, in Europe, a vicious cycle of
public finance, the financial system, and the real economy has been at work, mainly in
peripheral countries. Therefore, the stagnation in the European economy has been
protracted, and that has recently been spread to core countries, including Germany,
mainly in terms of business sentiment. The growth rate of the euro area economy has been
negative for three consecutive quarters.
In the meantime, the European authorities have been taking various policy measures. In
July, a financial support measure to inject public funds into Spanish financial institutions
was compiled, and in the beginning of September, the European Central Bank (ECB)
introduced a new program to purchase government bonds with a maturity of between one
and three years, with no ex ante quantitative limits on the size of purchases. However, in
starting purchases of government bonds, the ECB is going to make some conditions. For
example, the issuer countries of bonds to be purchased will have to accept monitoring by
the EU and the IMF on the progress of fiscal consolidation. Thanks to those various
policy responses, stability has been maintained in interbank funding markets, and investors'
risk aversion has abated somewhat in international financial and capital markets as a whole.
The policy responses by the ECB and other policy authorities are indispensable for
containing the vicious cycle of public finance, the financial system, and the real economy.
However, in order to resolve the European debt problem fundamentally, it is necessary for
countries whose fiscal sustainability has been a cause for concern to make some progress
in meeting the challenges such as fiscal consolidation, strengthening medium- to
long-term growth potential, and reinforcing the stability of the financial system. In
addition, for Europe as a whole, integrating fiscal policy and banking supervision of the
nations is an unavoidable challenge. None of these challenges is easy to meet and thus it
is likely that high uncertainty will continue to surround future progress.
Speaking of risks associated with the European debt problem, there is a risk that stagnation
in the real economy might become protracted under the vicious cycle of public finance, the
financial system, and the real economy, and there is a risk that a financial crisis might occur
due to concern over the financial system. Put simply about the recent developments in
Europe, it can be summarized that the risk that stagnation in the real economy, including the
spillover to core countries, might become protracted has still been large, while the risk that
a financial crisis might occur has subsided due to various policy responses.
Current state of the U.S. economy
Let me turn to the United States. The U.S. economy has been on a modest recovery trend
with a moderate increase in private consumption, including automobile sales, and signs of a
pick-up in the housing market. However, there have been weak developments. Improvement
in employment has been slow and, amid economic adjustment in Europe being
protracted, business sentiment, mainly of manufacturers operating globally, has recently
become cautious and an increase in business fixed investment has been slowing.
Against such a backdrop, the Federal Reserve has recently decided to keep the target
range for the federal funds rate at 0 to 1/4 percent and changed the outlook for the
duration in which exceptionally low levels for the federal funds rate are likely to be warranted,
from "at least through late 2014" to "at least through mid-2015." In addition, it has
decided to purchase mortgage-backed securities (MBS) issued by governmental financial
institutions, called agency MBS, at a pace of 40 billion dollars per month until the outlook for
the labor market improves substantially in a context of price stability.
In the United States, while balance-sheet adjustments due to the burst of a housing bubble
have been progressing to a certain degree, it has steadfastly remained. In such a situation,
in addition to the effects of the European debt problem, there are no prospects for a solution
to the so-called fiscal cliff problem and there is an increasing awareness about uncertainty
of fiscal consolidation over time. Those factors are likely to continue to constrain economic
activity for the time being through growing cautiousness in household and business
sentiment. While the U.S. economy is expected to continue recovering partly supported
by accommodative financial conditions, the pace of recovery for the time being is likely to be
only moderate.
Current state of the Chinese economy
Next is China. While the Chinese economy has been growing at a relatively high rate, the
state of slowdown has become protracted. It has been pointed out that, in the background,
there are a slowdown in exports to Europe and a deceleration in private real estate
investment due to the effects of past monetary tightening and policy measures to control
real estate transactions. With final demand at home and abroad declining, pressure for
inventory adjustments in the raw material industry and a wide range of areas has recently
been increasing, which has been spreading to production in the manufacturing industry.
In China, as the authorities were taking policy responses, including monetary easing and
advancement of infrastructure investment, the economy was considered to gradually
accelerate the pace of growth if those effects would manifest themselves. While I believe
such a scenario is still maintained, the slowdown has been lingering longer than expected
and it is certain that the time when economic activity gets out of the state of slowdown will
be deferred. While it is due mainly to greater-than-expected stagnation in the European
economy, which is the largest trading partner, there might be a more structural problem.
One is that the policy authorities seem to be hesitant about stepping on the gas pedal toward
economic growth. That might be due to a bitter experience that a large-scale fiscal spending
and monetary easing after the Lehman shock led to a rise in prices and a surge in real
estate prices. A simultaneous achievement of both economic growth and price stability is a
common challenge to many emerging and commodity-exporting economies, which I will
talk about in detail later. Another reason might be that, in China, as a result of continued
growth for a long period led largely by public investment and business fixed investment,
industries, mainly the raw material industry, have been carrying a structural problem of
excessive investment, and the balance between supply and demand has been prone to
be lost. In the process of China's transition from high growth to sustainable growth, an
answer to the question on how to change the balance between investment and
consumption, domestic and external demand, urban and rural areas, and coastal and
inland areas is yet to be found, and that might have been increasing uncertainty about the
future economic activity.
Overall picture of the global economy
While I have explained Europe, the United States, and China, respectively, that will not
suffice to see the overall picture of the global economy. There are other elements, including
challenges advanced countries are commonly faced with and challenges emerging
economies are faced with, that should be understood in the overall picture of the global
economy.
In order to consider the challenges common to advanced countries, let us go back to the
period up to the mid-2000s, which was called the "Great Moderation." At that time, as
various favorable factors including a rise in emerging economies and technological
innovation in finance overlapped, extremely favorable economic conditions of high growth,
low inflation, and low interest rates continued for a long period. Against such a backdrop, an
optimistic view on the economic outlook spread globally and an investment boom and a
boost of demand for consumer durables surfaced in the United States and Europe. On the
financial front, financial institutions' risk-taking attitude became aggressive, and a rapid
bloat in credit and a rapid increase in leverage took place. In short, an excess was generated
both on the real economy and financial front, and such excesses were finally corrected
by the Lehman shock.
Subsequently, the experience the United States, Europe, and other advanced countries had
is that, once a large-scale bubble bursts and a financial crisis occurs, economic
adjustment becomes protracted and, in the meantime, the economy is forced to grow at a
low rate - a phenomenon repeated over and over in history. In the United States, substantial
impairment of households' balance sheets due mainly to the subprime mortgage problem
has made a recovery in the U.S. economy a sluggish one. In Europe, amid an optimistic
mood called "europhoria," which is a word coined by combining "euro" with "euphoria,"
loose fiscal management in Greece and excessive real estate investment in southern
Europe took place, and left a severe problem in the balance sheets of the governments and
financial institutions. In the process of balance-sheet adjustments, economic activity will not
recover as wished. An economy that is unlikely to accelerate and remains vulnerable to
the downside will continue for a long period. Without recognizing that fact, frustrations of
"why the growth rate is not increasing despite those policy responses" or "why the
unemployment rate does not decline" are prone to surface. It seems that both the United
States and Europe are yet to identify "a normal pace of economic growth" in the
balance-sheet adjustment process. That seems to have induced difficult problems of
heightening expectations for economic policy and social unrest or dissatisfaction. While it
might be somewhat too much to say, from such a viewpoint, there is in a sense a
commonality among dissatisfaction among young people in Spain for a high unemployment
rate, demonstrations against fiscal austerity in Greece, and repeated conflicts on fiscal
management in the United States. At least, resulting increased reliance on central banks in
the United States and Europe is an obvious tendency.
In the meantime, China and other emerging economies were affected by a plunge in
advanced economies immediately after the Lehman shock, but they subsequently restored
growth at an early stage on the back of buoyant domestic demand and have been growing at
somewhat high rates. The continued capital inflow to emerging economies, while advanced
countries have been continuing monetary easing and providing ample funds, seems to
have also been boosting domestic demand in emerging economies. Recently, contribution
to the global economic growth by advanced countries has been declining markedly and
that by emerging economies has been increasing. According to the IMF, the proportion of
advanced countries and emerging economies in world GDP has shifted substantially from
"7 to 3" to "5 to 5" in the past 30 years.
While emerging economies have been leading the global economy, they have been faced
with a new challenge after the Lehman shock. That is a simultaneous achievement of high
growth and price stability. One important element that supported the "Great Moderation"
was a dramatic increase in the world's supply capacity due to emerging economies'
industrialization on the back of an ample and inexpensive labor force. However, demand in
emerging economies increased accordingly and that resulted in putting constant upward
pressure on commodity prices and food prices. In addition, for example in China, while
development in inland areas has progressed, a mechanism, in which an increase in the
labor force was covered by a population inflow from rural to urban areas, has recently
been changing. As a labor population as a whole is expected to decline in the future,
labor supply will become more prone to fall short than in the past, and inflationary pressure
might also stem from that aspect.
At present, in response to the pressure of economic slowdown from Europe and other
advanced countries, emerging economies have been taking policy responses, including
monetary easing, but it has been difficult to take drastic measures as the economy has
been susceptible to inflationary pressure. There is uncertainty as to when those policy
effects will surface in emerging economies and the pace of growth will accelerate. As crop
prices have recently been surging, a simultaneous achievement of economic growth and
price stability is likely to continue to be a challenge for emerging economies.
In such way, the global economy has moved somewhat deeper into a deceleration phase,
with the effects of the European debt problem combined with unique factors various countries
and regions have been involved in - namely, a great challenge of balance-sheet
adjustments in advanced countries and that of searching for a sustainable growth path in
emerging economies. As mentioned earlier, with the U.S. economy continuing to recover
moderately and policy effects gradually surfacing in the Chinese economy, the global
economy is likely to get out of a deceleration phase, but the exit has been deferred.
II. Current state and challenges of Japan's economy
Let me move on to Japan's economy. As I have just explained, overseas economies have
moved somewhat deeper into a deceleration phase. As a result, exports and industrial
production have been relatively weak. The month-on-month rate of change in real exports
has been negative for four consecutive months since May due to a weakness in exports to
Europe and China, and, against such a backdrop, industrial production declined again in
July relative to the April-June quarter, following a decline in the April-June quarter relative to
the previous one. On the other hand, domestic demand has been resilient mainly supported
by reconstruction-related demand. Public investment has been clearly increasing and
business fixed investment has been on a moderate increasing trend with an improvement
in corporate profits. Private consumption has been resilient with improving employment and
housing investment has generally been picking up. However, there have recently been
somewhat weak indicators in private consumption. While that is partly due to a weather
factor, a sluggish pace of growth in overtime wages mainly in the manufacturing industry due
to weak production and a decline in summer bonuses might have contributed to
constraining consumption from the income side. While an application for receiving subsidies
for eco-friendly cars ended at the end of last week, last minute demand was not
observed. That was partly because efforts by car sellers after ending of the application,
including a rebate in place of the subsidies and the release of popular fuel-efficient
new-models, had been anticipated, but it perhaps should be interpreted as a sign that
pre-consumption of future demand has reached its limit. As for business fixed investment,
while it is likely to continue increasing as a trend, attention should be paid to whether there
are any effects of a global deterioration in business sentiment. While domestic demand as a
whole is likely to maintain its firmness, it might be difficult to expect domestic demand to
have power to offset the weakness in external demand and further elevate economic
activity.
As explained, Japan's economy registered relatively high growth in the first half of 2012,
supported by the firmness in domestic demand, but the pick-up in economic activity has
come to a pause, reflecting the developments in overseas economies. Economic activity is
expected to level off more or less for the time being. On the price front, the year-on-year
rate of change in consumer prices excluding volatile food has been around 0 percent and
was minus 0.3 percent in July as the earlier fall in crude oil prices has been exerting
downward pressure. The year-on-year rate of change in consumer prices is expected to
remain at around 0 percent for the time being.
Regarding risks, there remains a high degree of uncertainty about the global economy,
including the European debt problem, the momentum toward a recovery in the U.S. economy,
and a simultaneous achievement of price stability and economic growth in emerging and
commodity-exporting economies. Furthermore, attention should be paid to the effects of
financial and foreign exchange market developments on economic activity and prices.
III. The bank's conduct of monetary policy
Comprehensive Monetary Easing
Based on the state of the economy at home and abroad, let me turn to the Bank's conduct
of monetary policy.
The Bank recognizes that Japan's economy faces the critical challenge of overcoming
deflation and returning to a sustainable growth path with price stability, and has been
pursuing powerful monetary easing. As powerful monetary easing is pursued within the
framework of Comprehensive Monetary Easing, let me first briefly explain the framework.
It was October 2010 when Comprehensive Monetary Easing was introduced and about two
years have passed since then. The basic reason for the introduction was, amid the policy
rate virtually becoming 0 percent, to further generate easing effects. The specifics of the
framework were as follows. First, the Bank has been encouraging the policy rate of the
overnight rate in the uncollateralized call market, namely, an interest rate of a quite short-term
of one-day borrowing, to move at around 0 to 0.1 percent, which can be said as virtually
0 percent. Second, the Bank introduced financial assets purchasing program named an
Asset Purchase Program (hereafter referred to as "the Program") and under the Program
has been purchasing short-term and long-term government securities as well as a wide
range of risk assets, such as commercial paper (CP), corporate bonds, exchange-traded
funds (ETFs), and Japan real estate investment trusts (J-REITs). That has been a measure,
through influencing longer-term interest rates and risk premiums, to urge the effects of
monetary easing to spread steadily over to firms' funding costs. Third, the Bank has been
aiming at 1 percent in terms of the year-on-year growth rate in consumer prices for the time
being and made a commitment to continuing its powerful monetary easing through the
pursuit of virtually zero interest rate policy and purchases of financial assets until it judges
the 1 percent goal to be in sight. By a central bank making a commitment to continuing
monetary easing for a long period, there will be momentum for pushing down the entire
yield curve, including longer term yields.
Background to the enhancement of monetary easing
At the Monetary Policy Meeting held last week, the Bank further enhanced monetary easing.
Specifically, first, the Bank decided to increase the total size of the Program by about
10 trillion yen, from about 70 trillion yen to about 80 trillion yen. The completion of the
purchases under the Program was extended for six months and the purchases will continue
until around the end of 2013. Second, the Bank decided to remove the minimum bidding
yield, which used to be set at 0.1 percent per annum, for the outright purchases in order to
ensure smooth purchase of the Japanese government bonds (JGBs).
Looking at the developments in economic activity and prices that led to the decisions, as
explained earlier, while overseas economies have moved somewhat deeper into a
deceleration phase, the pick-up in economic activity has come to a pause and is expected to
level off more or less for the time being. The year-on-year rate of change in the CPI
excluding volatile food is to hover at around 0 percent for the time being. In the meantime,
attention should be paid to the effects of financial and foreign exchange market
developments on economic activity and prices.
Until recently, the Bank had judged that, from a longer term perspective, Japan's economy
would return to the moderate recovery path as domestic demand remained firm and
overseas economies gradually emerged from the deceleration phase. And, the year-on-year
rate of change in the CPI excluding volatile food would start to gradually increase and
was likely to reach 1 percent in the not so distant future from fiscal 2014 onward.
However, taking into account the current developments in economic activity and prices, the
time of "overseas economies to gradually emerge from the deceleration phase" and the time
of "Japan's economy to return to the moderate recovery path" are both likely to be delayed.
While to what extent the delay will be is not clear amid continued high uncertainty concerning
China and other overseas economies, roughly speaking, it is likely to be about six months.
If things had remained as they were, Japan's economy would have been on the verge of
deviating from the assumed orbit of "return to the moderate growth path with price stability."
To avoid that, the Bank judged it necessary to further strengthen monetary easing this
time. The aim of the measures this time is, by pursuing powerful monetary easing,
inclusive of the measures this time, to bring back the outlook for economic activity and
prices in the long run to the orbit of returning to a sustainable growth path with price
stability.
Specifics of the enhancement of monetary easing
As mentioned earlier, the Bank decided this time to increase the total size of the Program
substantially by about 10 trillion yen. Based on the recognition of the current state of
economic activity and prices, the Bank considered that a large amount of funds would be
necessary in order to prevent the outlook for economic activity and prices in the long term
from deviating from the orbit of returning to the sustainable growth path with price stability.
While there was a choice to increase additional purchases in risk assets, as the current
financial conditions in Japan were not in a situation in which risk premiums increased due
to investors' anxiety or risk aversion, the Bank opted to increase purchases of short-term
and long-term government securities. By increasing purchases of those by about 5 trillion
yen each, the Bank aimed at influencing the entire yield curve. Japanese firms' funding
structure, unlike that of the United States in which the proportion of long-term corporate
bonds and mortgage loans are high, has a characteristic of a high proportion of bank loans
of three years or less. In particular, bank loans of one year or less account for about
one-third of new loans, and there are also long-term loans with variable rates. Taking into
account such structure of corporate finance, the effects on the entire yield curve, and
financial institutions' sense of security in their funding, the Bank considers that purchasing
government securities with a remaining maturity of three years or less in a balanced manner
will be effective in further spreading monetary easing effects.
While the increase in the outstanding amount of the Program was to be completed by the
end of June 2013, it is extended to be completed by the end of December 2013. Given the
economic situation, the Bank has judged it necessary to beef up the aforementioned
"commitment to continuing monetary easing for a long period" by extending the accumulation
period of the Program.
In addition, while the minimum bidding yield for purchases of the JGBs and corporate
bonds was set at 0.1 percent, the Bank has decided to remove it. With the Bank pursuing
monetary easing, the bidding yield for the JGB issuance as well as actual market transaction
rates up to three years have often fallen below 0.1 percent. To that end, in the purchases of
the JGBs, aggregate bids falling short of the Bank's offers, or the so-called
undersubscription, has taken place. While such phenomenon itself is an indication that
monetary easing has been spreading powerfully, in order to further ensure purchases of
financial assets, the Bank has decided to remove the minimum bidding yield. By combining
an increase in the total size of the Program and the removal of the minimum bidding
yield, the Bank believes that the effects of monetary easing will occur more powerfully.
As the current amount outstanding of the Program is about 60 trillion yen, hereafter, toward
the scheduled amount of 80 trillion yen by the end of 2013, the Bank will accelerate its
purchase schedule to further accumulate 20 trillion yen of financial assets. The Bank will
continue to proceed with monetary easing in a continuous manner by steadily increasing the
amount outstanding of the Program.
Accommodative financial conditions
Then through what transmission channels will this time's measures influence economic
activity and prices and "ensure the return of Japan's economy to the sustainable growth
path"?
First of all, since the measures are to increase the amount of purchase by the Program and
to enable the Bank to purchase the JGBs at a yield level of 0.1 percent or lower, they will
add further downward pressure on market interest rates. That will encourage a decline
in financial institutions' lending rates and influence interest rate formation in various financial
markets, thereby making financial conditions surrounding firms and households more
accommodative. That is an effect that could be clearly confirmed in two years' experience of
Comprehensive Monetary Easing.
Under the Bank's powerful monetary easing, Japan's financial conditions are
accommodative. Since the introduction of the Program, longer term market interest rates
have been steadily declining. Looking at the yields of the government securities, in a
manner of spreading from short-term to long-term, yields up to about three years have
already been hovering at an extremely low level of about 0.1 percent. A 5-year yield has
also declined to about 0.2 percent. Such a decline in market interest rates has encouraged
a decline in firms' funding costs and increased a sense of security for funding. According to
a survey on firms about their cash management and financial institutions' lending stance,
diffusion indexes have clearly improved to the levels better than the average since 2000.
Issuing conditions of CP and corporate bonds have generally been favorable and banks'
average contracted interest rates on new loans and discounts have been at about
1 percent for both short and long terms, which are at historically low levels of even lower
than those during the period of quantitative easing policy in the first half of the 2000s.
Against such a backdrop, average interest payment on firms' interest bearing debt has
declined to around
1.5 percent. That is an extremely low level compared with firms' return on asset (ROA)
being around 3.0-3.5 percent. Consequently, firms can now borrow a sufficient amount of
funds at much lower interest rates than their own profitability.
In such a way, as for the effects monetary policy exerts on the real economy, it can be said
that the effects of monetary easing have thoroughly spread