Ryuzo Miyao: Economic activity and prices in Japan and monetary policy
Summary of a speech by Mr Ryuzo Miyao, Member of the Policy Board of the Bank of Japan,
at a meeting with business leaders, Tokushima, 22 September 2010.
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I. Economic activity and prices
A. Overview
First, I will talk about the current situation of the Japanese economy. At present, an issue of
concern is the possible negative impact of instability in foreign exchange and stock markets
on corporate profits and business and consumer confidence. In this environment, there has
been a slowing of exports to East Asian and other emerging economies that have driven the
recovery from the sharp decline after the bankruptcy of Lehman Brothers. Private consumption,
meanwhile, remains relatively firm, supported by the extremely hot summer this year and a
last-minute increase in demand for durable consumer goods ahead of the expiration of
government subsidies. On the whole, Japan's economy shows further signs of a moderate
recovery.
B. Developments in overseas economies
Let me now look at developments in those overseas economies that are influencing Japan's
export-driven recovery. Among the emerging economies, the Chinese economy has been
boosted by fixed asset investment - comprising business fixed and real estate investments -
as well as private consumption, as a result of major stimulus measures to the value of
4 trillion renminbi. Since the rapid growth accelerated speculative investment in real estate,
making it difficult for middle-class citizens to buy housing, the authorities implemented a
series of measures, including window guidance, to restrain the increase in real estate
transactions. Subsequently, real estate investment slowed down and production and fixed
investment in sectors related to construction decelerated. Still, the rate of economic growth
remains high. With respect to those neighboring Asian nations whose economies have been
spurred by exports to China, although the rate of expansion is showing signs of deceleration,
growth remains high with domestic demand still robust.
With regard to economic activity in the euro area, production has expanded due to increasing
exports to emerging economies, although the growth differs by country. For example, in
Germany its strong recovery has been the main driving force, with real GDP for the April-
June quarter of 2010 having grown at an annualized 9 percent from the previous quarter. By
contrast, Greece, which is saddled with the burden of fiscal consolidation, has recorded
negative growth; and Spain, with its burst housing bubble, has not been able to find a way
out of a low growth predicament. For the euro area as a whole, domestic demand, such as
business fixed investment, is weak and the pace of economic recovery remains moderate.
Moreover, with the slowing pace of growth in emerging economies, particularly in China, the
growth rate of the euro area may slow down starting with exports, which have been the main
engine driving recovery.
Taking a look at recent developments in the U.S. economy, production has recovered due to
both an increase in exports reflecting a weaker dollar and inventory rebuilding, although the
household sector is under pressure from excessive debt and a delay in recovery in
employment. Consumption and business fixed investment have experienced moderate
recovery, reflecting a sharp improvement in the business performance of firms that have
undergone restructuring and the effects of fiscal measures to stimulate the economy. At
present, however, the pace of recovery is decelerating as the effects of stimulus measures
wane.
Regarding the outlook for overseas economies in the near future, it is expected that the pace
of growth in emerging economies, particularly in China, will continue slowing, while the
moderate pace of recovery in the U.S. economy will probably continue, due to slower growth
in exports to emerging economies and weakening of the effects of economic stimulus
measures. Starting in 2011, the growth rate of emerging economies is expected to pick up,
which will help the U.S. and European economies resume a path of moderate recovery.
Recently, however, I have become increasingly concerned about downside risks, mainly
because the risk is rising that the U.S. economy may experience a protracted period of low
growth. In the GDP data released in July, the growth rate of private consumption was revised
sharply downward, revealing that the real value had yet to regain the pre-Lehman shock
level. Furthermore, the personal saving rate was revised substantially upward, marking the
highest level in the past 20 years, excluding periods of temporary increases (Chart 1).
Meanwhile, housing investment, which had been recovering moderately, has resumed a
sharp slide since the expiry of tax credits for homebuyers at the end of April, while monthly
home sales have been at historically low levels. In the area of employment, the increase in
the number of private-sector employees in the April-June quarter of 2010 has slowed to
around 70,000 per month, while the growth in household income has been very slow. Initial
claims for unemployment insurance have been at a high level of around 500,000 per week.
These economic indicators suggest that the U.S. household sector has become extremely
cautious about spending, reflecting the strong repayment pressure on those who purchased
homes during the housing bubble, while the unemployed are having a hard time finding jobs.
In this environment, the corporate sector cannot be confident of future economic expansion.
This has made firms reluctant to increase employment or fixed investment even though their
profits are increasing. This is why the risk is increasing that a recovery in household
consumption will be delayed.
In addition, changes may be taking place in areas that once were considered the main
advantages of the U.S. economy. For example, while labor productivity may not attract a lot
of attention, I keep a close watch on its data. Labor productivity is calculated by dividing real
quarterly GDP by hours worked by the total number of employees. The data reflect growth in
technological progress and increases in capital stock, and indicate a nation's potential growth
capability (Chart 2). During 2009, labor productivity in the United States rose sharply to the
level of 2000 to 2005, the years of the "productivity growth explosion," as a result of drastic
corporate restructuring by means of personnel cuts in response to the economic crisis
following the Lehman shock. Productivity growth, however, had been lackluster during the
prosperous period of 2005 to 2008, and slipped into negative territory in the April-June
quarter of 2010. It has been said that the strength of the U.S. economy lies in its high
productivity backed by its ability to generate technological innovation. Over the past several
years, however, excluding a short period in 2009, longer-term growth potential has tended to
be sluggish. Thus, in the middle of August, the yield on the 10-year U.S. Treasuries declined
to around 2.5 percent, probably due to the decrease in the expected economic growth
accompanied by lower inflation over the longer term, rather than expectations of a temporary
economic slowdown (Chart 3).
C. The current situation of Japan's economy
Based on my views that I have just described regarding overseas economies and
accompanying risk factors, I will now turn to the current state of Japan's economy. Market
participants are accelerating their yen-buying activity to avert risks, reflecting concern about
the outlook for the U.S. economy as well as fiscal and economic conditions in Europe, while
stock prices remain weak despite the favorable outlook for corporate profits, partly due to the
appreciation of the yen (Chart 4). The negative effects of Japan's current market conditions
warrant attention since, if they continue, they would have a significant negative impact on
corporate profits, as well as business and consumer confidence. At present, however, the
mechanism for Japan's self-sustaining economic recovery remains intact.
Looking at recent developments in economic activity in more detail, exports continue to be on
an uptrend, although there has been a deceleration in those to East Asian and other
emerging economies that had supported Japan's high export growth. Meanwhile, production
has been increasing as a trend, although the pace of increase has been decelerating
gradually when the effects of the distortion in seasonal adjustments are taken into account.
Among domestic demand components, business fixed investment is showing signs of picking
up, given the favorable business performance. According to the Financial Statements
Statistics of Corporations by Industry, Quarterly, business fixed investment started to
increase in the April-June quarter of 2010, after having declined throughout the January-
March quarter. Private consumption has been generally picking up, as shown by (1) an
increase in consumer spending on such items as beverages and air conditioners due to this
year's extremely hot summer, and (2) a significant increase in car sales in August, reflecting
a last-minute increase in demand ahead of the termination of government subsidies for
purchasers of environment-friendly cars. At the same time, housing investment has been
leveling out: the number of housing starts increased for two consecutive months, and the
contract rate on newly built condominiums in the Tokyo metropolitan area remains above
70 percent. There are signs that employment and income are improving, although the ratio of
job offers to applicants remains low and the unemployment rate is relatively high. That said,
household income has been improving moderately, reflecting the year-on-year rise in
summer bonus payments.
In assessing the trend in the consumer price index (CPI), it is necessary to exclude fresh food,
the prices of which tend to be volatile, as well as the effects of subsidies for high school tuition,
which are a one-off downside factor and part of the government's economic stimulus measures
to reduce the cost of high-school education. The CPI, excluding these two factors, has recently
been hovering around minus 0.6 percent. It declined significantly in summer last year, but it
now appears to be recovering. The year-on-year rate of decline has been narrowing mildly, and
this trend is likely to continue, reflecting the narrowing negative output gap.
Regarding the outlook for Japan's economy, movements toward a self-sustained recovery
are expected to continue. While the pace of improvement is likely to slow temporarily, partly
due to a temporary slowdown of overseas economies and the waning effects of various
demand-boosting policy measures, exports are likely to increase, reflecting the high growth
in emerging economies such as in China, while business fixed investment and private
consumption are expected to recover as corporate profits increase.
As noted earlier, a downside risk that might necessitate revision of the above outlook is the
growing possibility that the U.S. economy will see protracted low growth. Were this to
happen, the outlook for the world economy would have to be revised downward. The
resulting decrease in exports would adversely affect Japan's economy and probably lead to
increased risk aversion, thereby discouraging business fixed investment, new businesses,
and household consumption. The deteriorating business and consumer sentiment could lead
to prolonged sluggish economic activity.
Despite the manifest downside risks outlined above, the emerging economies have shown
impressive growth. It is true that, for the present, the economies of some Asian economies
appear to be decelerating, mainly because of China's economic slowdown. Yet this means
that the risk is declining that an overheating economy might hurt sustainable economic
growth. This might be compared to "speed control," conducted for a limited period to ensure
a higher rate of growth over the long term. If this were the case, it would be an upside risk for
Japan's economic outlook, given that Japan is strengthening its ties with other Asian
countries. An upswing in these countries could partly offset the negative effects even if the
U.S. economy experiences a period of low growth.
D. Effects of foreign exchange markets on Japan's economy
Next, in order to understand the effects foreign exchange markets have on Japan's
economy, let me put the activities of foreign exchange markets in context. When prices of
goods are stable or falling in a given country, the value of that nation's currency is stable or
rising and, other things being equal, the value of this particular currency should rise against
other currencies. This is the basic idea of "purchasing power parity." So, if we look at the
purchasing power parity of the yen against the U.S. dollar (the ratio between prices in Japan
and the United States), we see that the yen has been appreciating fairly consistently against
the dollar, reflecting the weakness in Japanese prices relative to those in the United States
since the introduction of a floating exchange rate regime in 1973 - even though the actual
dollar/yen exchange rate is determined by a number of factors in addition to prices (Chart 5).
Needless to say, a yen that is strong against the U.S. dollar curtails the profits of
exportoriented firms, many of which are experiencing adverse business pressure that is affecting
stock prices. As a result, the Bank of Japan is closely monitoring the impact of the strong yen
and weak stock prices on the Japanese economy. Conversely, the appreciation of the yen
pushes up profits of import-oriented firms and serves as a tailwind for those firms considering
expanding operations by acquiring overseas firms. However, it should be remembered that a
balanced view is important when discussing the effects of a strong yen.
I will now give you an example of just such a balanced view. Trade statistics show that the
weight of U.S. dollars used as settlement currency for exports declined slightly from
52.4 percent in the second half of 2000 to 48.6 percent in the first half of 2010, while that
used for imports remained largely unchanged at slightly above 70 percent (Chart 6).
However, looking at the value of dollar-denominated trade settlements, one can see that net
imports have increased sharply. This is because trade with the United States, a large buyer
of Japanese exports, is decreasing, while exports to and imports from rapidly growing Asian
countries are growing and imports from the Middle East are increasing sharply. This
expansion in net imports, in dollar terms, indicates the possibility that Japan's settlement and
trade structure now is less vulnerable than before to the negative effects of a strong yen.
II. Monetary policy
A. Recent conduct of monetary policy
Japan's economy shows further signs of a moderate recovery, with exports increasing,
albeit at a slower pace, and demand components such as private consumption and business
fixed investment generally picking up. However, amid heightened uncertainty about the
future especially for the U.S. economy, foreign exchange and stock markets have recently
been unstable. Accordingly, the Bank held an unscheduled Monetary Policy Meeting on
August 30, 2010 and decided to introduce a six-month term in the fixed-rate funds-supplying
operation against pooled collateral and start providing additional funds amounting to
approximately 10 trillion yen with a six-month term. The Bank believes that the monetary
easing measure, together with the government's efforts, will be effective in further ensuring
Japan's economic recovery.
Downside risks to Japan's economy, however, still require close monitoring amid the growing
uncertainty about the future, especially for the U.S. economy. The Bank recognizes that
Japan's economy faces the critical challenge of overcoming deflation and returning to a
sustainable growth path with price stability. With such recognition, the Bank has been striving
to pursue powerful monetary easing. The Bank will continue to carefully examine the outlook
for economic activity and prices and, if judged necessary, will take policy action in a timely
and appropriate manner.
B. Fund-provisioning measure to support strengthening of the foundations for
economic growth
The strong easing measure discussed so far is designed to work on short-term
cyclical economic activity, but it is important that Japan maintain and enhance its medium- to
long-term economic growth potential. Recognizing this, the Bank sought a way of
contributing to such a task as the central bank, and in June 2010 introduced the
fundprovisioning measure to support strengthening the foundations for economic growth, with
loans totaling 3 trillion yen. This measure has the same characteristics as other
fundprovisioning measures, in that it supplies funds against eligible collateral submitted to the
Bank, but it differs in that the maximum duration of loans is four years and loans are provided
to each counterparty based on the counterparty's actual amount of lending and investment
carried out as part of the plan to strengthen the foundations for economic growth submitted
to the Bank.
The fund-provisioning measure does not aim to fully fund the foundations for economic
growth, but to act as a catalyst for financial institutions to make efforts toward strengthening
the foundations for economic growth. The first new loan disbursement was carried out at the
end of August 2010, involving more than 460 billion yen provided to 47 borrower financial
institutions, ranging from major banks to shinkin banks, that span a wide range of business
areas and regions. Records of individual investment or lending by these institutions
submitted to the Bank, making them eligible to receive funds from the Bank's first loan
disbursement, show that investment and lending were conducted in broad areas: investment
or lending in "environment and energy business" was particularly prominent, followed by
investment or lending in "development and upgrading of social infrastructure," "medical,
nursing care- and other health-related business," "business in the content creation industry,"
and "disaster prevention business." The results of the first new loan disbursement also show
that loans were made for long-term investment or lending, and this meets the objective of the
measure: the distribution of individual investment or lending by duration reveals that more
than 80 percent of the investment or lending is designed to be carried out over a period of
more than four years, with an average investment or lending term of 8.2 years. The new
measure, intended to act as a catalyst for financial institutions, has gotten off to a relatively
smooth start.
As pointed out with regard to the U.S. economy, expectations for economic growth and
expanded productivity have played an important role in achieving sustainable economic
growth. In other words, without prospects for increases in income and demand, firms remain
cautious about investing and households remain cautious about increasing consumption.
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 that
strengthening the foundations for economic growth implies improving productivity through
innovation and structural changes.
Improved productivity may give the impression that an increased supply of goods and
services would widen the output gap - that is, the differential between supply and demand -
and make it more difficult to overcome deflation. However, as many here will know,
innovation and the application of technology often generate new high-value-added goods
and services, thereby creating new demand. For example, the development of light emitting
diodes (LEDs) - which have been produced in large quantities here in Tokushima Prefecture
as light sources - has created new demand for products such as liquid crystal display
televisions, fluorescent-type LED lamps for the home, and LED lighting for use on fishing
vessels. Improved productivity thus means creating higher-value-added goods by making
use of increased efficiency in labor and capital. As a scholar, even before I became a
member of the Bank's Policy Board, I have been very much interested in the effects of
productivity on the economy. Using data available on Japan to conduct empirical studies, I
found that improved productivity, while increasing supply, results in a major increase in
demand and narrows the output gap.
Bearing in mind the future for Japan's economy, it is vital to create an environment that
enables firms - from a medium- to long-term perspective - to show their "animal spirits" and
willingness to meet challenges head on in order to achieve both greater competitiveness that
could lead to higher productivity and create new value added. As I have said, the Bank's
fund-provisioning measure to support strengthening the foundations for economic growth is a
catalyst for financial institutions, while its measures to enhance monetary easing - including
the new market operation introduced in August - have helped the private sector achieve the
same objective.
Chart 1
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BIS Review 162/2010
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BIS Review 162/2010