Hidetoshi Kamezaki: Recent economic and financial developments in
Japan
Speech by Mr Hidetoshi Kamezaki, Member of the Policy Board of the Bank of Japan, at a
meeting with Business Leaders, Kochi, 25 March 2010.
* * *
I. Economic developments
A. Global economy
First, let me provide an overview of economic developments worldwide until recently.
After the global economic slowdown due to the bursting of the IT bubble and the confusion
over the severe acute respiratory syndrome (SARS) in the early 2000s, the global economy
enjoyed a period of high growth led by strong demand from emerging economies.
Industrialized countries also maintained relatively high growth, as the prolonged period of low
interest rates stimulated investment and consumption. However, in the United States, amid
the declining risk awareness among investors, loans to borrowers with a deficient credit
history - that is, subprime mortgages - were extended based on the assumption of
evergrowing home prices. Housing investment consequently increased, pushing up home prices
further, which in turn encouraged homeowners both to take out loans using their houses as
collateral, and to boost their spending. Behind this phenomenon, European and U.S.
financial institutions purchased and pooled a large number of mortgage claims, restructured
them into securitized products - for which credit ratings appeared high as a result of financial
engineering - and then sold those products to investors worldwide.
However, when U.S. home prices started to fall after reaching a peak around the middle of
2006, the virtuous circle based on the assumption of ever-growing home prices began to
reverse. U.S. households that borrowed beyond their means defaulted on their payment
obligations, while there was a marked increase in the losses suffered by European and U.S.
financial institutions as well as investors worldwide that had purchased mortgage-related
securitized products, all as result of the decreased creditworthiness of mortgage-related
products that backed those securitized products. This brought about the turmoil in European
and U.S. financial markets around summer 2007, and against this background, the failure of
Lehman Brothers in September 2008 triggered the global financial crisis. It led to a vicious
circle - that is, an adverse feedback loop between financial and economic activity - in which
the difficulties and failures of financial institutions and the turmoil in financial markets left
funding for firms and households unstable, while the resultant deterioration in economic
activity in turn had a negative impact on financial institutions and markets. In this phase,
global economic conditions, including those of emerging economies, deteriorated
substantially, although just before the emergence of the global financial crisis, it was widely
acknowledged that there had been a decoupling between the economic slowdown in
industrialized countries and the strength in emerging economies.
The subsequent aggressive monetary and fiscal policies taken around the world to support
the economy helped initiate progress in the adjustment of excessive inventories, starting
around spring 2009. Since then, the global economy as a whole - despite some national and
regional differences - stopped worsening and headed toward a moderate recovery.
Looking at developments by region, the U.S. economy was recovering, albeit at a moderate
pace, supported by the 780 billion U.S. dollar stimulus package and a rescue package for
financial institutions that faced financial difficulties. However, there has been no notable
improvement in weak areas of the economy, such as housing markets, commercial real
estate markets, employment, and small financial institutions' business conditions. Therefore,
there is concern that adjustments made by various economic entities to still-fragile balance
sheets might continue to be a drag on economic growth.
In the euro area, albeit with some national differences, economic activity is picking up,
supported by an increase in exports led by the global economic recovery. However, the pace
of recovery in domestic demand is lagging, mainly due to weak private consumption
reflecting anxiety about employment in the future. In particular, the expanding fiscal deficits in
some countries, such as Greece, Spain, and Portugal, has caused concern in financial
markets, thereby putting downward pressure on the economy in the euro area as a whole.
Since all European Union member states, including these countries, are required to reduce
fiscal expenditures as laid down in the Stability and Growth Pact, I will pay attention to future
economic developments in the area, including the effects of expenditure reduction efforts.
The U.K. economic activity has started to pick up, mainly due to an increase in exports
boosted by the depreciation of the pound sterling.
In Asia, the Chinese economy has continued to grow at a relatively rapid pace, mainly
because of the hike in fixed asset investment due to the 4 trillion renminbi stimulus measure
adopted immediately after the Lehman shock. China's exports have also been growing
recently, owing to the global economic recovery. The current concern, therefore, relates to
the overheating of the economy, and the authorities have started to implement measures to
restrain this. The economy is unlikely to decelerate in 2010, however, partly because of the
effects of the World Exposition to be held in Shanghai. Nonetheless, if the measures to
restrain overheating are insufficient, attention should be paid to the possibility that the rise in
real estate prices might accelerate further, driving the economy into a full-scale bubble.
Economic conditions in the NIEs and the ASEAN countries are recovering as a result of
increased exports and production - supported mainly by demand from China - which are
leading to improvement in private consumption and a pick-up in business fixed investment.
The Indian economy has also continued to grow at a relatively rapid pace, with its exports
and domestic demand being generally favorable.
In sum, the global economy as a whole is experiencing a moderate recovery, a trend that is
likely to continue despite there being various risks. Yet, the contrast between the situations in
industrialized countries and in emerging and commodity-exporting economies is likely to
become even more striking. Specifically, in industrialized countries, the momentum of
selfsustaining economic recovery is likely to be only moderate due to strong adjustment
pressure persisting on various economic entities' balance sheets, while in the emerging and
commodity-exporting economies, where there is no such pressure, strong growth has been
achieved partly due to an indirect effect of fiscal and monetary policies taken around the
world.
B. Japan's economy
I will now turn to Japan's economy.
The post-bubble period of Japan's economy is often referred to as the "lost decade" or the
"15 lost years," but the economy actually experienced three phases of expansion during the
period. In particular, the expansionary phase that began in 2002 lasted more than five years,
marking the longest period of postwar expansion, supported by the high growth in the global
economy. However, in autumn 2007, Japan's economy fell into a contraction phase,
reflecting the downturn in the U.S. economy. Japan's economy then deteriorated rapidly, as if
rolling downhill, following the turmoil in the financial markets triggered by the Lehman shock
and the subsequent steep decline in exports and production.
Several points could be noted as reasons for the economy of Japan having deteriorated far
more severely than that of the United States and Europe where the recent financial crisis
originated. First, Japan's economy was hit hard by the downturn in the global economy
because manufacturing industries of durable goods, such as general machinery, electrical
machinery, and transport equipment, account for a large share of the overall economy, and
the ratio of exports in such industries is high. Second, these manufacturing industries are
linked to a wide range of domestic industries, and therefore the fall in exports broadly
affected domestic industries, including those that do not directly engage in export-related
activities.
Since then, as the global economy has stopped worsening and is headed toward recovery,
Japan's exports and production hit bottom at the beginning of 2009, since when it has been
recovering, mainly in the area of items meeting demand from China. Japan's economy has
ceased to deteriorate and started to pick up, despite the increasingly severe employment and
income situation, on the realization of the positive effects of the government's stimulus
measures that favor energy-efficient products, such as tax reductions applied to purchases of
environment-friendly cars and the eco-point system for electrical appliances. However, there
has not yet been sufficient momentum for self-sustaining recovery in domestic private final
demand.
In terms of economic outlook, it is expected that the effects of inventory restocking and policy
measures, which have been driving growth, gradually will abate. Against this background and
given the severe employment and income situation, there may be a leveling off in the area of
private consumption, which has been picking up recently. Meanwhile, business fixed
investment is likely to pick up gradually as firms can no longer postpone investment plans,
especially in light of pressing replacement demand.
In sum, I expect that the trend toward gradual economic recovery will continue. The situation
warrants careful attention, however, as many firms remain cautious about increasing
domestic investment and employment due to uncertainty concerning the outlook.
II. Price developments in Japan
A. The recent situation and the outlook
Next, I will talk about price developments against the background of the recent economic
situation I have just described. International commodity prices, which have a major impact on
Japan's domestic prices, surged at the start of the new century as commodity markets
tightened due to strong demand from and robust growth in emerging economies,
compounded by an inflow of speculative funds. Commodity prices then plunged as a result of
the rapid unwinding of speculative funds from commodity markets, prompted by the Lehman
shock and the subsequent financial market turmoil and global economic deterioration. These
commodity prices, however, have since resumed an upward trend in response to the recent
moderate recovery in the global economy.
Some items in the consumer price index (CPI) excluding fresh food (the core CPI), such as
the prices of petroleum products and food, started to show a definite rise around the end of
2007, reflecting the surge in international commodity prices. In the middle of 2008, the
yearon-year rate of increase in the core CPI was around 2.5 percent, marking the largest rise
since the early 1990s if we exclude the effect of the 1997 consumption tax increase.
Subsequently, commodity prices fell, causing the year-on-year rate of change in the core CPI
to a decline. In summer 2009, the rate of decline in the core CPI hit roughly 2.5 percent,
marking the sharpest fall ever. The pace of decline in the core CPI has recently been
moderating, underpinned by the rise in prices of petroleum products. However, in January
the CPI excluding food and energy, or the core-core CPI, which is not usually susceptible to
fluctuations in commodity prices, fell 1.2 percent year on year, marking the largest drop so
far.
Regarding the outlook, the pace of decline in the core CPI is expected to slow, as the robust
economic growth in emerging economies is likely to keep commodity prices high and the
negative output gap is likely to narrow as the economy recovers. However, it is unlikely that
an upturn in the trend of the core CPI will be achieved easily, since: the negative output gap
has been narrowing only moderately; there have been declines in both the inflation rate
currently perceived by households and that expected twelve months out; and the proportion
of households expecting prices to be lower in a year's time has increased. Such perceptions
could affect firms' price-setting behavior.
B. The cause of deflation
Japan's economy is currently experiencing deflation, a sustained decline in the general price
level. While the inflation rates in major economies have been declining since the 1990s and
marked a further fall after the Lehman shock, it is only in Japan that inflation has marked a
high negative rate in terms of the core-core CPI.
1. Output gap
One cause of deflation in Japan is its large negative output gap. When demand falls well
short of supply capacity for products, suppliers may opt to restrain rises in sales prices, or
reduce prices, to attain sales volumes. If this happens across the economy, the inflation rate
will falter. According to an International Monetary Fund (IMF) projection in the World
Economic Outlook, the output gap in Japan has remained consistently negative since the
second half of the 1990s, albeit with some cyclical fluctuations, and has been larger than in
other major economies. I believe this can be attributed to the excess supply capacity - a
legacy of the insufficient restructuring of industries, including their production facilities - that
remained out of line with sluggish domestic demand.
There are a number of reasons for the weakness in domestic demand, but the major one is
the lack of forward-looking investment since the bursting of the economic bubble, as a result
of the prolonged balance-sheet adjustments conducted by various economic entities. In
particular, the delay in financial institutions' disposal of impaired assets has weakened their
financial intermediary functions, thereby impairing their ability to provide sufficient funds for
new areas of growth. Although balance-sheet adjustments had been progressing significantly
from around 2005, the Lehman shock, which occurred before such adjustments had been
completed, triggered a plunge in overseas demand and, subsequently, a rapid widening of
the negative output gap, which in turn led to the present deflationary situation.
2. Inflation expectations
Although movements of the output gap and the inflation rate do not show a clear correlation,
a close look at data of the past phases reveals that a widening of the negative output gap
was followed by a decline in the inflation rate. However, over the long term, the actual
inflation rate has edged down even when the output gap has remained at the same level. It is
assumed that this is due to a decline in the medium- to long-term inflation expectations
among various economic entities. No one would rush to buy a product when he/she expects
its price to fall or remain almost unchanged. In such a situation, suppliers would set lower
prices to stimulate consumers' spending appetite. If this trend spreads across the economy,
the actual inflation rate will decline even when the output gap is at the same level.
The reason for the decline in medium- to long-term inflation expectations in the period from
the 1970s to the first half of the 1990s is that a rise in the prices of goods and services,
together with inflation expectations for the general price level, were contained by a
combination of factors such as stable crude oil prices, the continued appreciation of the yen
and resultant pressure to reduce the difference between domestic and foreign prices, as well
as deregulation and other measures to promote competition.
Nevertheless, since the latter half of the 1990s, the correlation between the output gap and
the actual inflation rate has been stable. At present, it seems that there is no major change in
medium- to long-term inflation expectations. However, as I noted earlier, there has been a
decline in the inflation rate that households anticipate twelve months out, and the proportion
of households expecting prices to be lower in a year's time has increased. If such a view
leads to a decline in medium- to long-term inflation expectations, it could become difficult to
overcome deflation. Therefore, a change in inflation expectations is an important factor that
requires careful monitoring.
C. The cost of deflation
The main reason for Japan's current deflationary situation is the widening of the negative
output gap. Deflation is disadvantageous for suppliers of goods and services but
advantageous for consumers. This phenomenon seems like a zero-sum game on the
surface, so, why is deflation said to have negative effects on the economy?
Price fluctuations, whether declines or otherwise, give rise to extra costs for society. For
example, sales price revisions incur costs for deliberations and negotiations prior to settling
on a price, and then for changing price tags. Such extra costs must be borne by some
entities within the economy. Furthermore, price revisions for a large number of products at
varying times and differing scales could hinder the efficient allocation of economic resources,
while uncertainty regarding price fluctuations would also add risk premiums to transactional
costs. In some cases, it might become difficult to conclude long-term contracts, thereby
affecting plans for consumption and investment. In addition, if price fluctuations cause a
change in the value of financial assets and liabilities that are fixed in nominal terms, or in the
real value of transactions and wages, distortions would arise in income distribution. Such
distortions would give rise to a sense of unfairness among those in different functional roles,
such as lenders and borrowers, or employers and employees. The possible loss of trust in
social fairness and equality would affect work ethic and incentives.
One of the costs unique to deflation is that real interest rates cannot decline to the level
corresponding to that of economic activity, since nominal interest rates do not fall below zero.
Furthermore, a rise in the real value of debt and the resultant increase in the burden on the
debtor may eventually lead to economic deterioration. In such a case, the real value of
creditors' assets would increase, but, since debtors' propensity to consume out of income is
generally higher than creditors', consumption in the overall economy would shrink. Therefore,
attention should be paid to the fact that there are costs unique to deflation.
III. Measures taken by the Bank
The Bank is gradually ending the measures that have been implemented to deal with the
"acute symptoms" manifested in the rapid contraction of financial market activity following the
Lehman shock in September 2008. At the same time, the Bank is putting forward additional
measures to dispel "chronic illness," namely deflation. Next, I will elaborate on the Bank's
monetary policy measures implemented since the Lehman shock.
A. Measures to address the acute symptoms, or the rapid financial contraction
Immediately after the failure of Lehman Brothers, financial market participants throughout the
world became overly cautious about their counterparts' creditworthiness, and there were
cases where even financially sound institutions found it difficult to acquire funds. During such
a rapid financial contraction, which we have described as acute symptoms, a central bank is
the sole provider of liquidity. Thus, from the day after the failure of Lehman Brothers, the
Bank successively injected abundant liquidity into the money market by conducting
sameday funds-supplying operations. Subsequently, it implemented measures to provide ample
liquidity to financial markets, such as increasing the amount of outright purchases of
Japanese government bonds and introducing U.S. dollar funds-supplying operations against
pooled collateral.
In Japan, it was the CP market that faced a particularly serious shortage of liquidity as
market participants withdrew their funds from the market, fearing the risk of corporate
failures. Firms that could no longer acquire funds through CP issuance flocked to banks for
financing. As banks tried to respond to the increased demand for loans, they found
themselves unable to afford to supply sufficient funds for small firms or firms with low credit
ratings, or for repo transactions. In this way, the liquidity shortage spread to various markets.
To address this situation, the Bank, in addition to increasing the frequency and size of CP
repo operations, introduced outright purchases of CP as a temporary measure. This was a
highly exceptional step, in that a central bank took on the credit risks of individual private
firms. The underlying objective was to facilitate corporate financing and resolve the liquidity
shortage in the CP market by helping to restore confidence in CP underwriting among market
participants. In addition, the Bank introduced a series of temporary emergency measures to
facilitate corporate financing, including: (1) the easing of the rating requirement for corporate
debt to be accepted as eligible collateral; (2) the special funds-supplying operation to
facilitate corporate financing (hereafter the special operation), through which the Bank
provided longer-term funds for an unlimited amount against the value of corporate debt
pledged as collateral at a very low fixed interest rate; and (3) outright purchases of corporate
bonds with a short residual maturity.
Furthermore, in order to ensure the accommodative financial environment, the Bank reduced
the policy interest rate - that is, the uncollateralized overnight call rate - from 0.5 percent to
0.1 percent, which is the lowest level in the world. In order to provide ample liquidity through
maintaining the policy interest rate at this low level, the Bank also introduced the
complementary deposit facility, whereby interest is made payable on excess reserve
balances held at the Bank by financial institutions.
At the same time, the Bank introduced temporary measures to secure the stability of the
financial system, given that the strains in global financial markets and the subsequent fall in
stock prices and rise in credit costs have greatly affected financial institutions' intermediary
function and financial soundness. Such measures include the stock purchases held by
financial institutions to help them reduce the market risk associated with stock holdings and
the provision of subordinated loans to banks to help them maintain sufficient capital bases.
B. Completion of measures to address acute symptoms after markets regained
stability
Subsequently, as the economy stopped worsening and headed toward recovery, while
financial markets regained stability, the amount of financial institutions' bids for central bank
funds started to fall short of the offered amount in the Bank's outright purchases of CP and
corporate bonds. In the CP market in particular, the issuance rates on high-rated CP
occasionally fell below yields on treasury bills, which in theory must command greater
creditworthiness. Furthermore, auction rates on ordinary funds-supplying operations tended
to decrease to such low levels that the advantages of the relatively low rates offered in the
special operation were eliminated. As a result, the Bank decided to end some of the
temporary measures adopted to deal with the acute symptoms. For instance, the Bank
decided in October 2009 to complete outright purchases of CP and corporate bonds, as well
as the special operation, at the end of December 2009 and March 2010, respectively.
C. Measures to address chronic illness, or deflation
The Bank is firmly committed to continuing its policy of maintaining the extremely
accommodative financial environment, given the moderate pace of economic recovery and
weak momentum for price increases. In fact, the policy interest rate is being maintained at a
low level of 0.1 percent and the complementary deposit facility remains in operation.
Furthermore, on December 1, 2009, in order to enhance easy monetary conditions, the Bank
introduced a new fixed-rate funds-supplying operation against pooled collateral (hereafter the
fixed-rate operation), whereby a large amount of funds totaling approximately 10 trillion yen
are to be provided at an extremely low fixed interest rate. This operation has contributed to
encouraging a decline in longer-term interest rates. On March 17, 2010, the Bank decided to
expand the measure to encourage a decline in these rates by increasing the amount of funds
to be provided through the fixed-rate operation to approximately 20 trillion yen, from the
previous amount of approximately 10 trillion yen.
Meanwhile, the Bank emphasized its stance on fighting deflation. Regarding the
"understanding of medium- to long-term price stability" (the level of inflation that each Policy
Board member understands, when conducting monetary policy, as being consistent with
price stability over the medium to long term; hereafter "understanding"), the Bank made it
clear that the Policy Board does not tolerate a year-on-year rate of change in the CPI equal
to or below 0 percent, and that the midpoints of most Policy Board members' "understanding"
are around 1 percent.
IV. Moving toward sustainable economic growth
As I have just explained, the Bank is making use of various policy tools to maintain the
extremely accommodative financial environment to overcome deflation. In the money market,
the interest rates applied for the Bank's funds-supplying operations have declined to 0.1
percent, and there are even cases in which financial institutions' bids fall short of the Bank's
offers. Market participants have become increasingly confident that they can acquire
sufficient funds at a low interest rate. Various types of interest rates have declined, including
those for funds transactions between financial institutions, market rates on Japanese
government securities, corporate bonds, and CP, as well as loans extended to firms and
households. It is hoped that the effects of monetary easing will further spread to other types
of interest rates, encourage vigorous activity by various economic entities, and in due course
lead to economic growth. However, a decline in interest rates alone may not be enough to
stimulate activity by private sector entities, namely, firms and households, and thereby raise
the level of overall economic activity.
So, what is necessary to encourage vigorous activity on the part of firms and households?
My belief is that the various economic entities need to free themselves from concerns about
the future and regain confidence in their ability to achieve sustainable economic growth. In
the post-World War II period, Japan has achieved high economic growth supported by the
continuous efforts of the Japanese people, who are hard-working by nature, and the belief
that they could achieve their high aim of catching up to the economic standards of European
countries and the United States. Yet, it seems that the Japanese people were unable to set a
new target once the goal of catching up had been achieved, and the ambition to achieve
further economic growth has weakened. This may be a factor behind the significant
economic slowdown since the 1990s.
In this situation, the government's "New Growth Strategy (Basic Policies)" released in
December 2009 is very meaningful, as it presents the objective with which the public would
seek to achieve sustainable economic growth. The measures laid down in the new policies
include Asia-focused strategies geared to benefit from growth in Asian markets; measures to
boost domestic demand - an issue requiring immediate action - with particular focus on
sectors related to environmental protection, energy, and an aging population with fewer
children, as well as farming and other food-related sectors. This is very much in line with my
viewpoint, as neglecting these sectors would inevitably lead to a decline in Japan's overall
economic strength, whereas proper attention would surely lead to the development of
promising businesses within these sectors. However, concrete plans for the new policies
have not yet been announced. I understand that such plans will be provided in the "Growth
Strategy Implementation Plan," which is scheduled to be released by June 2010 with more
specific and additional measures. I look forward to the release of the effective plans, so that
concrete measures aimed at new economic growth can be set in motion as early as possible.
Growth strategies - however ideal they might appear - can only serve to raise suspicions
regarding future sustainable growth, as well as add to the fears of fiscal bankruptcy and a
large increase in taxation, if they result in a further ballooning of the fiscal deficit, because
Japan suffers from by far the largest government debt of any industrialized country. Thus, it
is very important that the government's medium-term fiscal framework and fiscal
management strategy, also to be ready by June 2010, include measures to establish a
sustainable fiscal structure and present fiscal restructuring measures to ensure future
economic and fiscal soundness, thereby maintaining market confidence.
I am always aware that the Bank should implement policy measures proactively when
necessary, and its decision on March 17, 2010 to take an additional measure to enhance
easy monetary conditions was based on such thinking. The Bank will continue to make the
utmost effort to encourage various economic entities to regain confidence in their ability to
attain sustainable economic growth.