Ryuzo Miyao: Economic activity and prices in Japan and monetary policy
Speech by Mr Ryuzo Miyao, Member of the Policy Board of the Bank of Japan, at a meeting
with business leaders, Hakodate, 14 September 2011.
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Introduction
Thank you for giving me this opportunity to exchange views with people representing
southern Hokkaido, particularly the area around Hakodate. And I would like to express my
gratitude to everyone for your cooperation in the various business operations of the Bank of
Japan's Hakodate Branch.
Japan's economy temporarily suffered a steep decline after the Great East Japan
Earthquake occurred on March 11. I am aware that the Hakodate area was no exception and
was likewise affected by the disaster. Nevertheless, the efforts of all parties concerned to
work toward economic recovery are paying off in a number of ways. The challenge will
continue for the time being, and the Bank will do its utmost to support the efforts being made.
Today, I will present an overview of economic activity and prices in Japan, which is in the
process of recovery, followed by remarks on monetary policy. In my conclusion, I will touch
on the economy of southern Hokkaido, particularly the area around Hakodate.
I. Economic activity and prices in Japan
A. Overview
Japan's economic activity has been picking up steadily while the supply-side constraints
caused by the disaster have been mostly resolved and, in particular, production and exports
have recently been on an increasing trend. On the demand side, business fixed investment,
housing investment, and public investment are expected to increase, on the way to restoring
capital stock. Private consumption is picking up as household sentiment has improved.
Japan's economy is expected to return to a moderate recovery path as production activity
increases with the resolution of supply-side constraints. While the current solid recovery,
mainly in production, is welcome if it continues this autumn onward, there are also some
concerns. These include a slowdown in overseas economies, prolonged appreciation of the
yen, a rise in electricity costs, and possible protraction of deflationary expectations.
In the following, I will give an overview of overseas economies and then Japan's economy,
which is in the process of recovery, and discuss points to note in the current and future
situations.
B. Overseas economies
Let me first talk about the U.S. economy. Although the economy is recovering, the pace is
slowing remarkably. Since the Lehman shock, the United States has been suffering
balancesheet adjustments in the household sector, a problem in which households incur excessive
debts and a protracted period is required for resolution. In addition, since April 2011, a
bottleneck in supply chains associated with the Great East Japan Earthquake has surfaced
in the form of disruption of supply in automobiles and automobile-related parts, and gasoline
prices have surged reflecting a hike in international commodity prices. Moreover, a cutback
in local government spending has proceeded. As a result, consumption has been contained
due to a slowdown in real income, production has slowed, and employment has grown at a
sluggish pace. Of course, positive developments have also occurred. Exports, corporate
profits, and business fixed investment have been firm, benefiting from emerging economies
whose domestic demand is robust as well as the U.S. dollar's depreciation, and stock prices
have been at a relatively high level. However, real GDP for the April-June quarter on an
annualized quarter-on-quarter basis, announced at the end of July, was 1.3 percent (later
revised downward to 1.0 percent) and real GDP for the January-March quarter was
0.4 percent, reflecting a rapid slowdown in private consumption. An annual revision
conducted at the same time showed that real GDP has yet to recover to the level prior to the
Lehman shock.
Particularly since late July, markets have become highly volatile, as seen in a plunge in stock
prices, and household and business sentiment has declined due to various events such as
political turmoil over the federal debt ceiling, a series of deteriorating economic indicators
such as ISM manufacturing and nonmanufacturing indexes and consumer spending, and a
downgrading of U.S. Treasuries by Standard and Poor's from triple A to double A plus.
Longterm interest rates have also been declining. In response to this situation, at the Federal
Open Market Committee (FOMC) meeting held on August 9, the Federal Reserve Board
stated that the current economic conditions were likely to warrant exceptionally low levels of
0-0.25 percent for the federal funds rate at least through mid-2013. While volatility in the
financial markets has been contained to some extent, many of the economic indicators of
consumer and business confidence have remained weak. In addition, in a situation where
concern over the European sovereign debt problem has been reignited, it seems that the
trend of risk aversion in the financial markets is continuing.
Meanwhile, one after another, private research institutes have revised downward their real
GDP outlook for the second half of 2011 and for 2012. Judging from employment statistics
and a manufacturing survey for August 2011, the pace of economic recovery is likely to
remain very moderate. At the FOMC meeting in late September, it is expected that the Fed
will deepen discussions on additional easing by extending the duration of the meeting from
one day to two, and the Fed's potential actions have been drawing attention.
The European economy grew strongly at 3.4 percent on an annualized quarter-on-quarter
basis in the first quarter of 2011, but slowed to 0.6 percent in the second quarter. As in the
United States, the European economy was affected by the surge in international commodity
prices and partly by the disaster in Japan, but the main reason for the decline was the
economic slowdown in Germany and France, which had been driving growth in the euro
area. In the second quarter, Germany's growth was 0.5 percent on an annualized
quarter-onquarter basis, versus 5.5 percent in the first quarter, and France's growth was minus
0.0 percent, compared to 3.6 percent in the first quarter. The slowdown seems to reflect a
drop in exports to the United States and Asian countries, and therefore it is a matter of
concern whether growth in both countries will recover in the third quarter, given that
European peripheral countries have been subject to low or negative growth due to fiscal
austerity.
Since July, economic activity in the euro area has been lacking signs of resilience, as
confirmed by various economic indicators such as business confidence indexes, industrial
output, and the unemployment rate. As for the European sovereign debt problem, additional
support for Greece was decided at the European Union leaders' summit on July 21 and
sovereign bonds spreads against German government bonds and the credit default swap
(CDS) rate temporarily narrowed significantly; however, since the root cause of the debt
problem was not addressed, tensions spilled over to Italy and Spain, resulting in a spike in
government bond yields in both countries, and financial markets became destabilized.
Against this backdrop, the European Central Bank decided on August 4 to reinstate a
liquidity-providing supplementary longer-term refinancing operation with a maturity of
approximately six months, and to restart bond purchases under the Securities Markets
Programme. Some countries - France, Italy, Spain, and Belgium - started to restrict
speculative moves, and on August 11 they decided to ban short selling of financial stocks,
with Italian and Spanish government bond yields declining as a result. European financial
markets have remained unstable, however, with a rise again in Greek government bond
yields and a decline in stock prices, mainly of financial institutions. Since the outbreak of the
Greek crisis in May 2010, the number of countries targeted by the markets has increased.
While support by the monetary and fiscal authorities has expanded during this time, tensions
have spread even to Italy and Spain, and thus risks associated with the European sovereign
debt problem seem to be on the rise.
Concern from now on is the spillover of the European sovereign debt problem to the
financial/banking sector and economic activity. As this spillover appears to have partly
surfaced in the form of a rise in financial institution CDSs and a widening in corporate bond
spreads, further developments should be monitored carefully.
Asian emerging economies have been growing at a high rate, led by China, and medium- to
long-term growth expectations appear to have remained high. However, due partly to
monetary tightening conducted with a view to containing inflation, recent economic indicators
have been showing signs of a slowdown. This can be seen, for example, in the declining
trend in China's manufacturing purchasing managers index. In addition, Japan's disaster
adversely affected ASEAN countries in the April-June quarter.
While the effects of the disaster appear to have almost run their course as of July, external
demand might slow down from now on reflecting a slowdown in the recovery in the United
States and Europe. Domestic demand is robust, but, given continued concern over inflation,
further monetary tightening is necessary. For example, while China has been intermittently
raising bank lending and deposit rates as well as the reserve requirement ratio since the
beginning of 2011, year-on-year growth in the consumer price index (CPI) has remained
high, at 5.5 percent in May, 6.4 percent in June, 6.5 percent in July, and 6.2 percent in
August. Whether the Chinese economy can make a soft landing will be critical in ensuring
the sound development of the global economy, and therefore, developments in China
continue to warrant close attention.
Besides the problem of inflation, it should be noted that there is a risk in China that part of
the large-scale investment made through local government investment vehicles might
become nonperforming. In other words, considering China's economic outlook from a
somewhat longer-term perspective, the high-growth track led by investment is likely to
continue for the time being. However, if such large-scale investment continues for a long
time, some of it might become excessive in inefficient areas and financial institutions'
massive loans might become nonperforming. I will pay close attention to whether China can
maintain a balance between price stability and economic growth from a somewhat
longerterm perspective.
C. Japan's economy
Japan's economy is on the path to recovery following a plunge in growth due to the effects of
the March 11 disaster. The real GDP growth rate in the second quarter on an annualized
quarter-on-quarter basis, was minus 2.1 percent, marking three consecutive quarters of
negative growth - that is, minus 2.5 percent in the fourth quarter of 2010, minus 3.6 percent
in the first quarter of 2011, and minus 2.1 percent in the second quarter of 2011. After the
earthquake, firms' production activity plunged, consumer sentiment worsened, and labor and
income conditions deteriorated, due mainly to the constraints of supply chains and the
nuclear accident. As a result of strenuous efforts by the parties concerned, the economy has
recently been recovering, mainly in production, at a high pace. Production and exports have
nearly returned to their levels prior to the earthquake, and private consumption has been
gradually recovering due partly to demand stemming from the transition to digital terrestrial
transmission and power saving. Business fixed investment has also been picking up, and
household and business sentiment has been generally improving. In the meantime, the Bank
enhanced monetary easing on March 14 following the earthquake, and on April 7 decided to
introduce the funds-supplying operation to support financial institutions in the disaster areas.
The real GDP growth rate on an annualized quarter-on-quarter basis in the third quarter is
likely to turn positive, according to private surveys. Production, mainly that of automobiles,
continues to be at full capacity, and recovery demand is likely to gradually increase.
Following the removal of the supply constraints, moderate economic recovery, generated by
production and exports, is likely to continue.
Having said that, the future scenario for economic recovery is associated with the following
concerns and thus warrants vigilance.
First, as already stated, there is a possibility that overseas demand will be weaker than
initially envisaged amid the slowdown in the economic recovery in the United States and
European advanced economies, and this might make Japan's economic recovery weaker
than expected.
Second, the prolonged appreciation of the yen. If the appreciation of the yen continues in
response to the events such as downgrading of U.S. Treasuries, conditional maintenance of
the U.S. zero interest rate policy until mid-2013, and the renewed European sovereign debt
problem, concern will grow regarding the hollowing out of domestic industries.
There are both positive and adverse effects of the yen's appreciation on economic activity,
and the basic response to it should be to maximize the positive benefits and mitigate the
adverse effects as much as possible. In this regard, one can point to such positive effects as
providing firms and consumers with imported raw materials, products, and commercial goods
at lower prices, as well as facilitating domestic firms' equity investment and acquisitions of
overseas firms and projects, thereby raising the domestic firms' productivity. On the other
hand, the adverse effects, needless to say, include exposing domestic automakers and
electrical machinery manufacturers to severe price competition with overseas firms and thus
lowering profitability.
The important point here is that, while the prices of various goods and services have been
steadily rising in the markets to which Japanese firms export - including Asian emerging
economies and the United States - automobiles and electrical machinery products have
been competing severely with overseas products and their prices have been declining
markedly in these markets. Therefore, Japanese exporters of these products will be forced to
fiercely compete without being able to mitigate the impact of the yen's appreciation through
inflation in the export destinations. As developments in exports are linked with domestic
production and thus have a substantial impact on Japan's economy, downward pressure
from the yen's appreciation tends to become strong. In addition, if the yen's appreciation
leads to a relocation of key factories as well as research and development (R&D) bases, the
adverse effects on the economy's potential growth are a concern. Based on this
consideration, I believe it is meaningful that the government is considering support for R&D
in the manufacturing sector and small and medium-sized subcontractor firms, to alleviate the
pain associated with the yen's appreciation and prevent the hollowing out of domestic
industries.
Third, a rise in electricity costs. This summer, the shortage of electricity did not substantially
affect the production level, thanks to firms' creativity and endurance as well as individuals'
efforts to save electricity. As a shift from nuclear power to alternative energy sources is likely
from a long-term perspective, corporate profits could come under persistent pressure and
some firms might have to shift their businesses overseas if electricity costs - including the
imports of alternative energy sources - increase.
Fourth, protracted deflationary expectations. In August 2011, the base year for calculating
the CPI was switched from 2005 to 2010, and as a result the year-on-year rate of change in
the CPI components (all items less fresh food) was revised downward by 0.5 to
0.8 percentage point. The year-on-year rate of change in the new 2010-base CPI (all items
less fresh food) was minus 0.2 percent in April, minus 0.1 percent in May, minus 0.2 percent
in June, and 0.1 percent in July. Private research institutes had originally forecasted that the
year-on-year rate of change in the CPI (all items less fresh food), because of the change in
the base year, would decline from the recent level of around 0.6 percent to around 0 percent.
The Bank's forecasts were almost within the same range, and it has been confirmed that it
will still take some time to achieve price stability.
If expectations for the continuation of the zero interest rate become protracted in a situation
where more time is needed to achieve price stability, there is a risk that people's deflationary
expectations will intensify in a self-fulfilling manner. If by any chance deflationary
expectations prevail, it will become difficult to change the behavior of people who are
reluctant to take risks; people might postpone spending, and growth expectations would be
unlikely to increase. There is a risk that the economy will be unable to escape from such a
situation, which might be called a "deflation and low-growth trap." At present, even following
the change in the base year, it is still the case that the economy is emerging from deflation
amid the narrowing output gap, and careful attention should be paid to any possible changes
in people's inflation expectations.
In this regard, there are factors, including an incremental rise in commodity prices, that will
push up the actual price trend with a lag. From October 2011 onward, the effects stemming
from a rise in tobacco tax and an increase in non-life insurance rates will disappear. Due
attention should be paid to whether these factors will again put downward pressure on the
CPI.
In the meantime, at the Monetary Policy Meeting held on August 4, the Bank decided to
enhance monetary easing by increasing the total size of the Asset Purchase Program by
about 10 trillion yen: 5 trillion yen for the fixed-rate funds-supplying operation against pooled
collateral and 5 trillion yen for asset purchases. While Japan's economic activity is picking up
steadily mainly in production, its economic outlook entails various downside risks. Taking into
account such downside risks, including uncertainty about overseas economies and effects
stemming from the base-year change in the CPI, the Bank decided to further enhance
monetary easing, thereby ensuring a successful transition from the recovery phase following
the earthquake disaster to a sustainable growth path with price stability. The Bank will
continue to take proper measures if necessary.
II. Monetary policy
A. Monetary policy at the zero interest rate
Now let me summarize the efforts taken to enhance monetary easing in a general context.
If the conduct of monetary policy, which controls the ordinary policy interest rate (the
uncollateralized overnight call rate in the case of Japan) is defined as "traditional monetary
policy," monetary policy that is pursued while the policy interest rate approaches the zero
bound is often called "unconventional monetary policy." When the policy interest rate is
lowered to around 0 percent, it becomes difficult to further enhance monetary easing.
Instead, there are other policy measures to further exert powerful monetary easing effects,
such as committing to continue the zero interest rate policy into the future or increasing the
size of a central bank's assets, or changing the composition of its asset portfolio.
The "comprehensive monetary easing" implemented in Japan from October 2010 can be
interpreted precisely as an "unconventional monetary policy package" that includes all the
elements just mentioned. Namely, the Bank has confirmed that it will maintain the virtually
zero interest policy until it judges that price stability is in sight, and it has been purchasing
various financial assets such as government securities, corporate bonds, CP,
exchangetraded funds (ETFs), and Japan real estate investment trusts (J-REITs). Successive
monetary policy measures in the United States conducted following the Lehman shock were
similar in that they included large-scale asset purchases such as mortgage-backed securities
and government securities, changes in the composition of assets, and the continuance of the
zero federal funds rate policy, at least through mid-2013 given the conditions of economic
activity and prices.
All these measures are expected to work on firms' and households' spending and investors'
portfolio selection by encouraging a decline in longer-term market interest rates and various
risk premiums, and to ultimately influence economic and price conditions.
Regarding the effects of comprehensive monetary easing, as far as financial market
developments are concerned, we at the Bank believe that it has had certain positive effects.
Credit spreads on CP and corporate bonds have declined, and stock and J-REIT prices have
been firm on the whole. We consider these effects have played a role in underpinning
economic activity and prices.
With regard to the unconventional policy measures in the United States, particularly the
large-scale government bond purchase program - the so-called "quantitative easing II,"
implemented from November 2010 to June 2011 - there has been controversy about the
effects of the policy measures. Supporters of the effects have pointed out that the measures
have dispelled deflationary concern, raised stock prices, improved consumer confidence,
promoted exports due to the U.S. dollar depreciation, and enabled prompt repayment of
injected public capital through a rise in stock prices. On the other hand, critics of the effects
have indicated that economic indicators including employment have not improved markedly,
a mini-bubble in stock prices has formed and burst, a surge has been induced in international
commodity prices such as crude oil and gasoline, real income of low-income families (who
are unlikely to benefit from the surge in asset prices) has been reduced, and inflation has
been exported to emerging countries. Assessments of the policy measures are diverse, in
that some emphasize the positive effects of the measures while others cast doubt on the
policy effects or claim that unexpected side effects were far too large. The controversy
seems to suggest that it is difficult to grasp and foresee the size and channels of the policy
effects in advance.
B. Effects of monetary policy measures: a comparison of traditional and
unconventional policies
Is there a substantial difference between traditional and unconventional policies concerning
monetary policy effects and their transmission channels?
In traditional monetary policy, an expected transmission mechanism is to work on borrowing
costs, various asset prices including stock prices and foreign exchange rates, and bank
credits both through the interest rate channel and the portfolio adjustment channel. These, in
turn, influence firms' and households' spending behavior and ultimately economic activity
and prices.
Such a transmission mechanism of traditional monetary policy, in theory, also holds true for
unconventional policy. Influencing longer-term interest rates and various risk premiums is
nothing more than the interest rate channel and the channel through portfolio adjustments
and asset prices, both of which I have mentioned above. Almost all of the aforementioned
controversy over the policy effects in the United States can be explained in terms of the
traditional transmission channels.
On the other hand, some arguments remain to be specifically pointed out about transmission
mechanisms in unconventional policy, even though the qualitative mechanism in traditional
and unconventional policies is the same.
The first is about the effect of stabilizing financial systems and financial markets. This is the
effect of soothing anxiety about financial systems by supplying ample liquidity to financial
institutions, or the effect of stabilizing financial markets by central bank interventions when
the markets become excessively risk averse and the market mechanism deteriorates,
resulting in a surge in risk premiums. By preventing financial anxiety and preventing the
markets from plunging, adverse effects on economic activity can be prevented.
The second is about the effect of international spillover. With expectations for a protracted
zero interest rate, global investors will search for yield or become active in the carry trade
and risk taking, and capital will flow into high-interest-rate and commodity-exporting
countries. This will then expand economic activity and raise stock prices in overseas
emerging economies. As a result, there will be an effect that spills over to domestic economic
activity and prices through an increase in exports to the emerging economies and an
improvement in profits of global firms.
The third is about the effect through the expected rate of inflation. This is the effect that, in
addition to the existing channel of influencing demand, by attaching an expectation that a
central bank's balance sheet will expand for a protracted period, the expected rate of inflation
will rise and real interest rates will decline, thereby affecting economic activity and prices.
While these transmission mechanisms of monetary policy effects can be considered, the side
effects will be a source of concern if monetary easing becomes excessive. As for the first
effect I mentioned, if a central bank excessively intervenes in the markets and suppresses
risk premiums too much, this might ruin the intrinsic function of the markets of making prices
according to risks. In addition, financial institutions' profits might be compressed. By
encouraging excessive risk taking, the second effect could induce economic overheating or a
credit bubble in the countries receiving the capital inflows and subsequently cause a serious
economic downturn. As for the third effect, if excessive balance-sheet expansion continues,
the expected rate of inflation might rise unexpectedly or the markets might realize that the
balance-sheet expansion is an undisciplined monetary increase or the monetization of
government debts, leading to a surge in government bond yields.
It is necessary to take due account of the possibility that unconventional monetary easing will
be associated with such unique side effects.
C. Points to keep in mind
Based on the summary I have just given, there are several points to keep in mind.
First, as the transmission channels of the monetary policy effects overlap or are mutually
related, it is quite difficult, if not impossible, to recognize each transmission channel
separately or measure its quantitative effects. In particular, policymakers lack experience
with respect to the effects and side effects of unconventional policy. And an economic
situation that requires such a policy often occurs in the midst of severe and protracted
economic stagnation following a financial crisis, in which firms and households have
shouldered excessive debts. Therefore, it could indeed be an economic environment in
which a normal transmission mechanism cannot function properly. Taking into account that
there is limited experience with unconventional policy and such a policy is bound to face a
difficult economic environment, it becomes crucial to make a comprehensive and deliberate
judgment that requires vigilance for unexpected side effects, while referring to prior policy
experience.
Second, in a financial and economic environment after the effects of unconventional
monetary policy spread in a desirable way, interest rates will rise in a positive sense. When
somewhat longer-term interest rates decline or risk premiums fall by way of accommodative
monetary policy, funds' borrowers - for example, firms - can increase borrowing based on
low interest rates, or can purchase many more capital goods by issuing new shares thanks to
a rise in stock prices, thereby increase business fixed investment. As a result, economic
activity and prices will rise. In the aggregate, stock prices will rise, and bond prices will fall
and the interest rate will increase. As for investors, they feel discouraged by a decline in
profitability due to the initial decline in interest rates, and they will try to sell low yield bonds
and purchase other assets including stocks. As a result, asset prices including stock prices
will increase and bonds will be sold and interest rates will rise.
Consequently, at the transmission channel in which monetary policy effects surface gradually
and the economy grows steadily, it is natural that longer-term interest rates initially will fall
and then rise in due course. On the contrary, if longer-term interest rates remain low, this
would imply prolonged low growth, given that inflation expectations are unchanged.
As a footnote, let me point out that one needs to be careful in discussing the effects on an
economy of a case in which interest rates are increasing in a desirable way. For example, in
case of fiscal consolidation, if the assumed interest rate level rises, it will increase the
interest burden in public finance. On the other hand, an increase in revenue can be expected
from a rise in economic growth. Thus, it is important to discuss fiscal consolidation by taking
account of these two effects.
Third, desirable strengthening of growth potential cannot be achieved by monetary policy
alone. To begin with, it is understood that strengthening of an economy's growth potential will
be promoted primarily by structural reform efforts in the private sector and the government's
growth strategy to support such efforts. Having said that, monetary policy might have
medium- to long-term effects on the economy, in addition to an effect of containing
shortterm and cyclical swings in economic activity. In an ideal case, monetary easing might
contribute to strengthening productivity and growth potential by promoting quality business
fixed investment as well as R&D investment. In an undesirable case, there is a risk that
monetary easing will amplify swings in the economy in the medium to long term by
encouraging excessive risk taking and excessive business fixed investment, or that
undisciplined monetary easing will induce the erosion of confidence in the currency with an
unexpected timing and induce a surge in interest rates. Therefore, it is important to recognize
that potential effects of monetary policy could have both positive and negative effects on
medium- to long-term economic growth.
In relation to strengthening the medium- to long-term growth potential, the Bank has been
conducting the Fund-Provisioning Measure to Support Strengthening the Foundations for
Economic Growth since June 2010. With this measure, the Bank supplies long-term funds
- with an initial duration of one year and a maximum duration of four years - at a low interest
rate of 0.1 percent to qualifying financial institutions. The measure has already reached the
initial total amount of 3 trillion yen and has been playing the role of a catalyst. In addition, in
June 2011 the Bank decided to introduce a new line of credit of 500 billion yen. Through this,
the Bank provides long-term funds, with an initial duration of two years and a maximum
duration of four years, at a low interest rate of 0.1 percent to financial institutions that
undertake equity investments and asset-based lending. The Bank expects that the new
measure will further enhance financial institutions' efforts to strengthen the foundations for
economic growth through the use of a wider range of financial techniques including
assetbased lending.
I have talked about the transmission channel of monetary policy effects and some points that
should be kept in mind. As I mentioned earlier, when conducting actual monetary policy,
deliberate and decisive actions are required while considering carefully various conditions
and possibilities and identifying the timing and measures that will produce maximum positive
effects and keep side effects to a minimum overall. In a highly uncertain economic
environment, the Bank will continue to consistently make contributions as the central bank,
by pursuing powerful monetary easing consisting of comprehensive monetary easing,
ensuring financial market stability, and providing support to strengthen the foundations for
economic growth.
Concluding remarks
In my concluding remarks, I would like to say a few words about the economic potential of
southern Hokkaido, particularly the area around Hakodate.
There has been downward pressure on economic activity in the region, mainly in the key
industry of tourism, due to the effec