Haruhiko Kuroda: Overcoming deflation - the Bank of Japan's challenge
Speech by Mr Haruhiko Kuroda, Governor of the Bank of Japan, at the Council on Foreign
Relations, New York, 10 October 2013.
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Introduction
Good morning. I am honored to be given an opportunity to speak this morning at the
longestablished Council on Foreign Relations.
Today, I will talk about what Japan's deflation is all about and what challenges Japan is
faced with, followed by how the Bank of Japan is trying to overcome deflation.
I. Deflation that Japan has been experiencing
Japan has been mired in deflation for the past 15 years. Let me bring up some figures. In
Tokyo, the minimum fare for the subways of 160 yen, or 1.6 dollars, has not changed since
1995. During the same period, the fare in New York increased from 1.5 dollars to 2.5 dollars.
As fees for public services are not likely to be reduced as a rule, the minimum fare for the
subways in Tokyo has not declined, but prices as a whole have declined moderately for a
long period in Japan.
The feature of Japan's deflation is that it is moderate but persistent. This is a phenomenon
quite different from the deflation seen in the days of the Great Depression. In the period of
deflation that occurred in the United States during the Great Depression, prices plunged in a
short period. Prices declined significantly in the two years of 1931 and 1932, by almost
10 percent annually, but deflation continued for only four years. In contrast, Japan's
consumer prices have fallen 4.1 percent in the past 15 years from fiscal 1998 to fiscal 2012.
That is merely a 0.3 percent decline on an annual average basis. However, the deflation in
Japan has been extremely persistent. Young Japanese people have been born into a life of
carrying the recognition that prices either will be constant or decline.
The continuation of price declines, albeit moderate ones, for a protracted period has deprived
Japan's economy of vitality. In a state of deflation, the holding of cash or deposits will
become a relatively better investment. In fact, cash and deposits held by Japanese firms
have reached 230 trillion yen, close to 50 percent of nominal GDP. Persistent deflation has
created an environment in which the status quo is better than making investment in new
initiatives, and has brought a sense of stagnation to Japan. In an economy with few new
challenges and investment, growth potential will decline gradually. Therefore, it is necessary
to overcome deflation this time around and enhance people's willingness to take on new
challenges.
There were economic cycles during the past 15 years. However, even when the economy
recovered, prices did not increase in a sustainable fashion. The major reason for this is that,
due to prolonged deflation, persistent deflationary expectations - that is, the recognition that
it is natural for prices not to increase - have become entrenched among people, and they
took actions based on such expectations. In such a situation, firms, households, and even
labor unions will act on the assumption that prices will not increase, and thus it has become
intrinsically difficult to increase prices.
In the past, the Bank of Japan (BoJ) took a variety of initiatives, including the adoption of
unconventional measures ahead of other central banks, such as a zero interest rate policy,
quantitative easing, and - in the latest wording - forward guidance. Nevertheless, while
those policies were effective in terms of stimulating economic activity, they could not change
people's persistent deflationary expectations. The greatest challenge in overcoming deflation
this time is to raise people's inflation expectations.
II. Introduction of quantitative and qualitative monetary easing
The BoJ introduced the quantitative and qualitative monetary easing (QQE) in April. The new
policy aimed at working directly on inflation expectations, with the goal of increasing inflation
to the global standard of 2 percent. The question is: how?
The conclusion we reached was, first, to show our clear commitment to achieving the
2 percent price stability target in a stable manner as soon as possible, and, second, to
underpin this determination by launching massive monetary easing that clearly differed from
the past policies. Specifically, we declared that there would be a doubling in two years of the
monetary base the BoJ provides. With this QQE, Japan's monetary base two years from now
will become 270 trillion yen, or 2.78 trillion dollars, reaching 56 percent of nominal GDP. For
reference, the current monetary base in the United States is 329 trillion yen, or 3.39 trillion
dollars, which is 20 percent of nominal GDP.
To build the monetary base, on the asset side of the BoJ's balance sheet, the holdings of
Japanese government bonds (JGBs) would be doubled. An associated massive purchase of
JGBs would alter supply and demand conditions in the JGB market and put strong downward
pressure on long-term interest rates.
However, there was a problem. The 10-year government bond yield in Japan was less than
1 percent. How could we make additional room for monetary easing? The point was the real
interest rate, which is the nominal interest rate minus the expected inflation rate. In this
regard, the situation facing Japan, in which expected inflation rates were stagnant,
fortunately provided a breakthrough to this question. By raising inflation expectations while
containing a rise in nominal interest rates, we would be able to lower real interest rates,
which affect decision-making with respect to business fixed investment and private
consumption.
Let me elaborate on this. In the United States and Europe, amid stagnant growth, observed
inflation rates have been hovering around central banks' targeted inflation rate of 2 percent,
and firms' and households' medium- to long-term expected inflation rates have also been
stable at around 2 percent. In other words, expected inflation rates are anchored at around
targeted inflation rates. In such cases, central banks cannot afford to raise expected inflation
rates further. Therefore, to lower real interest rates, nominal interest rates need to be
lowered. When long-term interest rates fall to the historic low level of less than 2 percent,
room to further lower real interest rates becomes limited, as there is not much room to further
lower nominal interest rates.
By contrast, in Japan, expected inflation rates have been anchored at too low of a level
compared with the 2 percent price stability target, and thus there is sufficient room to raise
them. If a rise in nominal interest rates can be contained to a lesser extent than an increase
in inflation expectations, then real interest rates can be lowered by that extent. With such a
decline in real interest rates, business fixed investment and private consumption are
expected to be stimulated, thereby elevating economic activity. Observed prices are also
expected to increase gradually. In addition, a rise in observed inflation will lead to an
increase in inflation expectations.
There is little time today to explain all the transmission channels of the QQE, but I have
covered the core part. Through its effects, it is our aim to stimulate the economy, improve the
output gap and, above all, shift inflation expectations upward, and achieve the 2 percent
price stability target as soon as possible.
III. Achievements under QQE and perspective on overcoming deflation
Now that six months have passed since the QQE was introduced, is it working? As it turns
out, there have been improvements in financial markets, economic activity and prices, and
people's expectations, and the QQE has been powerfully exerting its effects. Let me point
out some examples.
In the financial markets, stock prices have risen by more than 30 percent since the beginning
of the year. This substantially exceeds the rate of increase not only in Europe, of around
13 percent, but also in the United States, of around 16 percent.
On the real economy front, real GDP has marked high growth since the turn of the year of
around an annualized 4 percent for two consecutive quarters. The unemployment rate has
recently declined to the levels seen prior to the Lehman shock of around 4 percent.
People's expectations have also changed. Consumer confidence indicators clearly have
tilted upward since around the end of last year. Looking at business confidence indicators,
Tankan
according to the BoJ's business survey, called the survey, the diffusion index (DI) for
business conditions bottomed at minus 9 percentage points in the last December survey and
has improved to plus 2 percentage points in the latest September survey - the same level as
that in December 2007, prior to the Lehman crisis.
Turning to price developments, expected inflation rates have increased as a whole,
according to market indicators and various surveys. The break-even inflation rate (BEI) has
increased to close to 1.7 percent, from around 0.70 a year ago. In the Opinion Survey on the
General Public's Views and Behavior conducted by the BoJ, in which consumers are asked
their views on the inflation rate one year from now, the proportion of consumers who
answered that prices would increase was just over 50 percent in the last December survey,
but increased to above 80 percent in the September survey. In addition, the DI for selling
prices in the Tankan survey, which is calculated based on a question firms were asked of
developments in selling prices of their own products and services, have improved for large
firms from minus 15 percentage points in the last December survey to zero in the September
survey.
Looking at the observed inflation rates, the CPI inflation rate turned positive in June for the
first time in 14 months, and accelerated to 0.8 percent in August.
As explained, stock prices have been rising and the real economy has been improving
steadily. The inflation rate has turned positive and inflation expectations have risen. Such
improvements in economic activity, prices, and people's expectations could be factors in
increasing interest rates. Nevertheless, thanks to strong downward pressure stemming from
the BoJ's JGB purchases, Japan's long-term interest rates have been slightly lower than
those of a year ago, with 10-year JGB yields hovering at less than 0.7 percent. In addition,
while long-term interest rates have been rising since May in the United States and other
overseas economies, those in Japan have been more or less flat or slightly declining.
Commercial banks' lending rates on new loans - an average of loans to firms and individuals -
have declined to a historic low of below 1 percent.
Meanwhile, as people's inflation expectations have been increasing gradually on the whole,
real interest rates have been declining. Thus, the situation we have aimed for has been
generated. This decline in real interest rates is likely to stimulate business fixed investment,
housing investment, and private consumption, thereby bolstering the economy. In addition,
the QQE and various measures by the government seem to have been gradually improving
people's sentiment, making them proactive and igniting their animal spirits. In fact, there are
signs that firms' funding is becoming active. The year-on-year rate of increase in bank
lending, which once declined to below 0.5 percent in the first half of fiscal 2012, has since
been moderately expanding to slightly over 2 percent. The amount of corporate bonds issued
in the April-June quarter reached a high level for the first time since the July-September
quarter of 1998, which was coincidentally the quarter when deflation began. Initial public
offerings by firms have also become active recently.
So far, the QQE has been exerting its intended effects, which is quite encouraging. By
continuing to pursue the QQE with a strong determination to achieve the 2 percent price
stability target, we are convinced that we will definitely overcome deflation.
Concluding remarks
Japan has a solid growth base. It has first-class technology and human resources. What has
been lacking is positive sentiment - both the confidence in our ability to succeed and in our
animal spirits - which were lost amid the sense of stagnation under persistent deflation. The
overcoming of deflation will progress in line with a dispelling of this sense of stagnation. I am
a firm believer that Japan will regain confidence and grow with vigor again.
There is another tail wind for Japan. The recent decision to hold the 2020 Olympics in Tokyo
is boosting the level of people's sentiment. At the time of the Olympics, seven years from
now, we will welcome you to a Japan that has regained its brightness. However, I am afraid
that you may not be able to ride subways in Tokyo at a minimum fare of 160 yen at that time.
Thank you for your attention.