Tadao Noda: Recent economic and financial developments and the
conduct of monetary policy
Summary of a speech by Mr Tadao Noda, Member of the Policy Board of the Bank of Japan,
at a meeting with business leaders, Shimonoseki, 15 September 2010.
* * *
I. Overseas economies
I will begin by outlining the current situation of and outlook for the overseas economies.
The world economy deteriorated significantly after the failure of Lehman Brothers, which filed
for bankruptcy two years ago, but it has been recovering moderately since the second half of
2009. This recovery has been supported by the effects of both fiscal stimulus measures
adopted around the world and inventory restocking in a bid to get them back to pre-slump
levels. However, the pace of the global economic recovery has been slowing, as the effects
of the stimulus measures and restocking have waned.
A. The U.S. economy: burdened with balance-sheet adjustments and
deceleration concerns
The U.S. economy is recovering at a moderate pace, with the second preliminary estimate
for the real GDP growth rate for the April-June quarter of 2010 marking 1.6 percent on an
annualized quarter-on-quarter basis, but the rate has fallen from its peak of 5.0 percent for
the October-December quarter of 2009. Given the gradual recovery in private consumption
and business fixed investment, as well as the increase in exports, the main causes of the fall
in GDP growth appear to have been the sharp rise in imports1 and the slower growth in
inventory investment.
The U.S. economy is undergoing balance-sheet adjustments, to reduce the huge debt
resulting from excessive consumption that had accumulated up to the 2008 financial crisis.
With the very slow improvements in employment and income, recovery - particularly in
household spending - lacks momentum. Housing investment weakened again as the boost
in demand ahead of the expiration of the home-buyer tax credit diminished, and it is likely to
be some time before we see a self-sustained recovery.
The pace of economic recovery is expected to slow temporarily by the 2010 year-end, due to
decelerating exports following completion of the restocking of inventories worldwide, and the
waning of effects of the government's economic stimulus measures, which will push down
the growth rate temporarily. The economic recovery trend, however, is likely to be
maintained, since exports, particularly to emerging and commodity-exporting economies, are
expected to continue increasing, while private consumption and business fixed investment
will probably remain on an upward trend amid an accommodative financial environment.
B. The euro area economy: facing intraregional disparities and fiscal problems
Turning to Europe, I will focus on the economic activity in the euro area. Economic activity in
the euro area as a whole has been recovering moderately, with intraregional disparities
increasing. The real GDP growth rate in the April-June quarter marked a large increase of
3.9 percent on an annualized quarter-on-quarter basis, up from the previous quarter's
1.3 percent. The increase mainly reflects a steady growth in exports due in part to the
depreciation of the euro.
The economy, however, has been facing two challenges that have arisen from fiscal issues,
and have intraregional disparities.
The first issue concerns fiscal consolidation. Looking at the April-June quarter's real GDP
indicators by country, Germany marked the highest growth since the country's reunification in
1990 and was supported by strong exports. Meanwhile Greece, the first to adopt substantial
fiscal tightening measures to combat its severe fiscal problems, saw declines for the seventh
consecutive quarter. Although the extent of the area's problems varies, fiscal consolidation
must be carried out not only by the most seriously troubled countries such as Greece, but by
all member states of the European Union.
The second issue concerns stability in financial markets. Since the start of 2010, concern
about fiscal problems in some European countries has caused the prices of government
bonds in these countries to fall, leading to heightened anxiety about the soundness of
European financial institutions that hold large amounts of the bonds. After the July release of
the stress test exercise results for these institutions, European financial markets restored
stability for a while, but a resurgence of fiscal problems in Ireland has revived market
instability.
It is anticipated that the two issues just mentioned will add downward pressure on the euro
area economy, thereby moderating the pace of future economic recovery.
The root of the two issues may lie in the use of a single currency, the euro, the structural
factor unique to the area. Its introduction, while stimulating an increase in the euro area's
intraregional trade, expanded the fiscal and current account deficits of some European
countries because of the disparity in productivity and competitiveness. Furthermore, fiscal
policy is the only tool available to the member states, given that monetary policy has been
centralized and that foreign exchange rates can no longer be adjusted to control deficits in
the area.
C. The Asian economy: adjusting for a soft landing
Asian economies, free of the need for balance-sheet adjustments, have been the driving
force of the world economy as they exhibit high growth as a whole led by recovery in
domestic demand. Private consumption is expected to increase steadily with robust demand
for durable goods reflecting the rising level of income and increase in the number of
households resulting from progress in urbanization. Capital inflows from abroad will support
the virtuous circle of growth in production, income, and spending, and so will help maintain
strong growth. The risk of overheating has caused more economies to conduct tighter
policies such as adjustments to accommodative monetary policy, but as a whole the financial
environment remains lax.
The Chinese economy, the most powerful engine of growth, continued to grow at a rapid
pace and marked a double-digit real GDP growth rate of 10.3 percent on an annualized
quarter-on-quarter basis for the April-June quarter of 2010, decelerating slightly from
11.9 percent in the previous quarter. Concerned about the hike in real estate prices, the
Chinese government this April introduced measures, including a higher down-payment ratio
for housing purchases, to restrain the increase in real estate transactions. These measures
are expected to place added downward pressure on economic activity to a certain extent by
slowing the pace of growth in fixed asset investments. This would be achieved by restraining
the increase in real estate transactions and, at the same time, decelerating production
growth, particularly of steel and other construction-related materials. As a result, the balance
between orders and inventories in the manufacturing sector is improving at a slower pace,
and the pace of economic expansion is expected to decelerate for a while. The Chinese
economy, however, is likely to continue growing at a rapid pace into next year, as private
consumption is expected to increase steadily, generated by higher income levels, while the
government will be ready to intervene flexibly to help support the economy.
II. Japan's economy
Next, I will outline the current situation of and outlook for Japan's economy.
A. The economy: recovering moderately, but with the self-sustaining momentum
still weak
Japan's economy has been showing signs of a moderate recovery supported by the
continued improvement in overseas economic conditions mentioned earlier. The real GDP
growth rate for the April-June quarter of 2010 in the second preliminary estimate was
1.5 percent on an annualized quarter-on-quarter basis, showing a clear deceleration in
growth compared to the previous two quarters. However, exports have been increasing;
private consumption has been picking up, due to the government's economic stimulus
measures favoring energy-efficient products; and business fixed investment is showing signs
of picking up, led by the increase in exports. Yet, the main economic indicators confirm that
the level of economic activity remains lower than its recent peak. In this situation, there has
been a persistent sense of excesses in capital stock and the workforce, and thus firms
remain cautious about spending despite a notable improvement in corporate profits.
Therefore, prospects for a self-sustaining recovery in domestic private demand remain
uncertain.
In terms of outlook, the economy is likely to recover at a moderate pace on the whole, with
exports continuing to increase. However, the pace of increase in exports is likely to remain
moderate for the time being, mainly due to the following: (1) the waning effects of inventory
restocking in overseas economies; (2) the slowdown in the high growth of emerging
economies, primarily reflecting tighter economic policies; and (3) the yen's recent
appreciating trend. A decline in private consumption seems inevitable in reaction to the
waning effects of the government's economic stimulus measures favoring energy-efficient
products. Thus, the pace of recovery in Japan's economic activity is likely to slow
temporarily.
Nevertheless, it is anticipated that Japan's GDP growth rate for fiscal 2010 will exceed the
potential economic growth rate. For reference, the median of the Policy Board members'
forecasts in July for real GDP was 2.6 percent for fiscal 2010, and 1.9 percent for fiscal
2011.2
B. Prices: weaker downward pressure from the negative output gap
Although prices continue to decline due to the substantial slack in the economy as a whole,
the pace of decline is slowing as a trend due to the gradual improvement in the aggregate
supply and demand balance. Excluding the effects of the special subsidies for high school
tuition introduced in April 2010, the year-on-year pace of decline in the consumer price index
excluding fresh food, or the core consumer price index (CPI), is gradually slowing. The
median of the Policy Board members' forecasts in July for the core CPI was at around minus
0.4 percent for fiscal 2010, and at around 0.1 percent for fiscal 2011.
C. Risk factors surrounding the outlook
I believe the outlook just outlined for Japan's economy and prices is the most probable
scenario. Projections, however, are always subject to many uncertainties. Let me elaborate
on major uncertainties that are also risk factors surrounding the outlook of the economy and
prices in Japan.
Since Japan's economic recovery has been induced by improving overseas economic
conditions, and a self-sustaining recovery in domestic demand remains uncertain, any delay
in the recovery of overseas economies could derail Japan's economy from a self-sustaining
recovery path. Therefore, I consider that developments in overseas economies represent the
greatest risk that Japan's economy faces.
1. Risks posed by the U.S. economy
The quarter-on-quarter slowdown in the real GDP growth rate for the April-June quarter and
declines in many economic indicators released since July have sparked serious concern
about the outlook for the U.S. economy. For example, forecasts by private-sector economists
for the real GDP growth rate have been revised downward from a mean of around 3.0 to
3.5 percent for 2010 and 2011, to a mean of just below 3.0 percent for both years. I believe
that these revisions are only corrections to the overoptimistic forecasts that resulted from an
incorrect appraisal of the substantial pressure exerted on economic growth by the
U.S. economy's balance-sheet adjustments. The recent developments are in line with my
forecasts: I had expected that the adjustment process would require a considerable amount
of time and money, considering Japan's long and harsh experience following the bursting of
the economic bubble and the scale of excesses in the run-up to the recent financial crisis.3 In
addition, it is possible that a negative chain reaction of downside risks will emerge: a
slowerthan-expected recovery in the employment situation or a renewed fall in housing prices
would further delay adjustment in household balance sheets. This would affect the corporate
sector negatively by restraining private consumption.
2. Risks posed by emerging and commodity-exporting economies
In addition to the underlying strength of self-sustaining growth, economic activities in
emerging and commodity-exporting countries are in part being supported by capital inflows
from advanced countries, which are persisting with large-scale monetary easing. Should
capital inflows continue and economic conditions in emerging and commodity-exporting
economies turn out to be stronger than expected, the greater exports thereby generated
could represent an upside risk for Japan's economy. Nevertheless, if the aforementioned risk
concerning the U.S. economy materializes and economic activities in advanced countries are
weaker than expected, growth in emerging and commodity-exporting economies might come
under downward pressure, generated by a decline in trading volume and an outflow of
capital. Furthermore, although a growing number of countries are making adjustments to
accommodative monetary policies,4 a delay in adjusting policy appropriately could lead to
economic overheating in the economies that fall behind the curve by delaying appropriate
monetary policy adjustment. Should this be the case, in the short run Japan's exports could
rise even further, while at the same time the worsening in the terms of trade associated with
a rise in commodity prices could also pose a downside risk for private domestic demand in
Japan. Moreover, in the medium to long term, if a sharp unwinding of excessive economic
and financial activity takes place in emerging and commodity-exporting economies, the risk
of deep adjustments in their economic activity would demand attention.
3. Risks in global financial markets caused by the situation in Europe
Global financial markets have been unstable since the beginning of this year, due partly to
growing fiscal problems in some European countries and subsequent growing concern about
the financial system. As mentioned earlier, a structural factor - the use of a single currency -
may lie at the root of the fiscal problems, and thus it is unlikely that there will be a quick
resolution to the volatile situation in financial markets caused by the situation in Europe.
4. Risks related to Japan's corporate sector
The last risk posed by overseas economies relates to the corporate sector in Japan. If
expectations are rising that demand in Japan will be lackluster, while expectations for
sustainable growth among emerging economies increase, there is a risk that investment in
and lending to emerging economies will expand and Japanese firms' spending on business
fixed investment and employment will be placed under undue restraint. According to the
Survey on Planned Capital Spending, released by the Development Bank of Japan, the ratio
of the Japanese manufacturing sector's overseas capital investment (capital investment
overseas divided by capital investment in Japan multiplied by 100) for fiscal 2010 was a
record high of 57.2 percent.5 Furthermore, according to the Annual Survey of Corporate
Behavior, conducted by the Cabinet Office, the ratio of overseas production has been on an
upward trend. Recently, an argument arose linking the yen's appreciation to the hollowing
out of domestic industry. However, I believe it necessary to view this issue from a medium- to
long-term perspective, linking it to the issue of productivity and the potential growth rate. I will
expand on this topic later in more detail.
III. Conduct of monetary policy
A. Policy responses by the Bank of Japan
Next, I will outline some of the Bank's monetary policy measures, implemented since the
Lehman shock in 2008. Policy measures become operative and effective through synergy,
however, for the sake of explanation, I will categorize them into three types according to their
objectives.
1. Measures responding to cyclical economic changes: pursue powerful monetary easing
Measures taken in response to cyclical economic changes were designed to overcome
deflation and return to a path of sustainable growth for Japan's economy, which had
deteriorated significantly following the Lehman shock. The Bank undertook interest rate
policy, lowering its target for the uncollateralized overnight call rate - the policy rate - by
0.2 percentage point both in October and December 2008, to 0.1 percent, or virtually zero
percent. Since then, the policy rate has remained at that level. The Bank has also been
encouraging longer-term interest rates to decline. In December 2009, it introduced a
fixed-rate funds-supplying operation against pooled collateral (hereafter the fixed-rate
operation) to provide three-month funds to financial institutions at a low interest rate of
0.1 percent, the same as the policy rate. Moreover, the Bank decided to start providing
additional funds with a six-month term in August 2010. The total amount of loans to be
provided through the fixed-rate operation will increase to approximately 30 trillion yen, of
which some 20 trillion yen would be available under the existing three-month term
operations. In this way, the Bank is working to further enhance easy monetary conditions by
providing ample and flexible funds to the money markets.
2. Measures to stabilize financial markets: promote recovery from the "acute symptom"
The stabilization of financial markets benefits the economy because the effects of monetary
policy spread to the economy through financial markets. With the failure of Lehman Brothers,
confidence in the overall financial market was suddenly undermined and the functioning of
the market deteriorated substantially. In a bid to recover from the resulting situation, which
has been described as an "acute symptom," the Bank adopted a number of measures,
including the outright purchases of CP and corporate bonds in early 2009, in response to a
fall in the number of CP and corporate bonds transactions; and special funds-supplying
operations, collateralized by corporate debt, to facilitate corporate financing that provided
funds to financial institutions with funds at a low interest rate equivalent to the policy rate.
These steps - completed by March 2010 after market functioning had been restored - were
exceptional, in that the central bank had taken on individual private firms' credit risks, which
would appear on its balance sheet.
3. Measures addressing structural issues of the economy: support strengthening the
foundations for economic growth
The third category of policy measures relates to Japan's economy from a medium- to
longterm perspective. The growth rate had remained high until the start of the 1970s, when it
started declining gradually, before dropping sharply following the bursting of the economic
bubble at the beginning of 1990s, after which the rate has been declining. Prices have been
deflationary since the end of the 1990s in terms of the year-on-year change in the CPI. The
fundamental cause of deflation is a lack of demand, caused by a protracted negative output
gap. A decline in the growth rate seems to have been the cause of the sluggish demand as it
dampened the public's expectations for future economic growth, or in other words,
expectations for an increase in wages. From a macroeconomic perspective, economic
growth comprises growth in both labor productivity and the number of employed. With the
birth rate declining and the number of those employed not likely to rise, labor productivity
must be raised if growth expectations are to increase and deflation is to be overcome.
While the measures to address cyclical economic changes, involving more or less short-term
economic fluctuations, would solve the lack of demand, they alone would be ineffective in
addressing the medium- to long-term issue of raising productivity.6
Bearing this in mind, the Bank has searched for ways in which it could utilize its functions to
raise the potential growth rate through higher productivity. Thus, in June 2010 it introduced a
new fund-provisioning framework to support, from the financial side, private financial
institutions' efforts of their own accord toward strengthening the foundations for economic
growth.
The first loan disbursement under the new fund-provisioning measure was executed on
September 6, involving a total of 462.5 billion yen, disbursed to 47 financial institutions, and
covering 1,342 investments and lendings.
The Bank hopes this fund provisioning will act as a catalyst for financial institutions in making
efforts on their own initiative toward strengthening the foundations for economic growth.
Having had years of experience in the business of loans at a private financial institution, I
strongly expect the measure will stimulate bankers in charge of loan disbursement and credit
screening to foster the innovation necessary to discover and nurture newly growing firms,
eventually leading to improvements in financial institutions' screening abilities and capacity to
produce information.
B. Future monetary policy
The Bank has been enhancing easy monetary conditions through various measures,
including those I have just outlined, and by also making clear its commitment to maintaining
an extremely accommodative financial environment. I am certain that the synergy resulting
from these measures has supported economic activity and helped clear the way to
overcoming deflation by improving the aggregate supply and demand balance.
As already noted, projections are always subject to uncertainties. Thus, it is necessary to
examine closely the forthcoming economic data and information, so that necessary policy
measures can be taken swiftly and decisively should downside risks threaten before deflation
has been overcome, raising the possibility that the economic outlook might deteriorate
significantly.
Today, I have outlined some of the measures the Bank has implemented over the past two
years since the collapse of Lehman Brothers. In addition, it implemented various pioneering
measures from the latter half of the 1990s to the early 2000s that are similar to those
adopted by central banks in other major countries in response to recent financial crises.
The selection of appropriate policy measures and enhancing of policies require that their
possible effects on the economic outlook be taken into consideration, based on domestic and
overseas expertise.
The selection of suitable measures requires that the costs which may arise from the
implementation of measures, their efficacy, potential risks, and means to prevent such risks
from materializing should be considered ahead of time. It is necessary, in addition, to keep
up-to-date information regarding the effectiveness, probable costs, and side effects of policy
measures, since they reflect changes in the economic and financial situation, as well as fiscal
and institutional structures.