Toshihiko Fukui: Reflections on what is happening in the global
economy today
Summary of a speech by Mr Toshihiko Fukui, Governor of the Bank of Japan, at the 2005 IIF
Annual Meeting, Washington DC, 25 September 2005.
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Introduction
It is a pleasure to appear before you this morning and share my thoughts on what is
happening in the global economy today.
Before I go any further, let me express my deepest condolences for the great suffering
caused by Hurricane Katrina just a few weeks ago.
My remarks will be divided into three parts. In the first, I will comment on the currents of
structural changes in the global economy from a long-term perspective. Against the backdrop
of these changes, I would then like to say a few words on the changing role of the
International Monetary Fund (IMF)--a medium-term issue for all of us in this room. Finally, I
will comment briefly on a conjunctural issue--the state of the Japanese economy and the
monetary policy of the Bank of Japan. I hope to answer a few questions, if we have time
before I have to head to Dulles Airport to catch my plane to Tokyo.
Structural changes in the global economy
The global economy has undergone significant structural changes in the last decade. Of
those changes, in my view, three are most important. The first is the entry of emerging
market economies into the market-based economic system. The second is the progress we
have observed in information, communications, and telecommunications (ICT) technology.
The third is the aging of the population, especially in mature industrialized economies. Let
me take up these developments in turn.
Since the 1990s, emerging market economies--China, India, and countries in Central and
Eastern Europe--have progressively been integrated into the market-based economic
system. Taking advantage of their relatively low wages and foreign direct investment (FDI)
and technology transfers from mature industrialized economies, these countries have
increased their supply of goods and services to the global economy. In this process, these
countries have broadened their exports as well. They are now exporting not only light
industry products, such as textiles, but also heavy and high-tech industry products. Exports
now also include services, such as operating call centers.
The advances in ICT technology, such as the widespread use of the Internet, have
significantly reduced the costs of processing and transmitting information. This has, in turn,
enabled firms to expand their operations globally. Production of goods and services is now
spread out over many economies. At the same time, ICT technology has also enabled firms
to enhance efficiencies of so-called middle-management functions, resulting in the flattening
of corporate organizations. The confluence of these developments with the integration of
emerging markets into the market-based economic system has reduced the costs of doing
business worldwide, and enhanced competition in the global marketplace.
Meanwhile, the importance of the third structural change that I just mentioned--the rapid
aging of the population especially in the industrialized economies--is just beginning to sink in.
We now realize that the shift in demographics may have profound effects on various aspects
of the global economic system. For example, it may change the savings-investment balance;
it may change flows of money through financial intermediaries; and it may influence asset
allocation among investors.
Today, I have chosen to focus on these issues, because various developments in the global
economy--sometimes puzzling developments--flow out from these changes. One is the
subdued rate of consumer inflation, which has defied extremely elevated price levels of
commodities and raw materials such as crude oil. Another is the relative stability of long-term
interest rates.
At the end of August, crude oil prices reached US$70 a barrel. Though prices have come off
the peaks, this starkly illustrates the rapidly rising prices of commodities and raw materials.
Factors such as political unrest in producer countries and bad weather have certainly
influenced such developments. Looking at crude oil, production capacity for petroleum
products is constrained, because not enough money was invested in exploration, extraction,
and refining in the wake of collapsing prices after the Second Oil Crisis. Nevertheless, the
most significant factor seems to be the tightness in supply and demand conditions caused by
strong demand. In particular, the combination of relatively high growth and relatively
inefficient energy use in emerging market countries seems to be contributing to higher than
expected growth in crude oil demand.
As I noted a few moments ago, emerging market countries are now being integrated into the
market-based economic system. Being new members of the system, however, their
economies are still evolving. There remain rigidities, such as price controls. Consequently,
they are not able to use resources as efficiently as mature industrial economies. Given this
environment, it seems we will have to live with higher prices of commodities and raw
materials, at least for the time being.
While input prices are thus rising, pass-through to output prices is rather limited. In fact, since
the 1990s, we are observing significantly lower rates of consumer price index (CPI) inflation
around the globe. Productivity growth in the corporate sector is providing some cushion.
However, the most important factor behind this development is again the integration of
emerging market countries into the market-based economic system. With increasing
integration, more goods are brought onto the market. In turn, competition is enhanced
globally, producers' pricing power is weakened, and consumers benefit from downward
pressures on prices.
Lower inflation is accompanied by smaller fluctuations of the economy. Not only are we
seeing lower inflation rates, we are also seeing lower inflation volatility. The volatility of
growth is also declining. The increasing importance of services, the demand for which is less
volatile than that for goods, is one contributing factor. As individual firms take advantage of
ICT in managing their output, economic activity at the macro level may see less fluctuation.
At the same time, greater flexibility in products and labor markets may help firms adapt
smoothly to changing business conditions.
Obviously, factors other than structural changes have also lowered inflation and volatility of
inflation and growth. Central banks have also contributed to enhancing stability. Independent
central banks, pursuing price stability through monetary policy, have successfully tamed
inflation. This has enhanced the credibility of monetary policy, and, in turn, stabilized inflation
expectations.
In financial markets, low and stable rates of inflation have led to lower long-term interest
rates around the world. Since I do not wish to repeat Chairman Greenspan, I will merely say
that the structural changes I have touched on today are definitely influencing interest rate
developments.
The three broad trends--globalization, ICT, and aging--will be sustained for some time.
Considering that there are still millions if not billions of underemployed workers in emerging
market countries, the integration process will probably continue for many more years. Since
human ingenuity is unlimited, we will find new and innovative uses for ICT in the years
ahead. Institutional changes to mitigate the effects of rapid aging have only just begun.
As a result of the interactions between these trends, we are sure to see economic
developments that we would never have imagined before. We have no crystal ball to
accurately identify the changes ahead of us or their consequences. This means that our
wellbeing will only be maintained if we can efficiently and effectively adapt to the changing
environment. We must monitor events closely as they unfold, and be ready to respond
flexibly. I am optimistic that central banks can adapt to changing economic conditions, as
they have done so over many years.
The changing role of the IMF
Structural changes are not confined to the real economy. The forces of globalization are
influencing the international monetary system as well.
Yesterday, at the meeting of the IMF Council, we discussed the results of the Strategic
Review of the IMF, initiated by Managing Director, Rodrigo de Rato. Rodrigo's project was
extremely helpful, drawing up a comprehensive list of issues that we have to address. The
consensus on where we stand was already described by Gordon Brown yesterday, and I will
not repeat it here.
The Strategic Review was necessary and useful in defining what needs to be done today. It
is, however, the first step.
Sixty years ago, the Fund was created to maintain a network of exchange rates anchored on
the U.S. dollar backed by gold. There was also a mechanism to facilitate adjustments.
Member countries were obliged to enter into annual consultations. In this process, the Fund
identified economic policies that would undermine the network of fixed exchange rates. The
Fund then suggested remedies, and lent money if necessary to buy time for policy
adjustments to take effect. If exchange rates really fell out of line with economic
fundamentals, it was possible to tweak the rates.
Fast-forward to today, and we no longer have fixed exchange rates, particularly between
systemically important countries. As a result, policy advice from the Fund is losing the force
and urgency it once had. At the same time, we are witnessing increasingly stronger and
more mobile private capital flows. These flows are, of course, generally beneficial. Though it
is hard to measure precisely, private capital has played a significant role in the robust
investment-led growth of many countries.
Private flows are not only getting bigger, they are getting more nimble. In the seventies and
eighties, banks were the main financiers for emerging market economies. On the other hand,
much of today's private capital flows are in the form of bond issues. Compared with banks,
bondholders tend to react very quickly. Bankers cannot call a loan until it is due. On the other
hand, when bondholders sense a problem brewing, they can sell their bonds immediately. If
everyone heads for the exit at once, bond prices will collapse and exacerbate problems for
the issuing country. There will also be coordination problems. You can cram a few dozen
bankers into one room and cut a deal, but we cannot do the same for bondholders.
No wonder that emerging market and developing countries tapping the international financial
market sometimes feel so insecure and helpless. The welcome rug could be pulled quickly
from under their feet, as many of them found out in the late 1990s. They can turn to the Fund
for help, but private flows could even overwhelm the Fund. Fund quotas, essentially
equivalent to paid-in capital, total about US$330 billion. This is only a fraction of global
financial flows.
In our recent efforts to reform the international monetary system, we have tried to deal with
these changes. As I said a few minutes ago, the Strategic Review is an important milestone.
Nevertheless, the recommendations will soon be overtaken by developments in the
international financial landscape. The three trends I mentioned in the first part of my
talk-globalization, ICT, and aging--will continue. This means that capital movements between
economies will accelerate, broaden and expand. The Fund must continue to evolve, if it is to
remain relevant in tomorrow's international monetary system.
Though we cannot predict the exact consequences of the structural changes, a general idea
of what we can expect seems to be clear enough. If private flows become increasingly
important, we should emphasize private solutions as well as public interventions. There are
two significant developments in this context.
One is the collective action clauses (CACs) in bond covenants, advocated by the G-10
countries in September 2002. Now almost all new international bond issues are governed by
CACs. In the near future, when bonds without CACs are all retired, CACs would govern the
resolution of sovereign debt crises. A typical CAC allows the terms of a bond issue to be
changed with the consent of 75% of bondholders. This means that if a country cannot pay its
debts in full, it needs to come up with a restructuring plan that satisfies 75% of the lenders.
The clear and transparent rules also reduce the chances for holdouts or rogue investors to
disrupt an orderly workout process. In turn, the market can more appropriately price the risks
and costs of defaults.
Another notable development is the "Principles for Stable Capital Flows and Fair Debt
Restructuring in Emerging Markets," released about a year ago. I know that Managing
Director, Charles Dallara and his colleagues at the IIF worked hard to see its publication. The
Principles offer a framework for enhancing flows of information between borrowers and
lenders. They also provide guidance for productive engagements between them. These
improvements should enable lenders to assess and price risks more precisely, enhance the
stability of flows to developing and emerging market countries, and facilitate resolution of
problems when they occur.
These developments, especially the Principles, would strengthen market discipline.
Borrowing countries would be encouraged to improve their institutions and adopt sound
economic policies. As a result, we should see fewer international financial crises. In the
unfortunate and hopefully rare event that problems do arise, a borrowing country and private
lenders can negotiate orderly settlements, under the framework of CACs. The public sector,
including the Fund, would only be called on in the rarest cases, where the speed and
magnitude of the problems might overwhelm efforts to formulate private solutions.
What does this mean for the Fund?
In terms of giving out policy advice, the Fund's role would be more relative. If private lenders
become more important, borrowing countries would be inclined to listen to what the market
wants. The Fund is facing formidable competition, but I think it can build on its excellent
reputation. I am especially looking forward to the efforts currently underway to enhance the
Fund's work related to financial issues.
Meanwhile, as I noted a moment ago, Fund lending will be necessary only when there is a
rapidly unfolding crisis of considerable magnitude. We should, therefore, consider if the
current rules for releasing Fund resources could appropriately cope with such a situation. In
the jargon of the Fund, this is a question of improving the rules for exceptional access. To
say that the Board is responsible for approving such lending is sidestepping the question.
Can the Board form a consensus quickly enough? Is the Board representative enough so
that members can subscribe comfortably to its decisions? Who is going to be held
accountable if something goes wrong? Answering these questions will tax our imaginations
to the fullest extent, but we must not dodge them. Disasters do happen.
Recent developments in the japanese economy
Before closing my remarks, let me briefly speak on the Japanese economy and the monetary
policy of the Bank of Japan.
If we put aside quarter-to-quarter fluctuations in the rates of growth, the Japanese economy
has been on a recovery track for three and a half years, since the beginning of 2002.
Nevertheless, from the summer of 2004, we had a period of sluggish growth in exports and
industrial production. This pause in growth was brought about by the global adjustment in the
ICT sector.
The Bank of Japan stated all along that slower growth was temporary, and that the Japanese
economy would eventually regain momentum. There were, however, concerns that Japan
had slipped back into recession. Fortunately, recent developments seem to indicate that the
pause in growth is finally over: the adjustment in the ICT sector is almost complete; domestic
demand components, private capital investments, and household consumption in particular,
are generally showing firm growth; and exports, which were flat for some months, seem to be
regaining traction.
I believe that this trend will be sustained for some time. The Japanese economy should
remain on a moderate but enduring growth path, supported by both domestic and external
demand. There are two particularly encouraging factors.
The first is that Japanese firms are at last seeing the end to structural adjustments
necessitated by the bursting of the bubble economy. For more than a decade, the Japanese
economy was under the yoke of "three excesses"--excess capacity, excess employment, and
excess debt. Japanese firms worked very hard to get rid of these excesses. They are now
adopting new strategies that enhance efficiency and competitiveness. As a result, they are
becoming more profitable. In fact, measured by the profits-to-sales ratio, Japanese firms are
more profitable than they were in the end of the 1980s, at the peak of the bubble economy.
Against this background, the growth of capital investment is relatively strong, not only at
large manufacturing firms but also at manufacturing small and medium-sized enterprises
(SMEs) and at non-manufacturing firms.
The second encouraging factor is that households are increasingly benefiting from the
recovery in the corporate sector. Employment is growing, and the jobless rate has dropped to
a seven-year low of 4.4%. Looking past the headline numbers, we see even more
encouraging signs. Until recently, Japanese firms hired part-time and temporary workers in
order to keep labor costs in check. Today, firms are stepping up their efforts to hire
permanent workers, against the background of improving profitability and thus business
confidence. Consequently, employee income, which was depressed by the rising proportion
of part-time and temporary workers, is rising moderately. The promising employment and
income environment is firmly supporting personal consumption, in both goods and services.
These trends in employment, income and consumption are expected to continue for the time
being.
Coming back to the broad trend, the Japanese economy grew by 2.7% in 2004 and is
expected to grow by 2.0% in 2005 according to the Fund's World Economic Outlook (WEO).
This is not as spectacular as the United States, which grew by 4.2% in 2004 and whose
WEO growth forecast is 3.5% for 2005. Nevertheless, it is a respectable growth path
compared to some other mature industrialized economies. I believe that this moderate
growth trend can be sustained for some time.
What does this mean for monetary policy?
The Bank of Japan is maintaining the policy framework of quantitative easing. As you know,
under this framework, the Bank supplies liquidity far in excess of required reserves, creating
an environment where short-term interest rates stay very close to zero. Another element of
our present policy framework is a firm commitment to maintaining that environment until
year-on-year inflation, as measured by core CPI, is stably zero or above.
Currently, Japanese core CPI is still declining slightly, and the Bank of Japan steadfastly
adheres to the commitment I have just explained. By doing so, we are supporting the
Japanese economy's return to a stable and sustainable path of growth.
Thank you for your attention. It has been a pleasure speaking to you.