Haruhiko Kuroda: Japan's economy and monetary policy
Speech by Mr Haruhiko Kuroda, Governor of the Bank of Japan, at a meeting with business
leaders, Nagoya, 2 December 2013.
* * *
Accompanying charts can be found at the end of the speech.
Introduction
It is my great pleasure to have this opportunity to address such a distinguished gathering of
business leaders in the Chubu region today. I would like to express my sincere gratitude to
you for your cooperation with our Nagoya branch.
The greatest challenge facing Japan's economy is overcoming deflation that has lasted for
nearly 15 years. Amid protracted deflation, corporate profits and wages have been
compressed, the spending of firms and households has declined accordingly, and Japan's
economy has become oriented toward contraction. Under deflation, as the real value of cash
rises with a decline in the prices of goods and services, saving cash at hand will be relatively
advantageous, rather than making investment that pursues new opportunities. In such a
situation, the incentive to take on challenging new business opportunities will decline and
people's mindset as a whole will become pessimistic, thereby depriving Japan's economy of
vitality.
In response, at the Monetary Policy Meeting held on April 3 and 4, the Bank of Japan made a
clear commitment to achieving a 2 percent price stability target at the earliest possible time,
with a time horizon of about two years, and introduced a new phase of "quantitative and
qualitative monetary easing" (QQE) to underpin that commitment. So far, the QQE has been
steadily exerting its intended effects, with an improvement in the real economy, financial
markets, and people's expectations and mindsets, and Japan's economy has been following
the path toward achieving the 2 percent price stability target, as expected.
Today, before exchanging views with you, I would like to explain the Bank's view on the
current situation and outlook for economic activity and prices as well as effects of the QQE,
in part by referring to the Outlook for Economic Activity and Prices (Outlook Report) released
at the end of October.
I. Current situation and outlook for Japan's economy
Japan's economy has been recovering moderately as domestic demand has been firm and
overseas economies as a whole have been picking up moderately. Compared with what was
anticipated at the time of the April Outlook Report, the economy as a whole has been
developing almost as expected, with external demand slightly weaker, as exports have been
picking up at a somewhat slower pace, and domestic demand slightly stronger.
Looking ahead, as external demand is expected to increase, albeit moderately, while
domestic demand is likely to maintain firmness, a virtuous cycle among production, income,
and spending is likely to be maintained. While the economy will be affected by a swing in the
front-loaded increase and subsequent decline in demand prior to and after the two scheduled
consumption tax hikes, it is likely to continue growing at a pace above its potential, which is
estimated to be around 0.5 percent, as a trend. In terms of the median of the real GDP
projections by the nine Policy Board members in the Outlook Report released at the end of
October, it is 2.7 percent for fiscal 2013, 1.5 percent for fiscal 2014, and 1.5 percent again for
fiscal 2015 (Chart 1).
As for price developments against such a backdrop, the year-on-year rate of change in the
consumer price index (CPI, all items excluding fresh food) turned positive in June 2013 and
recently accelerated to 0.9 percent in October (Chart 2). While it is true that a rise in the
prices of energy-related goods such as petroleum products and electricity has contributed to
lifting the index, improvement has been spreading in a wide range of items as domestic
demand, including private consumption, has been firm. This can be confirmed by the fact that
the year-on-year rate of change in the CPI (all items excluding food and energy) has turned
positive and that the number of items for which prices are increasing has surpassed that of
items for which prices are decreasing (Chart 3).
Looking ahead, the year-on-year rate of change in the CPI is likely to follow an increasing
trend, as an improvement in the aggregate supply and demand balance brought about by
economic recovery will contribute to lifting prices, and as people's medium- to long-term
inflation expectations are likely to rise, due partly to an increase in the observed inflation rate.
In terms of the median of the CPI growth projections by Policy Board members, on the basis
of excluding direct effects of the consumption tax hikes, it is 0.7 percent for fiscal 2013,
1.3 percent for fiscal 2014, and 1.9 percent for fiscal 2015 (Chart 1). Namely, it is likely to
reach around the price stability target of 2 percent toward the latter half of the projection
period up to fiscal 2015.
II. Outlook for Japan's economy and overcoming of deflation
Let me next talk about points that warrant attention with regard to achieving the
aforementioned outlook after confirming the features of economic recovery this time around.
Unlike the typical pattern of exports and large manufacturing firms leading economic
recovery, this economic recovery features the nonmanufacturing sector recovering ahead of
the manufacturing sector, led by private consumption and public investment. In fact, while the
Indices of Tertiary Industry Activity, which show the level of activity in the nonmanufacturing
sector, have recovered to a level close to that seen prior to the Lehman shock, production in
the manufacturing sector has remained at about 80 percent of its peak prior to the Lehman
shock. Looking at the diffusion index (DI) for business conditions in the Tankan survey, the
DI for the nonmanufacturing sector has been improving ahead of that for the manufacturing
sector (Chart 4).
Given the pattern of economic recovery this time, in looking to the sustainability of economic
recovery, the sustainability of firm domestic demand that has led the economy so far will be a
key. Another key will be whether overseas economies recover and exports see a smooth
increase while domestic demand underpins the economy. Let me touch on developments in
overseas economies, followed by those in households' employment and income situation
and in firms' business fixed investment in relation to the sustainability of domestic demand.
Overseas economies
Overseas economies as a whole are picking up moderately, although there are partly
lackluster movements.
They are expected to continue to pick up, led mainly by advanced economies. In its World
Economic Outlook, the International Monetary Fund (IMF) projects that the world economy
will grow 2.9 percent in 2013 and moderately accelerate its pace of growth to 3.6 percent in
2014, and to 4.0 percent in 2015 (Chart 5). Looking at respective regions, the U.S. economy
is expected to gradually see an acceleration in its pace of recovery, led mainly by domestic
demand, as the fiscal drag will gradually fade. The European economy is expected to
gradually pick up on the back of recovery in exports in tandem with a pick-up in domestic
demand. In addition, the Chinese economy is likely to maintain stable growth, as the
government, while progressing with reforms to address structural problems, is expected to
pursue policy measures that take due account of economic activity. Meanwhile, there are
partly weak movements in other emerging and commodity-exporting economies, and thus
those economies will likely lack growth momentum for the time being, from a longer-term
perspective; however, growth rates are expected to pick up again.
Of course, uncertainties remain high regarding the outlook for overseas economies, such as
consequences of the government debt problem in the United States, the debt problem and
efforts to restore financial soundness in Europe, outcomes of structural reforms to address
problems such as excess production capacity in the manufacturing sector in China, and
efforts to address structural problems in other emerging and commodity-exporting
economies, all of which warrant attention. However, even bearing in mind such uncertainties,
the baseline scenario is that overseas economies will continue to pick up and Japan's
exports will accordingly increase moderately.
Developments in employment and income
From the perspective of a sustainable recovery in domestic demand, I would like to talk next
about developments in employment and income. As mentioned earlier, Japan's economy is
expected to recover moderately in a virtuous cycle among production, income, and spending,
and will achieve the 2 percent price stability target. To this end, it is critical to have an
improvement in income in order to underpin private consumption.
Looking at current employment and income developments, supply and demand conditions in
the labor market continue to recover steadily, albeit moderately, due partly to resilient
domestic demand, and the unemployment rate has declined to the level observed prior to the
Lehman shock, of around 4 percent (Chart 6). This improvement in supply and demand
conditions in the labor market has started to influence nominal wages. The year-on-year rate
of change in nominal wages per regular employee has become slightly positive, partly
reflecting growth in summer bonuses for the first time in three years and an increase in
overtime pay. In addition, the year-on-year rate of growth in hourly nominal wages per
parttime employee has been modestly accelerating (Chart 7).
Going forward, as the improvement in supply and demand conditions in the labor market
continues, nominal wages are expected to be put under upward pressure gradually. While
scheduled wages per employee have remained negative year-on-year, due partly to an
increase in the proportion of part-time workers, if these stable wages start to increase, this
will contribute to a sustainable increase in household spending. Amid increasing corporate
profits, partly due to ongoing initiatives through cooperation among the government, workers,
and employers, we anticipate an increase in scheduled wages, including an increase in base
wages.
Developments in business fixed investment
Turning to the corporate sector, to achieve an economic recovery accompanied by a virtuous
cycle among production, income, and spending, it is critical that an increase in corporate
profits lead to an increase in business fixed investment. Corporate profits have been
recovering, due partly to a correction of the past yen appreciation (Chart 8). Business fixed
investment has been resilient in the nonmanufacturing sector, and there also are signs of
improvement in the manufacturing sector, which has been lagging (Chart 9).
Going forward, business investment is likely to follow a moderate increasing trend, reflecting
an improvement in corporate profits as well as effects of monetary easing. In the context of
investment profitability, profitability from business fixed investment is likely to improve and
monetary easing effects are likely to strengthen, reflecting a rise in the rate of return on
capital due to economic recovery together with declining real interest rates under the QQE.
In addition, reflecting past restraints on firms' investment, pent-up demand in business fixed
investment is likely to surface (Chart 10). Furthermore, firms' medium- to long-term growth
expectations are likely to rise moderately, due partly to the positive initiatives to strengthen
competitiveness and growth potential, such as the government's regulatory and institutional
reforms and various tax reduction measures, as well as firms' restructuring efforts. Given
such an environment, business fixed investment is more likely to increase as the level of
economic activity further elevates.
Looking back, amid nearly 15 years of deflation, firms have been accumulating cash in order
to prepare for the worst by, for example, containing business fixed investment relative to
cash flow (Chart 11). As a result, firms' cash at hand has reached 230 trillion yen, which is
almost 50 percent of nominal GDP. Given the deflationary economy, it seems rational for a
firm to increase its cash at hand as a relatively better investment; however, as a result of a
firm not effectively using precious cash, Japan's economy as a whole has been deprived of
vitality. In an economy that has overcome deflation, it will be better, unlike in the past, to
effectively use cash in the form of business fixed investment, research and development, and
staffing, rather than to save it. I expect firms to gauge such a change in environment as a
business opportunity that will lead them to take positive economic actions.
III. Conduct of monetary policy
Lastly, I would like to talk about the conduct of monetary policy. In April this year, the Bank
committed to achieving the 2 percent price stability target at the earliest possible time, with a
time horizon of about two years, and introduced the QQE to underpin the commitment.
Specifically, it would increase the monetary base at an annual pace of about 60-70 trillion
yen and double the monetary base in two years. In order to do so, it would purchase
Japanese government bonds (JGBs) so that the amount outstanding of JGB holdings would
increase at an annual pace of about 50 trillion yen (Chart 12). While the chart shows the
outstanding amounts of the monetary base and JGB holdings as of end-2013 and end-2014,
these are projected amounts under the current policy and do not suggest in any way a time
limit of the policy conduct. As I will mention later, the Bank will continue with the QQE, aiming
to achieve the price stability target of 2 percent, as long as it is necessary for maintaining the
target in a stable manner.
The effects of the QQE are expected to carry through the economy via several different
routes, and the most important of these is to lower real interest rates. To be specific, first of
all, by committing to achievement of the 2 percent price stability target at the earliest possible
time and announcing the continuation of a new phase of monetary easing into the future to
underpin that commitment, the Bank aims to drastically change people's expectations and
raise inflation expectations. Second, it will put strong downward pressure on nominal
long-term interest rates through massive purchases of JGBs. Consequently, real interest
rates could be lowered if the extent of a pick-up in nominal rates can be contained within the
extent of a rise in inflation expectations. And the decline in real interest rates is expected to
have the effect of stimulating business fixed investment and household spending.
For the last eight months, our endeavor on this front has been successful. According to
surveys on households and economists, inflation expectations seem to have been rising on
the whole (Chart 13). By contrast, long-term rates have remained stable at a low level of
around 0.6 percent in Japan despite the rise in long-term interest rates in other advanced
economies (Chart 14). Therefore, real interest rates have been declining. Under such
stimulative effects, Japan's economy has been recovering moderately and the year-on-year
rate of change in the CPI has turned positive. What contributes to a rise in people's inflation
expectations is not just the Bank saying that it will achieve the 2 percent inflation, but also the
fact that actual prices have been rising. In such a manner, the QQE has been exerting its
intended effects.
Concluding remarks
As I have explained to you today, Japan's economy has been following the path toward
achieving the 2 percent price stability target as expected. The Bank will continue with the
QQE, aiming to achieve that target, as long as it is necessary for maintaining it in a stable
manner. It will examine both upside and downside risks to economic activity and prices, and
make adjustments as necessary to achieve the price stability target. I would like to conclude
my speech by promising that the Bank will surely manage to overcome deflation, which is the
largest challenge facing Japan's economy, through such conduct of monetary policy.
Thank you for your attention.
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