Sayuri Shirai: Japan's economic and price developments and monetary
policy - underlying inflation trend and inflation expectations
Speech by Ms Sayuri Shirai, Member of the Policy Board of the Bank of Japan, at a meeting
with business leaders, Shimane, 25 November 2015.
* * *
Accompanying charts can be found at the end of the speech.
I. Introduction
Good morning. I feel honored to have an opportunity to meet with the local government officials
and business representatives here today. Let me also express my sincere gratitude for your
kind cooperation with the activities of the Bank of Japan's Matsue Branch. Today, I would like
to talk about the Bank's baseline scenario of the outlook for economic activity and prices
through fiscal 2017 as well as risks to the scenario, as described in the October 2015 Outlook
for Economic Activity and Prices (hereafter the Outlook Report). Accordingly, I also will present
and explain my views.
II. Japan's medium-term outlook for economic activity and risk assessment
Let me begin with Japan's economic activity.
A. Outlook for economic activity
In the Bank's baseline scenario of the outlook for economic activity, the projected growth rate
for fiscal 2015 was revised considerably downward while the projections for fiscal 2016 and
2017 were more or less unchanged, compared with those in the July 2015 interim assessment.
Nevertheless, domestic demand is likely to increase and exports are expected to continue
increasing moderately on the back of the recovery in overseas economies. A virtuous cycle
among production, income, and spending is likely to be maintained in the corporate and
household sectors. Firms' and households' growth expectations and potential economic
growth are also likely to rise moderately in line with continued accommodative financial
conditions. In fiscal 2017, the rate of economic growth is likely to decelerate significantly -
mainly due to the effects of the planned consumption tax hike and cyclical deceleration in
business fixed investment - but is still likely to remain positive (Chart 1).
My outlook for economic activity is somewhat lower than the median of the Policy Board
members' forecasts: around 1 percent for fiscal 2015; a little less than around 1.5 percent for
fiscal 2016; and slightly above 0 percent for fiscal 2017, owing to a significant decline in the
growth rate, due, for example, to the planned consumption tax hike. Let me explain in some
detail.
For fiscal 2015, my projection is lower than that in the July 2015 interim assessment, reflecting
the negative economic growth recorded in the April-June quarter (relative to the previous
quarter), mediocre performance thereafter, and the prospect that such performance is likely to
continue for the time being.
Several factors comprise the background to this outlook. First, I adopted a more conservative
projection of real exports, not only because external demand was temporarily weak, but also
because more consideration was being given to the possibility that structural changes had
been hampering rapid export recovery. The latter point is consistent with the fact that industrial
production and exports by Japanese firms have remained sluggish while those by their
overseas subsidiaries have expanded rapidly since 2009.1 In particular, a shift to overseas
production, mainly in the transportation machinery and electrical machinery sectors, left the
Japanese economy with the general-purpose, production & business oriented machinery, and
information & communication equipment sectors, etc. as the main engine for generating
domestic production and export growth. The export performance of these leading sectors has
been stagnant, mainly due to a deceleration in economic growth in Asia. Although real exports
improved very recently, partly due to the release of new smartphones, they are likely to be
more or less constant for the time being in light of the economic slowdown in emerging
economies.
Second, I revised downward my projection of real private consumption for fiscal 2015.
Quarteron-quarter growth rates for real consumption and real retail sales have turned positive in the
July-September quarter. However, this downward revision was attributable to (1) very
moderate real wage growth after turning positive in July this year and (2) stagnant
developments in the consumer confidence index and its components over the next six months
- including consumer perception indices on income growth and willingness to buy durable
goods. Nevertheless, looking ahead, a moderate recovery trend in consumption is likely to be
maintained as nominal wages will continue on a moderate rising trend, amid the tightening
labor market conditions.
Third, I revised downward my projection of business fixed investment for fiscal 2015 as well,
owing to negative growth recorded in the April-June quarter (relative to the previous quarter).
In contrast to positive business fixed investment plans for fiscal 2015 reported by the Bank's
Tankan (Short-Term Economic Survey of Enterprises in Japan), actual machinery orders and
capital goods shipment have remained disappointing; some firms may postpone their fixed
investment plans because of higher unexpected costs caused by labor shortages and rising
prices of construction materials. One positive development, meanwhile, is a sustained
recovery in residential investment. The recent problems related to the apartment construction
wrongdoings in Yokohama and other related problems may dampen such investment
temporarily. However, I continue to project a steady recovery in residential investment under
the low interest rate environment, since a front-loaded increase in demand prior to the planned
consumption tax hike will gradually materialize.
For fiscal 2016, I am projecting relatively high economic growth owing to a front-loaded
increase in private consumption and residential investment prior to the planned consumption
tax hike, amid the favorable employment situation. However, I made a moderate downward
revision compared with the July 2015 interim assessment, mainly due to lower-than-expected
real export growth. My outlook is more cautious than the median of the Policy Board members'
forecasts, probably because I allocate a greater weight to a potential loss of economic
opportunities arising from labor shortages, resulting in a more moderate pace of economic
growth. In Japan, firms with good business conditions tend to feel labor shortages and to be
increasingly constrained from expanding business activities, while firms with bad business
conditions tend to operate their businesses by managing existing employment. This may be
one reason why the pace of replacing nonviable less active firms with viable active firms is
slow, thereby hampering economic growth.
B. Upside and downside risk assessment with regard to economic activity
In the October 2015 Outlook Report, the Bank pointed out the following as risks to its baseline
scenario for economic activity: (1) developments in overseas economies; (2) the effects of
the planned consumption tax hike in April 2017; (3) firms' and households' medium- to
longterm growth expectations; and (4) fiscal sustainability in the medium to long term. On the
whole, it assessed that risks are skewed to the downside.
In my risk assessment related to economic activity, the upside and downside risks are
likely to remain balanced through fiscal 2015 and 2016. By contrast, risks for fiscal 2017 are
tilted to the downside. Particularly, I find the following risks related to overseas economies
important:
• In the Chinese economy, while the labor force population ratio declines, private
consumption and Internet sales are firm, due in part to a continuing rise in wages. But
the year-on-year rate of increase in retail sales for the first ten months of 2015 remains
moderately below the annual target of 13 percent. The tertiary sector, i.e., services
industries, is growing and already accounts for over 50 percent of the total value
added of the economy. Whether the services industries could become an engine for
domestic and global economic growth in the foreseeable future is yet to be seen and
may incur downside risk, given that an increasing number of private-sector firms face
uncertainty with respect to financing conditions amid the more cautious lending
behavior of the banking sector.
• Other Asian economies are expected to see stronger growth, led mainly by domestic
demand, since the pace of trade growth through the global value chain has
decelerated. However, the downside risk is that such developments in domestic
demand could be contained by large-scale portfolio capital outflows and the amplified
volatility in the foreign exchange and capital markets, perhaps as a result of the
normalization of the U.S. monetary policy.
• The U.S. economy may achieve greater-than-expected growth if business fixed
investment and residential investment expand firmly in tandem with greater growth in
labor productivity and wages. This is plausible given that the deleveraging process
has made progress in the corporate and household sectors.
• In the euro area, the fragmentation in interbank markets has improved and some
cross-border capital flows have increased, partly owing to the accommodative
monetary easing performed by the European Central Bank, thereby leading to an
increase in lending to firms and households. In addition, the intra-regional
competitiveness gap has shrunk as the wage growth rate per worker in Germany has
been maintained at a high level, at around 3 percent, while wages in peripheral
countries have been contained and adjusted. The upside risk is that these favorable
developments may enable the euro area to generate stronger-than-expected
economic recovery.
In addition, for fiscal 2017, the downside risk is greater because there is considerable
uncertainty at present related to subsequent declines in demand and in real income after the
planned consumption tax hike. It is not clear how much these negative impacts could be offset
by a "quantitative" expansion of public- and private-sector fixed investment associated with the
Tokyo 2020 Olympic Games, amid the tightened labor market conditions.
III. Japan's medium-term outlook for prices and risk assessment
Next, I will turn to the price outlook and risk assessment.
A. Outlook for prices
In the Bank's baseline scenario of the outlook for prices, the year-on-year rate of change
in the core consumer price index (CPI, all items less fresh food and excluding the direct effects
of the consumption tax hikes) is likely to be at around 0 percent for the time being, lower than
that in the July 2015 interim assessment. After that, the rate of increase in the core CPI is
projected to accelerate toward 2 percent as the underlying trend in inflation steadily rises and
the effects of the decline in crude oil prices dissipate. Although the timing of reaching around
2 percent depends on developments in crude oil prices, this is projected to happen around the
second half of fiscal 2016, assuming that crude oil prices will rise moderately from the recent
level. Thereafter, Japan's economy is expected to gradually shift to a growth path that sustains
such inflation in a stable manner (Chart 1).
Regarding my outlook for prices, let me first present an overall picture. Although the
mechanism of the price rises I assume is the same as that in the Bank's baseline scenario, my
projections remain more cautious than the median of the Policy Board members' forecasts.
The outlook throughout fiscal 2017 was revised somewhat downward. Currently, my projection
is that the rate of increase in the core CPI is likely to rise closer to around 2 percent "from the
end of fiscal 2016 to early fiscal 2017" - a delay of about a quarter from my previous projection
of "toward the end of fiscal 2016." Let me explain my outlook in some detail.
My projection for prices for fiscal 2015 is that the core CPI will be at around 0 percent. The
slight downward revision from the July 2015 interim assessment is attributable to the decline
in crude oil prices. Also, the delay in the pace of the output gap improvement was taken into
account as the actual output gap deteriorated in the April-June quarter. My projection for
fiscal 2016 that the core CPI inflation will rise to a little over 1 percent is rather cautious
compared to that presented previously. This reflects (1) the remaining effects of the drop in
energy prices, (2) a delay of about a quarter in terms of the timing for the output gap to turn
positive, and (3) a delay in the timing for inflation expectations to begin rising owing to a slower
pace of increase in prices. Thereafter, the rate of increase in the core CPI will accelerate and
reach around 1.7-1.8 percent, or rise closer to around 2 percent from the January-March
quarter of 2017 (the peak of the front-loaded increase in domestic demand) to the April-June
quarter (the period most likely to see an opportunistic price increase with the planned
consumption tax hike). My outlook for fiscal 2017 as a whole is that the average rate of core
CPI inflation will decline somewhat and reach around a little over 1.5 percent - slightly below
my July assessment - mainly due to the effects of the decline in demand following the
frontloaded increase and a decline in real income.
On the timing with respect to achieving sustained inflation of around 2 percent in a
stable manner, it might be necessary to assess this over a little longer time span. This is
because there is high uncertainty regarding the effects of the planned consumption tax hike
and the "quantitative" expansion of public- and private-sector fixed investment associated with
the Tokyo 2020 Olympic Games. Moreover, it is likely to take some time for inflation
expectations to rise.
B. Upside and downside risk assessment with regard to prices
With regard to risks to the Bank's baseline scenario for prices, the Bank highlighted the
following four factors: (1) developments in firms' and households' medium- to long-term
inflation expectations; (2) developments in the output gap; (3) responsiveness of inflation to
the output gap; and (4) developments in import prices. It assessed that risks are skewed to the
downside.
My risk assessment related to prices, on the other hand, is that risks for fiscal 2015 are
balanced but those for fiscal 2016 and 2017 are tilted to the downside. In particular, there is a
great deal of uncertainty related to crude oil prices and foreign exchange rate developments,
which could generate both upside and downside risks to the price outlook. On the other hand,
there is a downside risk that a steady increase in inflation expectations, a key factor in raising
inflation in a stable manner, may not take place as fast as projected. On the whole, therefore,
the risks are judged to be tilted to the downside.
C. Expression on the timing with respect to achieving around 2 percent inflation
In the baseline scenario described in the October 2015 Outlook Report, the Bank postponed
the timing of reaching around 2 percent inflation by two quarters, from "around the first half
of fiscal 2016" as described in the April Outlook Report to "around the second half of fiscal
2016." On this front, I opposed the expression "around the first half of fiscal 2016" and
proposed to change it to "in or around fiscal 2016" at the Monetary Policy Meeting (MPM) held
on April 30. Meanwhile, at the MPM held on October 30, I supported the Bank's revised
expression. Let me explain why.
Due to the fact that the median of the Policy Board members' forecasts was revised downward
sharply this time, it is apparently unfeasible to achieve around 2 percent inflation around the
first half of fiscal 2016. Therefore, it is reasonable for the Bank to change the expression.
However, given that it assessed that risks to prices are skewed to the downside, it may be
appropriate for the Bank to use an expression that allows for a wider time span to reach around
2 percent, such as "from around the second half of fiscal 2016 to around the first half of fiscal
2017" - instead of "around the second half of fiscal 2016."
On the other hand, the timing expressed as "around the second half of fiscal 2016" practically
corresponds to the latter half of the intended period in my proposal in April. Also, more
importantly, the expression is very similar to my present projection and could be regarded as
more or less in line with it by interpreting "around 2 percent" flexibly. Based on these two
reasons, I supported the Bank's revised expression.
IV. Conduct of monetary policy
Despite the downward revision of the Bank's outlook for economic activity and prices from the
July 2015 interim assessment, I view that it is important for the Bank to maintain the
accommodative monetary environment by continuing the current guideline for money market
operations. Before I elaborate on my line of thinking, by making referrals in contrast to trends
observed last October when the expansion of quantitative and qualitative monetary easing
(QQE) was implemented, let me emphasize that the price stability target of 2 percent does not
just pursue a price hike; the target should be achieved with sustained wage growth and
expansion of private consumption. On this front, it is important to assess whether Japan's
economy continues to face a virtuous cycle among production, income, and spending
operating in both the corporate and household sectors. Let me highlight five viewpoints that
are essential to making such an assessment.
First, firms' business conditions and current profits are more favorable than those in the
previous year. For example, the Bank's September 2015 Tankan indicates that the diffusion
index (DI) for actual business conditions for all industries - calculated by subtracting the
percentage share of firms responding that business conditions are "unfavorable" from the
share of those indicating that business conditions are "favorable" - improved moderately from
7 percent in June to 8 percent in September, in contrast to a decline from 7 percent to 4 percent
over the same period last year. In particular, the business conditions DI of large
nonmanufacturing enterprises improved further from 23 percent in June to 25 percent in
September - exceeding the levels of the previous year (dropping from 19 percent to 13 percent
over the same period). Projected current profits are favorable as well. The September
Tankan shows that the year-on-year rate of change in projected current profits of all industries
for fiscal 2015 recorded 3.3 percent (4.0 percent in manufacturing and 2.7 percent in
nonmanufacturing). The profitability outlook shows a complete change from that for fiscal 2014
reported in September last year, when the rate of change in projected profits was minus 4.0
percent (minus 2.6 percent in manufacturing and minus 5.1 percent in nonmanufacturing).
Furthermore, let me plot the relationship between the year-on-year rate of growth in projected
current profits and sales for all industries for fiscal 2015 as of September 2015 (Chart 2).
This shows that a relatively large number of sectors are positioned in the first quadrant (positive
territory for both growth in current profits and sales). Generally, growth in current profits is
much greater than that in sales - reflecting an improvement in the terms of trade (caused by a
plunge in commodity prices such as for crude oil) as well as profits from revaluation of
dividends from overseas and higher yen-based export prices, both driven by the yen's
depreciation. Noticeable developments are that the rates of growth in current profits and sales
in (1) food; (2) accommodations, eating & drinking services; and (3) services for individuals
are greater than those for fiscal 2014 reported in September 2014. The food sector, which is
included in manufacturing, projects export sales growth of 5 percent and domestic sales growth
of 3 percent - suggesting that domestic private consumption is quite solid as well. The
aforementioned data indicate that domestic demand is recovering from the adverse effects of
the consumption tax hike in April 2014.
Second, a risk of returning to deflation is considered low given that prices of a wide range of
consumption items, excluding energy, have been rising. While the Bank assesses the
underlying trend in inflation based on various indicators, typical indicators are mainly the core
CPI and trimmed mean. Both exclude temporarily volatile items in order to grasp the trend
behavior of prices. They often are utilized to project future prices owing to their relatively high
predictive power. The difference is that the core CPI always excludes the same items that tend
to show high volatility from the consumption basket weight. In contrast, the trimmed mean
looks at the price changes every month for each item of the CPI and eliminates a certain
fraction (e.g., 10 percent) of the most extreme observations at both ends of the largest and
smallest changes. Thus, items eliminated each month could vary month to month.
The Bank uses the CPI for all items less fresh food, or the "core CPI," in determining its
medium-term outlook for prices in the Outlook Report. Energy prices are included in the core
CPI because they did not have a statistically significant impact on CPI movements in the long
term. However, as a sharp fall in energy prices since the latter half of the previous year has
amplified the volatility in the core CPI, it has become more important to assess the underlying
trend in inflation in a comprehensive manner, not only with the core CPI but also with multiple
indicators. As one such indicator, the Bank has begun to release the "CPI for all items less
fresh food and energy" on a monthly basis. While the rate of change in the core CPI has been
at around 0 percent recently, that in the CPI for all items less fresh food and energy has risen
to 1.2 percent lately (Chart 3). Moreover, the trimmed mean is increasingly becoming
important since the indicator automatically removes highly volatile items every month - given
that fluctuations in commodity prices and foreign exchange rates have amplified. The "10
percent trimmed mean" has been rising moderately and is currently at 0.6 percent, and this
contrasts sharply with the declining trend observed about the same period last year.
Third, firms' pricing behavior with respect to sales prices has shown positive developments.
To see this, let me plot the relationship between the actual sales price DI and the rate of
growth in projected domestic sales for fiscal 2015, according to the September Tankan
(Chart 4). The sales price DI is calculated by subtracting the percentage share of firms
responding that their sales prices are "falling" from the share of those indicating that the prices
are "rising." Chart 4 indicates that a few sectors are positioned in the first quadrant (positive
territory for both the actual sales price DI and projected domestic sales). Developments in
sectors such as (1) food and (2) accommodations, eating & drinking services are worthy of
note. The sales price DI in these sectors used to be negative to a relatively large degree or
showed greater responses with "fall" than those with "rise" before QQE was launched. This
indicates a significant turnaround in firms' pricing behavior toward an environment where they
find it easier to raise their sales prices than before.
The current rise in a wide range of CPI items reflects three factors: (a) an import price rise
driven by the yen's depreciation; (b) an increase in domestic demand; and (c) a pass-through
of a wage rise. While it is difficult to disentangle these factors, the impact of (a) above, the
import price rise, seems large and it eventually will fade away unless a further depreciation of
the yen takes place. Meanwhile, firms have provided high value-added goods and services,
and higher sales prices have accompanied a sales increase in some items, as seen in the food
and accommodations, eating & drinking services sectors. Looking ahead, nominal wages are
likely to rise and the output gap is likely to improve in positive territory, which will help enhance
the sustainability of a price rise.
Fourth, developments in inflation expectations should be monitored closely, although some
indicators have declined recently. Inflation expectations are a collective term referring to those
of households, firms, and economists, as well as market-based indicators. Attention should be
paid to a recent decline in inflation expectations of firms and economists, as well as in
marketbased indicators. At the same time, however, a decline in inflation expectations has been a
global phenomenon since summer 2015. Therefore, it is important to understand whether such
a decline reflects a downward revision of commodity price projections and a temporary
deceleration in global economic growth, or alternatively a deterioration of the outlook for the
domestic supply-demand balance. On this front, domestic private consumption has been
resilient. The corporate sector has maintained its positive business fixed investment plans
according to various recent surveys, and thus fixed investment is likely to expand in the near
future. These domestic demand conditions support the view that domestic supply-demand
balance is not bad at all. Inflation expectations, therefore, are likely to show a sustainable rise
once the rate of change in the CPI begins to rise following an improvement in the output gap.
Fifth, as a related issue, households' inflation expectations tend to be higher than those
of firms. Households tend to perceive that prices are always rising and they always keep
positive inflation expectations even under a mild deflationary phase or a very slight inflationary
phase (Chart 5). This suggests the presence of an upward bias in inflation expectations. On
this point, I have delivered several speeches abroad in the past and have suggested that the
scale of upward bias appears to be generally greater in Japan than in Europe and the United
States.2 Given the past long-standing stagnant wages, households appear to have formed an
expectation over time that future wages will always decline. This has led households to
anticipate tighter budgets, and such strong defensive action has resulted in a larger upward
bias in their inflation expectations. In this environment, it is important for households to form a
perception that wages will increase steadily and that such an increase will continue; indeed,
wages are currently improving moderately. In addition, at present, a further monetary policy
action is unnecessary given that current sluggish movements of the core CPI caused by a
decline in energy prices are temporary, and that a decline in production costs and the resultant
improvement in corporate profits might enhance the opportunity for firms to raise wages more
readily.
Based on these five viewpoints, it is time to closely monitor whether prices will exhibit a rising
trend under the current accommodative monetary easing environment. If such a path toward
price rises does not materialize at all, the Bank - depending on the causes - may consider
some adjustments with regard to the monetary policy.
This brings me to the end of my speech.
Thank you very much indeed for your kind attention.
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