Haruhiko Kuroda: Two years under QQE
Speech by Mr Haruhiko Kuroda, Governor of the Bank of Japan, to the Yomiuri International
Economic Society, Tokyo, 15 May 2015.
* * *
Introduction
It is a great honor to be invited to this meeting hosted by the Yomiuri International Economic
Society today.
The last time I addressed this meeting, in April 2013, was immediately after the Bank of
Japan's introduction of Quantitative and Qualitative Monetary Easing (QQE). Two years have
passed since then, and the economic and price situation has improved substantially under
QQE. Although the year-on-year rate of increase in the consumer price index (CPI) had
declined, due mainly to the effects of the substantial decline in crude oil prices since last
summer, and recently has been about 0 percent, the underlying trend in inflation has steadily
been improving, as I will explain later in more detail.
Today, I will review the developments in Japan's economic activity and prices during the past
two years and explain the effects QQE has been exerting. On this basis, I will touch on the
outlook and the Bank's monetary policy, referring to the April 2015 Outlook for Economic
Activity and Prices (hereafter the Outlook Report).
I. Effects of QQE
Transmission mechanism of QQE
The Bank, in introducing QQE two years ago, envisioned the following transmission
mechanism of QQE as a main channel (Chart 1). Namely, (1) inflation expectations will be
raised through a strong and clear commitment to achieving the price stability target of
2 percent and through large-scale monetary easing to underpin the commitment,
(2) downward pressure will be put on nominal interest rates across the entire yield curve
through massive purchases of Japanese government bonds (JGBs), thereby (3) decreasing
real interest rates. The decline in real interest rates will stimulate private demand, which will
lead to an upturn in the economy, improving the output gap. Then, the improvement in the
output gap, together with a rise in inflation expectations, will increase inflation rates. As
people experience actual price increases, their inflation expectations will rise further.
Meanwhile, on the financial front, asset prices - such as stock prices and foreign exchange
rates - reflect these developments in economic activity and prices or else incorporate future
developments. Moreover, due to the decline in JGB yields, coupled with the Bank's
purchases of exchange-traded funds (ETFs) and Japan real estate investment trusts
(J-REITs), investors will increase their risk-taking, thereby exerting positive effects on prices
of risk assets, and an increase in lending is also expected. These improvements in finance
will support economic activity. QQE aims at giving rise to such a virtuous cycle of finance,
economic activity, and prices, which in turn raises inflation rates toward 2 percent
accompanied by a positive turnaround in the economy.
The downward effects on real interest rates
Let me assess the outcome of QQE. First, I will review to what extent real interest rates have
declined, which is the starting point of the transmission mechanism.
Long-term interest rates, which had already been at historical low levels at the time of the
introduction of QQE, have declined further with the Bank's massive purchases of JGBs.
Yields on 10-year JGBs have declined by about 0.3 percentage point. Meanwhile, inflation
expectations have increased. When asked "to what degree do you think prices will rise," I
believe that you would feel differently now versus two years ago, and that your answer also
would be different. The word "deflation" - or defure in Japanese - has not been heard so
much except in the context of "overcoming of deflation." Firms' price- and wage-setting
behavior has been changing and rises in base pay, which had not been seen for more than a
decade, have taken place in two consecutive years starting from last year. Given these
changes, there is no doubt that inflation expectations have increased. That said, when trying
to express such expectations in terms of numeric figures, a single figure cannot be easily
found because expectations are what exist in people's minds. The results of surveys
conducted of various economic entities including households, firms, and economists, in
addition to figures implied by inflation-indexed bonds that are traded in markets, are wide
ranging. With this in mind, medium- to long-term inflation expectations of economists and
market participants, for which the results can be obtained in a numerical form, have
increased by about 0.5 percentage point. Based on these figures, the degree of decline in
real interest rates seems to have been slightly less than 1 percentage point, as calculated by
adding the degree of decline in nominal long-term yields mentioned earlier (Chart 2). There
are various methods for estimating the degree of decline in real interest rates, such as
calculating the degree of downward effects on real interest rates brought about by the Bank's
cumulative JGB purchases thus far; interestingly, regardless of the method employed, the
results have been mostly the same. The fact that similar results are obtained from different
methods means that it is reasonable to judge that, numerically, real interest rates have
declined by less than 1 percentage point; medium- to long-term inflation expectations have
increased by about 0.5 percentage point and nominal long-term interest rates have
decreased by about 0.3 percentage point. According to research conducted in the United
States and Europe, a decline in long-term interest rates has policy effects on economic
activity and prices that are approximately a couple of times larger than those of a decline in
short-term interest rates. Moreover, our empirical analysis of downward pressure from QQE
on nominal interest rates across the entire yield curve showed that, if the same effect were to
be gained exclusively through the decline in short-term interest rates, it would be necessary
to decrease the rate by about 2 percent. While these analyses are subject to a margin of
error due to the situation for each country and to the relevant premises, the policy effects of
QQE are such that they are roughly equivalent to those that would arise from making almost
ten 0.25 percent cuts in short-term interest rates in one shot under conventional monetary
policy.
Financial markets responded to QQE relatively swiftly. Stock prices have increased
substantially and the appreciation of the yen was corrected in the foreign exchange markets.
Lending, including that to small and medium-sized enterprises (SMEs), has been increasing
moderately, at a pace of 2.5-3.0 percent on a year-on-year basis recently. In addition to the
decline in real interest rates, such developments have made financial conditions even more
accommodative.
Economic activity and prices under QQE
With QQE producing effects, a virtuous cycle from income to spending has been operating in
both the corporate and household sectors, and the economy has seen a significant
turnaround.
In the corporate sector, profits have improved to their highest level historically and fixed
investment has been on a moderate increasing trend (Chart 3). Meanwhile, exports, which
had been lacking momentum despite the correction of the appreciation of the yen, have
finally been picking up clearly, as seen in their increase for three consecutive quarters since
the July-September quarter of 2014 (Chart 4).
Turning to the household sector, labor market conditions have tightened and the employment
situation has improved, as seen in the unemployment rate declining to around 3.5 percent.
Consequently, in fiscal 2013 - during the year after the implementation of QQE - the number
of employees increased in particular. In fiscal 2014 - the second year after the
implementation - wages also turned to an increase. Employee income - that is, nominal
wages multiplied by the number of employees - has been rising moderately (Chart 5).
Against the background of an improvement in the employment and income situation, private
consumption as a whole has been resilient. The effects of the consumption tax hike had
been protracted during fiscal 2014, but they have been dissipating recently.
Reflecting this turnaround in the economy, the underlying trend in inflation has also steadily
increased. As seen in the decline in the unemployment rate, labor and capital have been
heavily utilized, and the output gap has already improved to about 0 percent, which is the
level of the past long-term average. As mentioned earlier, inflation expectations have also
increased. As a result, the year-on-year rate of change in the CPI (all items less fresh
food) - about minus 0.5 percent before the introduction of QQE - improved to 1.5 percent
last April excluding the direct effects of the consumption tax hike.
Thereafter, the rate of increase in the CPI has slowed against the background of somewhat
weak developments in demand following the consumption tax hike and the substantial
decline in crude oil prices since summer 2014. While the decline in crude oil prices exerts
positive effects on Japan's economy, there is a risk that the mechanism I have explained
thus far will not operate if it were to affect firms' price- and wage-setting behavior through
changes in inflation expectations. In order to preempt the manifestation of such risk, the
Bank expanded QQE in October 2014 to pursue a stronger monetary easing measure.
Looking at developments in inflation expectations thereafter, market-based indicators and
various survey results have not declined despite the fall in crude oil prices. Moreover, in the
annual labor-management wage negotiations this year, many firms will increase wages,
including base pay, which was raised to a larger extent than last year. More firms have been
shifting their price-setting behavior toward a strategy of raising sales prices while increasing
value-added. Inflation expectations can be judged as rising on the whole from a somewhat
longer-term perspective.
The financial, economic, and price developments I have outlined are mostly in line with the
mechanism anticipated by QQE. The developments are qualitatively described as a decline
in real interest rates, a rise in stock prices and depreciation of the yen, improvement in
corporate profits, tightening in the labor market, an increase in employee income, and a rise
in the CPI. Let me now explain these developments by referring to our quantitative analysis.
During the two years since the introduction of QQE - more precisely, up to end-2014, for
which quarterly data are available - actual changes in economic activity and prices
amounted to improvement of 2 percentage points in the output gap, which represents
improvement of about 10 trillion yen, and a 1.0 percentage point improvement in the
year-onyear rate of increase in the CPI. Simulating the effects of the less than 1 percentage point
decline in real interest rates that I have mentioned by using our macroeconometric model,
the results are as follows: the output gap improved by 1-3 percentage points and the
yearon-year rate of increase in the CPI rose by 0.6-1.0 percentage point. While these results
vary depending on the assumption about how much stock prices and foreign exchange rates
are affected by QQE, the results obtained by using the model are generally in line with the
actual changes in economic activity and prices. During the past two years, there were both
positive and negative effects on economic activity and prices in addition to QQE - such as
measures by the government including large-scale public investment, the consumption tax
hike, a surge in stock prices, foreign exchange rate movements, and a significant decline in
crude oil prices. In reality, however, economic activity and prices as a whole could be
assessed - even on a quantitative basis - as being mostly in line with the mechanism
anticipated by QQE.
Having said this, the year-on-year rate of increase in the CPI has slowed to about 0 percent
due to the effects of the decline in energy prices. In order to achieve the price stability target
of 2 percent in a stable manner, it is necessary that the CPI inflation rise as inflation
expectations increase further. As mentioned earlier, inflation expectations are rising on the
whole from a somewhat longer-term perspective, due partly to the effects of the expansion of
QQE last October despite the decline in crude oil prices. We will examine whether the trend
rise in inflation expectations will continue in a situation where CPI inflation has declined. In
the following, I will touch on the outlook for economic activity and prices.
II. Outlook for economic activity and prices
Outlook for economic activity
Looking ahead, Japan's economy is expected to continue its recovery trend with a virtuous
cycle from income to spending maintained in both the household and corporate sectors and
with a favorable environment of inexpensive crude oil prices. Exports are expected to
increase moderately against the background of the recovery in overseas economies - mainly
in advanced economies - and support from the correction of the appreciation of the yen.
Turning to domestic demand, with an improvement in corporate profits and monetary
accommodation both continuing to provide a boost, business fixed investment is projected to
increase steadily, additionally supported by recently emerging developments toward the
enhancement of domestic production capacity. Private consumption is projected to
accelerate its pace of increase due to a steady improvement in the employment and income
situation, given that consumer sentiment has been improving recently and that the effects of
the decline in demand following the consumption tax hike in April 2014 have been
dissipating.
Against this background, with regard to the outlook over the next three years, the economy is
projected to continue growing at a pace above its potential from fiscal 2015 through fiscal
2016. Under these circumstances, the output gap is likely to turn positive and thereafter
move further into excess demand territory. Expressing the outlook in terms of the median of
the Policy Board members' forecasts of the real GDP growth rate, this was 2.0 percent for
fiscal 2015 and 1.5 percent for fiscal 2016 (Chart 6). Subsequently, through fiscal 2017, the
economy is projected to maintain its positive growth, although with a slowing in its pace to
around a level somewhat below the potential growth rate. The slowdown is due mainly to
(1) the effects of a front-loaded increase and subsequent decline in demand prior to and after
the consumption tax hike planned in April 2017 and (2) cyclical deceleration. In terms of the
median of the Policy Board members' forecasts of the real GDP growth rate, this was
0.2 percent for fiscal 2017.
Outlook for prices
Next, I will discuss the outlook for prices. The improvement in the output gap and an increase
in inflation expectations are likely to continue, and thus the underlying trend in inflation is
expected to steadily rise. In addition, downward pressure from the decline in energy prices
will gradually dissipate. Therefore, the year-on-year rate of increase in the CPI (all items less
fresh food) is likely to be about 0 percent for the time being but accelerate toward 2 percent
as the negative contribution of energy prices on a year-on-year basis narrows in the second
half of fiscal 2015. Although the timing of the year-on-year rate of increase in the CPI
reaching around 2 percent depends on developments in crude oil prices, this is projected to
happen around the first half of fiscal 2016, when the negative contribution of energy prices
will become almost zero, assuming that crude oil prices will rise moderately from the recent
level. Thereafter, the year-on-year rate of increase in the CPI is expected to be around
2 percent on average, although it will be affected by various factors each month. In the April
2015 Outlook Report, the median of the Policy Board members' forecasts of the year-on-year
rate of increase in the CPI (all items less fresh food) was 0.8 percent for fiscal 2015,
2.0 percent for fiscal 2016, and 1.9 percent for fiscal 2017 (Chart 6). Comparing the
projections in the Outlook Report with those in the January 2015 interim assessment, the
projected rate of increase in the CPI is somewhat lower. The timing of reaching around
2 percent is delayed, albeit slightly, from the former projection of "in or around fiscal 2015."
III. The Bank's monetary policy
As I have explained, QQE has exerted its intended effects. The improvement in economic
activity and prices is likely to continue, and the CPI inflation is projected to reach the price
stability target of about 2 percent around the first half of fiscal 2016. The Bank will keep its
stance of continuing with QQE, aiming to achieve the price stability of 2 percent, as long as it
is necessary for maintaining that target in a stable manner.
The timing of achieving the 2 percent target has been delayed compared to the previous
forecast. Some have raised the question of how the delay should be reconciled with the
Bank's commitment to achieving the price stability target at the earliest possible time, with a
time horizon of about two years.
Changing people's deflationary mindset and raising inflation expectations through its
commitment to achieving the price stability target of 2 percent at the earliest possible time is
by itself an aim of overcoming deflation, and at the same time the starting point of QQE's
effects. As I have explained, the perception of inflation by firms and households started to
change markedly. This is because the Bank presented a time frame of achieving the price
stability target at the earliest possible time with a time horizon of about two years, and made
a clear commitment to doing whatever is necessary to achieve that target.
In reality, prices change due to various factors. A slowdown in the inflation rate in Japan
since last summer is mainly attributable to the decline in crude oil prices, and it is common to
many countries. The rate of decline in crude oil prices since last summer was very large -
about 60 percent within about six months. It has been taken for granted among major central
banks that the inflation rate would deviate for some time from the price stability target as a
result of changes in commodity prices, such as crude oil prices. In fact, the year-on-year
rates of change in the headline consumer price index have become zero or even slightly
negative in economies such as of the United States, the United Kingdom, and the euro area,
and the timing of reverting to 2 percent inflation is projected to be two or three years from
now in these economies. In Japan, as I have described, the underlying trend in inflation has
improved steadily, and as the effects of the decline in crude oil prices dissipate, the
year-onyear rate of increase in the CPI is projected to accelerate toward the price stability target of
2 percent. We believe that this forecast is consistent with the commitment to achieving the
price stability target at the earliest possible time, with a time horizon of about two years. That
said, if there are changes in the underlying trend in inflation and it is deemed necessary to
take action in order to achieve 2 percent inflation, the Bank will make adjustments as
appropriate without hesitation.
Concluding remarks
So far, I have reflected on the progress made in the two years since the introduction of QQE,
and with this in mind, I also have discussed the developments in economic activity and prices
and the Bank's monetary policy. Lastly, I will conclude today's speech by sharing my
thoughts.
In implementing economic policies, many things can happen, expected or unexpected.
Looking back at the two years since the introduction of QQE, there have been expected
developments and unexpected events. During the first year - in fiscal 2013 - most of the
developments were judged as expected or as better than expected, as the economy
experienced a positive turnaround and the inflation rates increased steadily. Exports,
however, had been lacking momentum, and this was below my expectations. The effects of
firms' relocation of production overseas, which had taken place amid the excessive
appreciation of the yen, were more significant than I had expected. Because of these effects,
it is only recently that exports have picked up. During the second year - in fiscal 2014 -
private consumption was weaker than expected. This was attributed to the effects of the
decline in demand following the consumption tax hike being somewhat prolonged, as well as
to other factors, such as the effects of the bad weather last summer. From consumers'
perspective, it was natural that they perceived the consumption tax hike as being part of
price increases. Given that the rate of wage increases did not catch up with that of price
increases including the tax hike, private consumption weakened. Such effects on private
consumption have been anticipated since tax hikes place a burden on consumers, but they
have been somewhat larger than our expectations. On top of this, I would note the decline in
crude oil prices, which amounted to a 60 percent drop within about six months, as the
most unexpected event. As a result, the CPI inflation rate has declined to about 0 percent
from 1.5 percent. This decline in the inflation rate created a risk for the mechanism of
QQE - namely, the formation of inflation expectations in particular - and this was why the
Bank decided to expand QQE.
Despite these unexpected events, the mechanism of QQE has been operating as intended.
During the past two years, QQE - in tandem with the government's policy measures - has
markedly changed people's negative mindset, which had taken root under deflation. If the
economy continues its turnaround and deflation is to be overcome, Japan will provide a rare
example of a regime shift through macroeconomic policy. Despite some unexpected events, I
feel encouraged by the fact that the big picture of economic development for these two years
is in line with what we envisioned at the outset. The Bank will continue to steadily pursue
QQE to achieve the price stability target of 2 percent at the earliest possible time.
Thank you.
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