Bank of Japan's summary of the annual review of monetary and economic
developments in fiscal 1996 BANK OF JAPAN, ANNUAL REVIEW 1997.
Overview
Japan's economy followed a moderate recovery trend in fiscal 1996. The pace of
recovery began to accelerate at the end of 1995, aided by substantially stimulative monetary and
fiscal policy measures, and the recovery continued in fiscal 1996. In the second half of the fiscal
year, the economic recovery firmed, particularly in private demand, driven in part by the
depreciation of the yen since the previous year.
With respect to final demand in the first half of fiscal 1996, net exports declined
sharply, reflecting such factors as the appreciation of the yen until the middle of 1995 and the
increase in imports of manufactured goods from Japanese affiliates overseas. However, the
economic recovery was underpinned by policy-related demand factors, such as the increase in
public-sector investment reflecting the economic stimulus package of autumn 1995, and the
high level of housing investment induced by low interest rates. In the middle of fiscal 1996,
public-sector investment began to decline gradually from its peak, while net exports, which had
been restraining the economic recovery, started to rise, partly reflecting the depreciation of the
yen. Regarding private demand, business fixed investment increased steadily throughout the
fiscal year, reflecting recovery in corporate profits, progress in stock adjustments, and a rise in
autonomous investment, such as in information technology, and the increase spread across
industries from large manufacturing firms to small nonmanufacturing firms. Personal
consumption followed a moderate recovery trend in line with a recovery in compensation of
employees despite fluctuations caused by factors such as the weather. From autumn 1996,
automobile sales, which have a large influence on production, accelerated. Housing investment
remained high, owing both to the increase in demand ahead of the rise in the consumption tax
rate, implemented in April 1997, and to low interest rates.
Industrial production remained virtually unchanged until the middle of 1996,
reflecting the decrease in net exports, and adjustments in the excessive inventories of some
producer goods. However, growth in production has gradually gathered pace since the middle of
the year, as private demand has increased steadily, net exports have begun to increase, and the
increase in final demand has led more directly to a rise in production because of progress in
inventory adjustments. At the end of the fiscal year, both industrial production and shipments
recovered to the levels recorded at the previous peak in the economic cycle reflecting the
increase in demand before the rise in the consumption tax rate. In these circumstances,
corporate profits continued to recover primarily among large manufacturing firms, driven in
part by a rise in profits of processing industries reflecting the depreciation of the yen and the
success of corporate restructuring efforts. Business confidence also improved gradually,
according to the Bank of Japan's "Tankan-Short-Term Economic Survey of Enterprises in
Japan." The improvement in profits of large manufacturing firms was reflected in an increase in
their expenditures, which in turn contributed to a recovery in the business conditions of
corporate service industries and small manufacturing firms. As for labor market conditions, the
unemployment rate remained high and growth in the number of the regularly employed
stagnated owing to persistent adjustment pressures on personnel expenses in the corporate
sector. However, overtime working hours and the number of new job offers increased steadily,
reflecting production growth and improvements in corporate profits, and compensation of
employees rose gradually, particularly in special cash earnings. In sum, the overall labor market
conditions followed a recovery trend.
While substantially stimulative monetary and fiscal policy measures in fiscal
1995 continued to underpin economic recovery in early fiscal 1996, a positive cycle of demand,
production, and income began to operate, underpinning the economic recovery throughout fiscal
1996. That is, an increase in final demand pushed up production and led to an improvement in
corporate profits, particularly among large manufacturing firms. This in turn led to an
improvement in profits and a rise in compensation of employees among nonmanufacturing
firms and small firms, thereby expanding expenditures. During the second half of fiscal 1996,
the recovery in private demand firmed, reflecting the positive effects of the depreciation of the
yen on corporate profits, despite a decrease in public-sector investment. In other words,
although the pace of the economic recovery remained moderate, a recovery led by policy
demand is gradually shifting toward one led by private demand.
Although Japan's economy bottomed out at the end of 1993, the pace of recovery
remains relatively moderate, owing to various structural adjustment pressures on industries.
These include (1) pressures for the industrial structure to change in response to global
competition resulting from the expansion of supply capacity in Asian countries, and to the
constant appreciation of the yen until the middle of 1995; and (2) balance-sheet adjustment
pressures owing to the sharp and significant decline in asset prices since the bursting of the
economic "bubble" in the late 1980s. Steady progress has been made in dealing with the
pressures for the industrial structure to change, as reflected in (1) a significant improvement in
corporate profits, particularly among large manufacturing firms, resulting from the successful
restructuring efforts and the depreciation of the yen from the middle of 1995; (2) progress in the
reorganization of the international production system as seen in the shift in Japan's exports and
production toward more capital- and technology-intensive goods; and (3) increased business
fixed investment in new sectors owing to technological innovations and deregulation in
information and communications industries. With regard to balance-sheet adjustments, strong
adjustment pressures remained throughout fiscal 1996, as seen in the persistently high level of
the ratio of debts to assets, especially among small nonmanufacturing firms.
In fiscal 1996, weakening of prices came to a halt. Domestic wholesale prices
followed a downward trend until the middle of 1996, but in the second half of fiscal 1996 they
virtually stopped declining, owing to a moderate improvement in domestic supply and demand
conditions, as well as a rise in import prices reflecting the depreciation of the yen and the rise in
crude oil prices. In March 1997, the year-to-year change shifted from decline to increase.
Although corporate service prices continued to decline compared to the level of the previous
year, reflecting the decrease in leasing prices and real estate rents, the year-to-year declines
were smaller in the second half of fiscal 1996, due to a recovery in demand for services
following the improvement in corporate profits. Consumer prices (nationwide, excluding
perishables) also increased by a slightly wider margin from the previous year owing to a smaller
decline in commodity prices as a result of the depreciation of the yen, and the halt in the decline
in domestic wholesale prices, as well as a gradual increase in service prices. While prices
seemed to have stopped declining, the increase in import prices from the depreciation of the yen
and higher crude oil prices had little impact on domestic prices, as there remained persistent
downward pressures on prices from imports of manufactured goods, particularly final goods,
and technological innovations. As for commercial land, prices for large and well-located plots
of land suitable for development virtually stopped declining owing mainly to the gradual
progress in stock adjustment for office space. However, the prices of smaller plots of land with
limited commercial value continued to decline. The recent development in commercial land
prices thus indicates a distinct splitting into two groups. Meanwhile, residential land prices are
bottoming out, reflecting the high level of residential housing construction.
The cyclical momentum for economic recovery gathered strength in fiscal 1996.
However, the pace of the recovery remained moderate owing to continued structural adjustment
pressures, including the balance-sheet problems. Although weakening of prices had come to a
halt by the second half of fiscal 1996, prices were unlikely to follow an upward trend. Against
the background of these economic and price conditions, the Bank of Japan maintained an easy
monetary policy, keeping the official discount rate at its September 1995 level of 0.5 percent to
establish a solid foundation for the economic recovery.
As for financial developments, the overnight call rate (uncollateralized) remained
on average slightly below the official discount rate following monetary adjustments by the Bank
of Japan. Long-term interest rates continued to rise with some fluctuations in the first half of
1996, but fell sharply in the second half. Interest rates on short-term instruments, namely
3-month certificate of deposit (CD) rates, followed a similar trend, although with smaller
fluctuations than those in long-term interest rates. Stock prices continued to rise during the first
half of 1996, but began to weaken in the summer, and fell sharply from the end of the year. The
year-to-year growth rate of M2+CDs, a representative indicator of monetary aggregates,
generally remained around 3.0-4.0 percent, but declined slightly in the second half of the fiscal
year, partly due to the slow growth in funding in the private sector.
Despite the firm recovery of the real economy, particularly in the private sector
during the second half of fiscal 1996, the financial markets during this period adopted a more
cautious stance. This was because (1) the financial markets reacted in anticipation of the fiscal
tightening measures-such as the rise in the consumption tax rate and the termination of special
tax reductions in fiscal 1997-and this had restraining effects on economic conditions; and
(2) there was renewed awareness that various adjustment pressures, especially balance-sheet
adjustment pressures, remained strong among small nonmanufacturing firms and financial
institutions. Under these circumstances, the cyclical developments of the economic recovery
were not immediately reflected in financial indicators through the confidence of market
participants. Meanwhile, significant progress was made in fiscal 1996 in the solution of the
jusen (housing loan companies) problem, and steady progress was also made in solving the
problem of nonperforming assets of financial institutions, including improvements in the
framework for the resolution of failed financial institutions.
With respect to the outlook, the probability that Japan's economy will continue to
recover is rising, although the pace of recovery may decelerate temporarily. This expectation is
based on the fact that the positive cycle of production and consumption has not been deterred by
the reaction to the increase in demand ahead of the consumption tax rate rise. Despite the
continued economic recovery, the private sector has not gained sufficient confidence in its
future growth, reflecting persistent uncertainty about structural adjustments. Under the
structural adjustment pressures, expected growth rates are unlikely to rise at the same pace in
different industries and firms. However, from a long-term perspective, the establishment of a
new industrial structure based on the principle of comparative advantage can be expected to
enhance growth by promoting the efficiency of resource allocation.
In order for Japan's economy to achieve sustainable growth, it is vital to create
investment opportunities and raise expected growth rates of economic entities through effective
reforms of the economic structure. Such efforts are essential in adapting to the medium- to
long-term changes in economic environment, including increasing global competitive pressures,
and the further aging of the population, and in maintaining Japan's economic strength.
Considering the important role that the financial sector must play in the reforms of the
economic structure, it will be necessary to continue implementing measures to stabilize the
Japanese financial system, and increase domestic and overseas confidence in the system. At the
same time, the financial system must be reorganized to enhance its functions and
competitiveness, by improving the infrastructure in order to promote competition in accordance
with the Japanese "Big Bang" deregulation package.