Yutaka Harada: Economic activity and prices in Japan and monetary
policy
Speech by Mr Yutaka Harada, Member of the Policy Board of the Bank of Japan, at a
meeting with business leaders, Tochigi, 11 November 2015.
* * *
Introduction
This will be my first speech to deliver as a Policy Board member of the Bank of Japan.
Before starting, I would like to extend my sincere condolences for the lives lost and to the
people who have suffered from the heavy rains that devastated areas including Tochigi
Prefecture in September.
Thank you for giving me this opportunity to exchange views with people representing Tochigi,
who have taken time to be here despite their busy schedules. It is indeed a great honor to be
here today. Please allow me to express my gratitude for your great cooperation with the
activities of the Bank's Research and Statistics Department on the economy of Tochigi, and
also with those of the Bank's other departments.
Around two and a half years have passed since the Bank introduced quantitative and
qualitative monetary easing (QQE) in April 2013. Today, I would like to offer my assessment
of QQE and then discuss the Bank's outlook for economic activity and prices through fiscal
2017 indicated in its report, the Outlook for Economic Activity and Prices (hereafter the
Outlook Report), which was released at the end of October this year. Following my speech, I
look forward to hearing your views on the actual situation for Tochigi's economy, and to your
candid opinions.
I. Major shift in monetary policy
The current QQE was adopted following a major shift from the previous monetary policy
regime. In January 2013, the Bank introduced the price stability target of 2 percent in terms
of the year-on-year rate of change in the consumer price index (CPI). Furthermore, in March
that year, Mr. Haruhiko Kuroda was appointed as Governor of the Bank, and in April, the
Bank introduced QQE in order to achieve the price stability target at the earliest possible
time, with a time horizon of about two years.
QQE consists of a strong commitment to achieving 2 percent inflation in terms of the
yearon-year rate of change in the CPI and bold monetary easing measures to underpin such a
commitment. At the Monetary Policy Meeting held on April 3 and 4, 2013, the Bank decided
on the following specific measures. First, it decided to change the main operating target for
money market operations from the interest rate - namely, the uncollateralized overnight call
rate - to the monetary base, and to conduct money market operations so that the monetary
base would increase at an annual pace of about 60-70 trillion yen, doubling in two years,
from 138 trillion yen at the end of 2012 to 270 trillion yen at the end of 2014. Second, in
terms of the qualitative aspect, with a view to encouraging a further decline in interest rates
across the yield curve, the Bank decided to purchase Japanese government bonds (JGBs),
so that the amount outstanding of its holdings would increase at an annual pace of about
50 trillion yen, similarly doubling in two years, from 89 trillion yen at the end of 2012 to
190 trillion yen at the end of 2014. In addition, the Bank decided to extend the average
remaining maturity of its JGB purchases from slightly less than three years to about seven
years. Third, with a view to lowering the risk premia of asset prices, the Bank decided to
purchase exchange-traded funds (ETFs) and Japan real estate investment trusts (J-REITs)
so that their amounts outstanding would increase at an annual pace of 1 trillion yen and
30 billion yen, respectively. And fourth, the Bank committed to continuing with QQE, aiming
to achieve the price stability target of 2 percent, as long as it was necessary for maintaining
that target in a stable manner.
Furthermore, the Bank decided to expand QQE in October 2014 to prevent a risk that
conversion of the deflationary mindset would be delayed because, after the consumption tax
hike in April that year, it became clear that the negative effects of the hike on economic
activity and prices would persist, and also because of the drop in crude oil prices - a factor
that would be desirable in the longer term but exert downward pressure on prices in the short
term. Specifically, the Bank decided to accelerate the annual pace of increase in the
monetary base from 60-70 trillion yen to 80 trillion yen, and to increase purchases of JGBs
so that the amount outstanding of its holdings would be increased from an annual pace of
50 trillion yen to 80 trillion yen. The average remaining maturity of the Bank's JGB purchases
would be extended from about seven years to a range of seven to ten years. In addition, the
Bank decided to accelerate the annual paces of increase in the amounts outstanding of its
holdings of ETFs and J-REITs from 1 trillion yen and 30 billion yen, respectively, to 3 trillion
yen and 90 billion yen.
Next, I will explain what has occurred as a result of these monetary easing measures, as well
as the problems with them.
II. Consequences of the monetary policy shift
Trends in production, consumption, and investment
First, I will talk about trends in production, consumption, and investment over the period of
around two and a half years since the introduction of QQE. Chart 1 shows that, excluding the
negative effects of the consumption tax hike in April 2014, investment, in terms of domestic
shipments and imports of capital goods, has been expanding as a trend, although it has
shown weakness very recently. On the other hand, production and consumption have been
stagnant. Even excluding such factors as the effects of the front-loaded increase in demand
prior to the consumption tax hike and the subsequent decline, it is difficult to say that
production and consumption have been recovering steadily.
The effects of the consumption tax hike have been particularly large on consumption. The
Synthetic Consumption Index - which is a combination of supply-side and demand-side
statistics and shows similar movements to consumption on a GDP basis - has not yet
surpassed the peak before the front-loaded increase in demand. However, it is natural that a
consumption tax hike leads to a decrease in consumption because the hike reduces
households' real income. What is important is whether real consumption is increasing as a
trend despite this phenomenon. The Bank's baseline scenario is that consumption has been
resilient, but I think that there have been some worrisome developments in consumption very
recently, as in production.
Steady growth in employment
In contrast, employment has grown steadily since the shift to QQE. As shown in Chart 2, the
numbers of both part-time and full-time employees have continued rising. The unemployment
rate has been declining steadily.
The active job openings-to-applicants ratio, as shown in Chart 3, was 1.24 times in
September 2015, marking its highest since January 1992.
Improvement in employment is spreading across Japan, although we have heard voices of
concern that the economic recovery has only been observed in major cities. As shown in
Chart 3, the active job openings-to-applicants ratio has risen in all regions, although it had
temporarily declined following the consumption tax hike. It rose to 0.99 times in September
2015 in Hokkaido, where the ratio has been the lowest in Japan.
Increase in wages
It has been said that wages have not increased despite the rise in employment. However, as
shown in Chart 4, employee income - that is, wages multiplied by the number of
employees - has increased. Real employment income has also increased, when excluding
the effects of the April 2014 tax hike. Since April 2015 - when the effects of the tax hike
dissipated - the uptrend in employee income has become clearer.
Here, I would like to note that, according to the Monthly Labour Survey, employment income
fell sharply in June and did not rebound much in July. However, the results seem odd given
that all surveys concerning the outcome of summer bonus payments in 2015 indicated a
year-on-year increase.1 I personally think that there was a sample bias in the Monthly Labour
Survey.
One reason wages are not rising is that the commonly used data on wages are the monthly
average of wages for all employees. During the early stage of an economic recovery, firms
try to meet increases in labor demand by hiring non-regular employees. This is because they
are not sure whether such demand will grow continuously. As a result, during this stage of
economic recovery, the number of employees increases for those with low hourly wages and
short monthly working hours. Statistically, this appears as a decline in the monthly average
wages for all employees. If economic recovery continues, firms will start to hire regular
employees, but it takes time before they do so.
Chart 5 shows nominal hourly wages for full-time and part-time employees. As wages for
fulltime employees include bonuses, their wage level fluctuates widely even after making
seasonal adjustments, and therefore it is difficult to find a clear trend. However, the wage
level for part-time employees has been rising in a stable manner. Wages for both full-time
and part-time employees are likely to increase in a sustainable manner as the economic
recovery continues, enabling us to confirm an uptrend in wages. As for the rate of increase in
wages between April 2013 - when QQE was introduced - and September 2015 - the latest
month for which the data are available - the rate for part-time employees was 3.8 percent,
which is higher than the rate for full-time employees of 1.2 percent.
Sluggish growth in exports
There has been criticism that exports have not grown even after the introduction of QQE. On
the other hand, those who have opposed monetary easing have argued that this policy would
create a serious problem by causing exports to surge, which would reignite trade frictions.
However, the economy is improving and exports have not grown much, as shown in Chart 6,
and I believe this is a rather desirable situation on balance. I will refer to the outlook for
exports later.
There is a strong perception that exports have been the main driving force of Japan's
economic recovery. However, past experience shows that exports have not necessarily
acted as such during economic recovery phases.2 Chart 6 shows the real export index, the
real import index, and the difference between the two; that is, the real trade balance. Here,
only the upward/downward movement of the real trade balance, and not the absolute level, is
meaningful. Japan's economy has experienced five recovery phases since 1990, from the
troughs of October 1993, January 1999, January 2002, March 2009, and November 2012.
However, exports and the trade balance increased simultaneously only in two phases, in
2002 and 2009. Moreover, in the 2002 phase, the trade balance started to increase after
more than three years had passed since the trough. In the 2009 phase, the trade balance
increased at first but decreased thereafter.
These findings indicate that the monetary easing policy can achieve economic recovery
without causing such problems as trade frictions.
Decline in crude oil prices has been weighing on price increases
We cannot rule out the risk of a pause in economic recovery, and yet, as I have explained,
the economy thus far has continued to recover, albeit at a moderate pace. In particular,
employment has been improving continuously. Even so, some people may criticize the Bank
for not being able to achieve the price stability target of a year-on-year rate of increase in the
CPI of 2 percent. As shown in Chart 7, prices do not appear to be rising, as the year-on-year
rate of change in the CPI (all items less fresh food) was negative for September, registering
minus 0.1 percent3. However, this was caused by a decline in energy prices due to the fall in
crude oil prices worldwide, and prices in terms of the CPI for all items less fresh food and
energy show a steady increase. As energy prices will not continue falling forever, I am
confident that the CPI for all items, including energy, will start to rise as the effects of the fall
in energy prices dissipate over time.
Monetary policy and price movements
Chart 8 shows the correlation between the monetary policy and price movements since
2012. This chart indicates the actual inflation rates in terms of the CPI and inflation
expectations; namely, the breakeven inflation (BEI) rates, which are calculated from the price
of inflation-indexed JGBs.4 Both the BEI rates and the CPI started to rise after the
introduction of QQE in April 2013 that followed the inauguration of the second Abe Cabinet in
December 2012. However, after entering fiscal 2014, increases in the CPI excluding the
effects of the consumption tax hike, the CPI for all items less fresh food, the CPI for all items
less fresh food and energy, and also the BEI rates became stagnant. To resolve this
situation, the Bank expanded QQE in October 2014, and the BEI rate and the CPI for all
items less fresh food and energy started rising again. In light of this result, the introduction
and expansion of QQE have been effective in pushing up the inflation rate, as recent price
developments show.
Here, I would like to note that the consumption tax hike has a negative impact on economic
activity, and that this works to push down the inflation rate. The hike reduces consumer
demand by exerting downward pressure on households' real income, which then lowers the
inflation rate. I feel that, in many cases, this is a point that is forgotten in discussions on
prices.
The reasons why the bank had not implemented monetary easing
Japan's economy has been recovering and moving toward overcoming deflation as a result
of QQE. Until this bold measure was taken under Governor Kuroda's leadership, there had
been criticism that the Bank had not been implementing sufficient monetary easing. The
following arguments have been pointed out as reasons behind the Bank's hesitation at that
time. The Bank was not able to implement monetary easing given that interest rates were at
zero. Even if quantitative easing were to be implemented, this would only increase the
outstanding balance of private banks' current accounts held at the Bank and would not
stimulate lending. Under zero interest rates, quantitative easing would not affect the yen's
exchange rates against other currencies. Should the yen depreciate, there would be a
serious problem of invoking competition among countries to devalue their currencies. In
reality, the Bank has managed to implement effective monetary easing both in terms of
quantity and quality. Bank lending has been increasing, and, as I discussed earlier, the yen
has depreciated without causing competition among countries with regard to devaluing their
currencies.5,6 Another argument that has been pointed out is concern about the risk that
monetary easing would lead to higher interest rates in the long term and cause some banks
that are holding a large amount of JGBs to be saddled with massive unrealized capital losses
on their JGB holdings. A rise in interest rates is naturally a positive factor for banks' business
conditions in the long term, but it is likely to temporarily increase their losses before getting to
that stage. However, I believe that, even if there was indeed such a risk, the Bank should not
have put off monetary easing. This is because, if deflation is allowed to continue, banks will
have no option but to increase their holdings of JGBs in the absence of borrowers.
Loans account for a large portion of banks' assets. An interest rate rise of 1 percentage point
would reduce the total value of bonds held by the entire banking sector by 7.5 trillion yen,
compared with the total assets outstanding of nearly 1,200 trillion yen.7 If deflation is
overcome and interest rates rise as a result of economic recovery, the business conditions of
banks' borrowers will improve, enhancing the soundness of loan assets. In other words, the
business conditions of banks will improve when interest rates rise as a result of economic
recovery.
In a newspaper opinion page, Professor Paul Krugman of Princeton University, a Nobel
economic sciences laureate, cited "the Fed's strange, destructive turn away from
expansionary policy in 1932" in the midst of the Great Depression, arguing that "a key factor
[behind the decision] was the complaints of commercial banks that low interest rates on
government securities were squeezing their profits."8 Given that the monetary tightening led
to a further deepening of the depression and deterioration of banks' business conditions, the
tightening clearly was a misjudged action that focused on narrow and fleeting interests.
III. Transmission mechanism of QQE for economic recovery
Thus far, I have shown that QQE has helped Japan's economy recover, albeit at a moderate
pace. Now, I would like to discuss the mechanism through which this has been achieved.
QQE has been effective in reducing real interest rates by lowering long-term interest rates
and raising inflation expectations. The Bank has committed to increasing the monetary base
in order to raise inflation expectations, and the increase in the monetary base has had
portfolio rebalancing effects in the broad sense of the term; namely, the effects of boosting
stock prices and weakening the yen.9
Chart 9 shows the BEI rates, which are calculated from the price of inflation-indexed JGBs,
and real interest rates. From the chart, we can see that inflation expectations in terms of the
BEI rate started to rise following the introduction of QQE. This will reduce real interest rates,
leading to a rise in asset prices, a decrease in the yen's exchange rate, and an expansion in
employment and production through an increase in business fixed investment and
consumption of durable goods, and consequently economic recovery.
IV. My views on criticisms against QQE
As I have explained, QQE has somehow managed to support economic recovery. There is a
theoretical basis for this, but even so, criticism against this policy has not subsided.
Let me first introduce a general criticism.
(1) Many people do not feel that the economy is recovering. Indeed, only about
10 percent of respondents answered that economic conditions have improved in the Bank's
survey. Chart 10 shows the trend in responses to the question: "How do you think economic
conditions have changed compared with one year ago?" Here, 10 percent is by no means
low. Even at its peak before the Lehman shock, the ratio was only at around 20 percent.
Considering the effects of the consumption tax hike in fiscal 2014, it will take time before
people begin to feel more strongly that economic conditions are improving.
Criticisms against monetary policy are as follows.
(2) Exports have not grown even after the introduction of QQE. It is true that exports
had been sluggish at the time of the introduction. However, this was due to the shift of
Japanese firms' production sites to overseas that was brought about by the fact that no
measures were taken to deal with the appreciation of the yen after the Lehman shock. Even
though the yen has depreciated, it takes time to shift production sites back to Japan. If a
monetary easing policy like the one that is now in place had been adopted immediately
following the Lehman shock, I think that this situation could have been avoided.
Meanwhile, revenue from inbound tourism, which is part of service exports, has grown by a
considerable degree. Such revenue, which was 1.2 trillion yen in 2012, rose to 1.5 trillion yen
in 2013 and nearly 2.0 trillion yen in 2014, and already has exceeded 2.0 trillion yen in the
January-August period of 2015. It takes time to shift production sites back to Japan, but
tourism is apparently an industry that can respond quickly. However, it is necessary to make
additional investment, such as in hotels, in order to continue attracting international tourists,
as the lack of hotels has become conspicuous.
Since the beginning of 2015, exports have been declining again, but this has been caused by
a temporary pause in the U.S. economic recovery and the slowdown in growth in emerging
economies, including China.
(3) Another criticism concerning monetary policy is that QQE will weaken fiscal
discipline by making it easier for the government to issue JGBs. Needless to say, the
objective of monetary policy is to dispel the deflationary mindset and achieve the price
stability target of 2 percent, thereby improving and stabilizing economic activity.
If fiscal discipline weakens due to monetary policy, the same is true in the case of a tax hike.
If the government squanders revenues because it is easy to issue JGBs, I believe that it will
also squander additional revenues gained from a tax hike. The government and the
parliament are responsible for maintaining fiscal discipline, and monetary policy should be
independent.
(4) Another line of criticism is that QQE is a failure because prices are not rising. QQE
would be criticized as a serious failure if prices rose without employment growth. In my
opinion, growing employment means that this policy has been very successful. Prices will
rise in due course in line with the narrowing of the output gap and a decline in the
unemployment rate, both of which follow expansion in employment; thus, there is no cause
for concern.
(5) The last example pertains to future concerns: a serious problem will come up sooner
or later even though the current situation may be favorable. For example, people making
such a criticism argue that QQE eventually will lead to hyperinflation despite the lack of an
increase in prices so far, a surge in interest rates, or a loss of confidence in the currency due
to impairment of the Bank's balance sheet. I think that these arguments are merely pointing
to what could occur in the future, whereas the present situation has proved to be favorable.
V. The October 2015 outlook report
I have basically talked about the past thus far, but would now like to discuss the outlook for
Japan's economy in and after fiscal 2015, based on the recently released October 2015
Outlook Report.
The Bank's baseline scenario of the outlook for economic activity - that is, the median of the
Policy Board members' forecasts of the real GDP growth rate - as in Chart 11, was
1.2 percent for fiscal 2015, 1.4 percent for fiscal 2016, and 0.3 percent for fiscal 2017.
The forecast of the real GDP growth rate for fiscal 2017 is low because consumption
obviously is likely to be restrained as the result of another consumption tax hike scheduled to
take place in April 2017. To respond to this situation, I believe that various approaches are
expected to be taken under the government's strategic framework of Abenomics as well as
the promotion of dynamic engagement of all Japanese citizens.
The Bank's baseline scenario of the outlook for prices - that is, 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 0.1 percent for fiscal 2015, 1.4 percent for fiscal 2016, and 3.1 percent for fiscal
2017 on a basis including the effects of the scheduled consumption tax hike, and 1.8 percent
on a basis excluding such effects. The forecast for fiscal 2017 is lower than that for fiscal
2016 because the negative impact of the scheduled consumption tax hike on the economy
will exert downward pressure on prices as well.
I have explained the Bank's baseline scenario so far. My outlook for economic activity and
prices is only slightly weaker, and I do not feel it is necessary to explain it in detail.
Risk of economic deceleration
In terms of economic activity and prices, there are indeed many risks that deviate from
projections. Here, I will discuss solely the Chinese economy, over which uncertainty has
been spreading since this summer. There is a criticism that data on the Chinese economy
released by the Chinese statistics office are unreliable. I admit that these data may be
questionable. But I do not think that the economic activity indicated by these data has
diverged widely upward from the actual situation.
How can we confirm whether the recent economic activity in China indicated by the official
statistics - for example, production - diverges widely from the actual situation? On this point,
rather than looking at statistics with a high degree of processing, such as those for
production and GDP, I think we should examine economic data with a relatively low degree
of processing - for example, real exports and imports, as well as the Purchasing Managers'
Index (PMI) for manufacturing activity that consists of an indicator compiled by the Chinese
government and one by a private-sector organization called Markit - or data for economies
that are closely connected with production in China, such as production in Taiwan and South
Korea. All of these data showed movements corresponding to the official statistics on
Chinese production. Recently, however, the figures estimated by the regression between
these data and the official statistics have shown higher growth rates than the official
statistics. Among them, I have shown only the results calculated using data on Taiwan and
South Korea in Chart 12. The results indicate that the official statistics on Chinese production
have not been overly assessed upward.
Japan's exports to China may face stagnation due to the economic slowdown in China, and
this eventually may lead to deceleration in Japan's economy. In fact, Japan's exports to
China have already been decreasing. However, I do not think that they will see a significant
further decrease. Meanwhile, the possibility cannot be ruled out that, if such a decrease in
exports becomes large, this will lead to a decline in production, and further to a deterioration
in employment.
Concluding remarks
As I mentioned, QQE has been exerting its intended effects. Despite the negative impact of
the April 2014 consumption tax hike, employment has continued to recover. The active job
openings-to-applicants ratio has risen in all regions, although it had been said that
Abenomics would not benefit local economies. It also has been said that wages have not
increased despite the rise in employment, but hourly wages have been rising. Employee
income - that is, wages multiplied by the number of employees - also has increased in real
terms. Corporate profits have been increasing as well, and thus so has income. If these
developments lead to positive movements in spending, such as consumption and
investment, production will recover. Unfortunately, however, recoveries in consumption and
investment remain weak despite the continued rise in income.
Prices have not risen as much as initially had been expected, but I think that QQE would be
criticized as a serious failure if prices rose without employment growth. Prices eventually will
start rising as the output gap in the overall economy tightens. We will be able to confirm by
the end of fiscal 2015 that the year-on-year rate of increase in the CPI is accelerating toward
2 percent.
However, there are still risks of economic deceleration in Japan, caused by factors such as
(1) a further slowdown in emerging economies, particularly China; (2) the possibility of an
unexpected shock stemming from an interest rate hike in the United States; and (3) a
resurgence of the European sovereign debt crisis. If the virtuous cycle of income to spending
ceases to operate, with employment deteriorating, consequently undermining the mechanism
through which prices trend upward, I think that the Bank should implement additional
monetary easing without any hesitation. Particular attention also should be paid to the fact
that indicators of employment are lagging those of economic activity.
Thank you for your attention.


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