Takehiro Sato: Recent economic and financial developments and
monetary policy
Speech by Mr Takehiro Sato, Member of the Policy Board of the Bank of Japan, at a meeting
with business leaders, Kofu, Yamanashi Prefecture, 10 June 2015.
* * *
Accompanying charts can be found at the end of the speech.
Introduction
Thank you for giving me this opportunity to exchange views with people representing the
political, economic, and financial arena of Yamanashi Prefecture. I would like to take this
opportunity to express my sincere gratitude for your cooperation with the activities of the
Bank of Japan's Kofu Branch.
In today's speech, I will begin by focusing on economic and financial developments in Japan
and abroad, as well as the Bank's recent monetary policy. I will then touch briefly on the
economy of Yamanashi Prefecture. Following my speech, I would like to hear your views on
actual conditions in the local economy and on the Bank's conduct of monetary policy.
I. Recent economic and financial developments in Japan and abroad
A. Developments in the world economy
The world economy has been sluggish, despite the decline in energy prices (Chart 1). In the
January-March quarter of 2015 in particular, it exhibited signs of a slowdown, as the growth
rate of the U.S. economy turned negative due to the effects of the severe winter weather and
the labor disputes at West Coast ports, and as the growth rate of the Chinese economy
remained at around 7 percent. These developments in the world economy affected Japan's
economy to some degree as well.
The decline in energy prices since 2014 was initially expected to have positive effects on the
world economy, but negative effects seem to have preceded them - such as the decline in
income in commodity-exporting countries and the decrease in investment in resource
development - due to the rapid pace of the energy price declines. As for the outlook, the
world economy is expected to see a moderate increase in its growth rate, with the recent
improvement in soft data reflected in hard data, as positive effects of the decline in energy
prices - such as an increase in real income in the energy-consuming countries - permeate
gradually.
As for the U.S. economy, a substantial deceleration in growth in the January-March quarter
has been observed three times in the past five years. The deceleration occurred for different
reasons each time, but there seems to be a seasonal pattern of some kind. Besides the
severe winter weather and the labor disputes at West Coast ports, the appreciation of the
dollar also casts a shadow on manufacturers' sentiment, thereby affecting indicators of
business fixed investment. The effects of the decline in energy prices on investment in
resource development are also evident (Chart 2). In contrast, reflecting the improvement in
the employment situation and the decline in gasoline prices, consumer sentiment has
generally stayed at a high level. It is a matter of concern that, despite the favorable
sentiment, private consumption remains lackluster and growth in the April-June quarter of
2015 has been sluggish so far. However, the economy is expected to gradually return to a
recovery path led by private consumption on the back of a moderate increase in wages as
the employment situation continues to improve - following more or less the same pattern of
the past five years. The inflation rate has been stable due to the decline in energy prices, but
the slack in the labor market seems to be diminishing to a certain degree, reflecting the
decline in the unemployment rate, although there are such problems as the increases in the
number of long-term unemployed workers and part-time workers. In this situation, the
Federal Reserve (Fed) has been communicating to the public a path toward raising the policy
interest rate, but is taking a flexible and cautious stance that the exact timing will depend on
future economic indicators.
In Europe, manufacturers' sentiment has been picking up in reflection of the decline in
energy prices and the depreciation of the euro, and consumer sentiment has also started to
recover (Chart 3). With the improvement in soft data, the pick-up in hard data has become
evident, as seen, for example, in positive GDP growth for eight consecutive quarters. The
inflation rate, which temporarily had been negative, has recovered to around 0 percent. That
being said, given that the effects of the debt problem remain, the risk of prolongation of low
inflation leading to a postponement of investment and consumption has receded but seems
to still exist, and I have been monitoring these developments closely. Meanwhile,
unconventional monetary policy measures introduced by the European Central Bank (ECB)
initially had significant effects on the foreign exchange and bond markets; however, these
markets have recently shown large fluctuations. Many points are being made regarding the
sustainability of such large-scale asset purchases, and I will pay attention to any progress
made regarding this matter.
With regard to the Chinese economy, the GDP growth rate for the January-March quarter of
2015 decelerated to 7.0 percent. Looking at recent developments in electricity consumption
and railway freight turnover, my impression is that actual economic growth could be slower
than suggested by the GDP figures, although we should not make a decisive judgment as
these developments may reflect the effects of the shift toward a service economy and the
progress in structural reforms that are promoted by the Chinese government (Chart 4).
Moreover, manufacturers' sentiment has been dampened further. Movements toward
inventory adjustments in Japan - in materials and related goods such as iron and steel -
seem to be partly affected by the slowdown in the Chinese economy.
As for the outlook of the Chinese economy, the growth rate is likely to remain
downwardbiased, owing to a sharp change in the demographic situation and the resultant fall in the
potential growth rate. However, given the typical pattern observed over the past few years -
in which, once the economy is projected to deviate downward from the growth target, the
government implements small-scale economic packages, thereby achieving the pick-up in
the economy - the same developments generally seem to be taking place this year as well.
Meanwhile, attention should be paid to the point that downward pressure on inflation has
been increasing, as evidenced by the year-on-year rate of change in the GDP deflator for the
January-March quarter of 2015 turning negative for the first time since 2009.
B. Developments in global financial markets
Taking into account the developments in the world economy that I have illustrated, let me
turn to developments in global financial markets for the time being. The first key point is how
a hike in the policy rate in the United States affects global financial markets. In light of the
recent U.S. economic indicators, the timing of a hike in the target federal funds rate that
market participants expect is either moving forward or backward. On the other hand, the Fed
is working to let the markets factor in a rate hike in the near future while cautiously avoiding
providing decisive information. Judging from pricing in the federal funds futures market, this
intention by the Fed has generally permeated the markets, and the difference in views
between Federal Open Market Committee (FOMC) participants and the markets - which was
seen some time ago - is starting to be resolved (Chart 5). Of course, if market participants
begin to identify the specific timing of a rate hike, global financial markets might show a
different reaction from the past. This concern seems to have materialized in the market
reaction when Fed Chair Janet Yellen mentioned the valuation in the stock and bond markets
in early May 2015. Meanwhile, as a result of a number of financial regulations, major market
makers' risk-taking activities have been restricted, inducing concern regarding a decline in
liquidity even in the U.S. Treasury markets. Given these circumstances, I would like to
monitor carefully whether, when the timing of a rate hike becomes clearer in the future, a
change in the international flow of funds will not cause any significant repricing or
unexpected knock-on effects in various asset markets.
The second key point in terms of developments in global financial markets is the effects of
large-scale asset purchases by the ECB (Chart 6). When these purchases were first
implemented, it was considered that the effects of the purchases had already been factored
in. However, even after the implementation, long-term interest rates in European countries
fell markedly; for example, 10-year German bund yields declined to around 0 percent
temporarily. At the same time, the euro depreciated further. Since late April, however -
probably because of a reaction to the sharp drop in interest rates - long-term interest rates in
Germany have risen above the level seen before the implementation of the ECB's asset
purchases, and thus have exhibited rather volatile movements. This increase in volatility
appears to be related to a decline in market liquidity, resulting from the scale of the ECB's
purchases being massive relative to the size of sovereign bond markets. Also, in Japan, a
rise in volatility in long-term interest rates was observed both after the introduction of
quantitative and qualitative monetary easing (QQE) in April 2013 and following the expansion
of QQE at end-October 2014. Specifically, contrary to the initial intention, yields on 10-year
Japanese government bonds (JGBs) temporarily jumped up somewhat significantly
immediately after the implementation of QQE. In contrast, they declined further after the
expansion of QQE and have recently returned to around the level seen before such
expansion. These fluctuations in long-term interest rates appear to be attributable not only to
monetary policy but also to external factors, and therefore should be assessed carefully. That
being said, if the effects of monetary policy are produced by the declines in nominal or real
interest rates, due attention should be paid to the possibility that liquidity premiums in the
JGB markets - brought about by the Bank's massive JGB purchases - might in part be
weakening the effects of monetary policy. There is also a possibility that the fluctuations in
long-term interest rates reflect the move to factor in improvement in the outlook for economic
activity and prices.
The third key point is also related to European factors - namely, developments in political
and economic conditions in Greece. As the Greek government faces severe financing needs,
negotiations regarding financial assistance to the country continue. At this point, possible
effects on peripheral European countries are limited. However, I would like to monitor future
developments whether or not any unexpected knock-on effects emerge in global financial
markets.
C. Developments in Japan's economy
Looking at developments in Japan's economy for the January-March quarter of 2015, not
only business fixed investment but also exports and production maintained their moderate
improving trend. Private consumption and imports were resilient and final demand remained
firm. For the April-June quarter, the economy is expected to continue recovering moderately
because, for example, it seems that private consumption has been resilient since March,
although production is projected to be more or less unchanged, mainly due to inventory
adjustments in some industries (Chart 7). Expectations for somewhat higher growth in the
world economy will also serve as a tailwind for Japan's economy. The virtuous cycle from
income to consumption and investment will likely operate, with its certainty gradually
increasing, on the back of the firm employment situation and favorable corporate results.
However, we should probably be mindful of the risk that the increase in households' real
purchasing power and the improvement in corporate profits, both brought about by lower
crude oil prices, will not lead to an expansion of spending by as much as expected, and
consequently pressure for excess savings - or for an increase in current account surplus -
will not be alleviated easily.
With regard to the employment and income situation, which forms the basis for the virtuous
cycle that I just mentioned, wages continue to rise moderately in a situation where labor
market conditions have become increasingly tight, even after the year-on-year growth in total
cash earnings was revised downward due to the replacement of samples in the Monthly
Labour Survey (Chart 8). Wages are expected to continue increasing moderately, reflecting a
base pay increase that is likely to take place for a second consecutive year. Thus, private
consumption is expected to reach a moderately higher level as the effects of a decline in real
income due to the consumption tax hike in April 2014 dissipate gradually.
From a somewhat longer-term perspective, I focus on the pace of increase in firms'
productivity, which is the basis for a sustainable rise in wages, as well as on the impact of the
aging population. In order for consumption to maintain its uptrend in the medium term, it
would be necessary to have a sustainable recovery in real wages of about 60 million workers
that could offset developments in real income of about 40 million pensioners. The pace of
recovery in private consumption will likely remain very moderate from a somewhat
longerterm perspective, even considering that wages will gradually see a higher rate of increase in
accordance with a rise in productivity brought about by an increase in business fixed
investment, and that confidence in the sustainability of the social security system will
increase because of the implementation of related reforms.
Regarding private business fixed investment, such investment on a GDP basis has been
slow to increase so far despite a pick-up in monthly indicators, such as shipments and the
aggregate supply of capital goods, and the firmness in investment plans suggested by the
results of the Tankan (Short-Term Economic Survey of Enterprises in Japan). However, fixed
investment overseas has been marking consecutive double-digit increases recently,
suggesting that firms' appetite for fixed investment on a consolidated basis has been robust
for some time (Chart 9). What matters is not whether firms will increase fixed investment
further, but whether they will make investments in Japan. In this regard, domestic fixed
investment so far has been made by nonmanufacturers in particular, but some
manufacturers are finally beginning to increase production capacity in Japan, reflecting the
yen's depreciation the past two years, although automobile firms' shifting of production
facilities to overseas, which has been made in a full-fledged manner since around 2014,
remains in some part.
From a somewhat longer-term perspective, whether a change in firms' production network
strategies will become widespread, in turn leading to increasingly building up production
capacity in Japan rather than overseas, depends on their medium- to long-term projections
for exchange rates. Specifically, if firms judge the yen's depreciation the past two years to be
a sustainable trend, they would proceed with increasing their production capacity in Japan.
On the other hand, firms that have concern regarding a possible resurgent appreciation of
the yen would not easily change their production network strategies even with the recent
depreciation of the yen. In this regard, the Annual Survey of Corporate Behavior, conducted
by the Cabinet Office, provided a favorable factor: the yen-U.S. dollar rate for the next year
forecasted by firms was 119.5 yen/dollar, marking a weaker yen forecast for the third
consecutive year (Chart 10). However, it should be noted that, when firms decide their fixed
investment, long-term projections for the next five to ten years are important. Therefore, it is
uncertain whether a trend of increasing production capacity in Japan will become widespread
in the future.
D. Developments in prices
Let me now turn to developments in prices. The year-on-year rate of increase in the
consumer price index (CPI) for all items less fresh food has been about 0 percent recently,
reflecting the decline in energy prices. It is likely to be at this level for the time being, due to
the remaining effects of the decline in energy prices (Chart 11). This suggests that consumer
prices also lack momentum at present. However, a decline in general prices due to the
decrease in energy prices exerts upward pressure on real income, and therefore I consider
this to be a favorable factor for Japan's economy. What matters is not the fluctuations in
monthly figures of the year-on-year rates of change in the CPI, but the underlying trend in
inflation, which reflects the overall economic conditions. In my view, the underlying trend in
inflation is firmly maintained.
In a situation where the inflation rate rose mainly due to the depreciation of the yen and the
increase in energy prices in the past two years, various soft data suggested a negative
reaction by households to a rise in the inflation rate in light of sluggish growth in real wages.
In fact, private consumption, which was also affected by the consumption tax hike, had been
sluggish (Chart 12). This should prove that people consider it desirable to see the inflation
rate rising in balance with wages and income as economic conditions improve, rather than
seeing the inflation rate simply rising. I believe that the price stability target intrinsically aims
for such desirable developments.
A matter of concern is whether the deceleration in the rate of increase in the CPI or the
decline in the CPI on a year-on-year basis, which have been observed recently, will not affect
people's medium- to long-term inflation expectations in a backward-looking manner. In this
regard, judging from firms' price-setting behavior, consumers' spending activity, and the
recent developments in wage negotiations, people's perception of inflation has been
changing steadily despite the decline in energy prices. Moreover, a wide range of estimates
- such as those of expected inflation derived from nominal interest rates1 and those of trend
inflation using a regime-switching model2 - suggest that medium- to long-term inflation
expectations in Japan appear to be rising since the introduction of QQE from a somewhat
longer-term perspective (Chart 13). However, under the deflation that lasted for over
15 years, medium- to long-term inflation expectations appear to consistently remain lower
than those in the United States. The challenge is to re-anchor these expectations at around
2 percent, comparable to the level in the United States.
What I consider important as factors that determine people's medium- to long-term inflation
expectations are not just the past developments in the inflation rate that I mentioned earlier,
but also developments in the overall economy and in asset prices, as well as forward-looking
expectation formation based on, for example, wage revisions. Taking this point into account,
I hold the optimistic view that it is less likely that people's medium- to long-term inflation
expectations will be negatively affected by a decline in the inflation rate due to the fall in
energy prices.
I would note that the recent results of academic research on the methods for measuring
inflation rates offer valuable suggestions for the old but also new issue of how to define
consumer prices. For example, the SRI-Hitotsubashi Unit Value Price Index, which has been
developed by Professor Naohito Abe of Hitotsubashi University, incorporates prices of new
goods that firms frequently introduce into markets in calculating price indexes3 According to
the research by Professor Abe, 46-47 percent of goods do not exist in the same week of the
previous year at the average retailers, indicating that replacement rates of goods are very
high in reality (Chart 14). The same research also finds that some new goods are virtually
unchanged from the previous ones, suggesting a possibility that firms replace goods
frequently as a means of adjusting prices in effect. In calculating a change in prices of goods
over a particular period, general consumer price indexes only cover the goods for which price
information is available at the beginning and the end of the period; on the other hand, the
SRI-Hitotsubashi Unit Value Price Index quantifies the importance of the introduction of new
goods that I have just mentioned. The research concludes that, mainly due to the effects of
such introduction on prices, the year-on-year rate of increase in the SRI-Hitotsubashi Unit
Value Price Index for supermarkets has recently been at about 1 to 1.5 percent, which shows
a higher rate of inflation than in CPI statistics released by the Ministry of Internal Affairs and
Communications (MIC) and in a price index that only covers continuing goods (Chart 15).
These research results do not allow simple comparison with the CPI statistics released by
the MIC, in part because the coverage of the SRI-Hitotsubashi Unit Value Price Index is
limited to goods with point-of-sale (POS) data. However, I take the view that they provide
useful insights to firms' price-setting behavior through the introduction of new goods and its
effects on developments in prices, and to a divergence between the inflation rate perceived
by households and that measured by price statistics.
II. Future conduct of monetary policy
A. The price stability target and conduct of monetary policy
In what follows, I explain issues regarding monetary policy. About two years ago, the Bank
introduced QQE to achieve the price stability target of 2 percent in terms of the year-on-year
rate of change in the CPI at the earliest possible time, with a time horizon of about two years.
The latest figure for the year-on-year rate of increase in the CPI is about 0 percent due to the
decline in energy prices, and the baseline scenario outlined in the April 2015 Outlook for
Economic Activity and Prices shows that the timing of reaching the price stability target has
been delayed to around the first half of fiscal 2016 (Chart 16). However, the Bank's Policy
Board has judged that no policy actions are necessary at this point based on the view - as I
mentioned earlier - that the underlying trend in inflation is firmly maintained under the
virtuous cycle of the economy.
With regard to the timing of reaching the price stability target, I believe that the phrase "at the
earliest possible time" represents the essence and that "a time horizon of about two years" is
only a non-binding target, as the commitment to achieving a specific price level within a
specific time frame, in my opinion, does not fit the conduct of monetary policy adopted by
other major countries in the first place. That is, in my understanding, the price stability target
is a rolling target with a time horizon of about two years, and this is broadly in line with the
idea of inflation targeting adopted by major countries. From this viewpoint, the delay in the
timing of reaching the price stability target would not be the essential problem. As I touched
on earlier, firms and households generally have a negative reaction to mere inflation, mainly
due to concern over a rise in costs and to the negative effects on real wages, both stemming
from a rise in import prices.
On the other hand, in continuing with QQE, I consider it necessary to take into account that
this policy is a kind of shock therapy that influences formation of people's inflation
expectations through the lowering of real interest rates and risk premiums brought about by
massive asset purchases, as well as through a strong commitment. The Bank has provided
forward guidance - namely, that it will continue with QQE, as long as it is necessary for
achieving the price stability target in a stable manner - and of course, the necessity of
continuing QQE will be judged in line with this guidance. I therefore do not think that the
current policy framework should be reviewed in an automatic fashion simply because two
years have passed since the introduction. In my understanding, the price stability target is a
flexible concept with a certain range for upward and downward deviations of the actual
inflation rate from the target under the framework of forecast targeting. It is also my
understanding that achieving the price stability target in a stable manner does not refer to a
state in which the year-on-year rate of increase in the CPI simply marks 2 percent, but rather
one in which people's medium- to long-term inflation expectations are re-anchored at around
2 percent - in other words, a situation in which households and firms are projected to shift
their consumption and investment behavior to one that assumes around 2 percent inflation.
The status of achieving the price stability target and the necessity of continuing QQE will be
judged by the Bank's Policy Board at each Monetary Policy Meeting. In doing so, I would like
to take into account (1) the effects of QQE after its expansion, (2) the sustainability of the
Bank's massive JGB purchases, and (3) a wide range of QQE's side effects, all of which I will
elaborate on shortly.
B. Effects of QQE after its expansion
The first point that needs to be examined in continuing with QQE is its policy effects
(Chart 17). After the expansion of QQE at end-October 2014, the 10-year JGB yields
temporarily dropped below 0.2 percent, but these recently have recovered to around the level
seen prior to the expansion. Meanwhile, the market's outlook for economic activity and prices
has actually been revised downward, and therefore there is a lack of persuasive evidence of
a further rise in inflation expectations.
One of the assumed transmission mechanisms of QQE is to put downward pressure on
nominal interest rates across the entire yield curve through massive purchases of JGBs. I
understood the expansion of QQE at end-October 2014 as an action that would strengthen
such a mechanism. In reality, however, it appears to me that the degree of difficulty in
implementing QQE is rising, as the effect of lowering nominal interest rates has been
diminishing gradually, due mainly to a rise in liquidity premiums, despite a large-scale
expansion of the Bank's JGB purchases.
Let me give you some background as to why it has become difficult for long-term interest
rates to decline. First, interest rate levels are already low, and it is becoming difficult to see a
linear relationship between the amount of JGB purchases and interest rates. Second, there
tends to be less demand for JGBs from final investors under extremely low interest rates.
Third, dealers' risk tolerance is declining, as there is an increase in volatility due to the
decline in market liquidity and to the effects of overseas interest rates.
I will explain these three factors in more detail. With regard to the first one, the key is whether
real interest rates will decline further - in other words, whether people's medium- to
longterm inflation expectations will rise further only with the Bank's "strong and clear
commitment" - in a situation where it is becoming difficult for nominal interest rates to
decline. Of course, it may be theoretically possible to further push down nominal interest
rates if the Bank continues its purchases of JGBs even with negative interest rates. However,
in that case, the Bank would become the only buyer of JGBs, which would likely give rise to a
concern over the Bank's purchases being perceived as financing the fiscal deficit, as well as
to a further decline in market functioning. Regarding the second factor, whether or not
demand from final investors will decrease depends in part on their future stance on JGB
purchases. For example, a reduction in life insurance companies' promised return for some
insurance products that will start from July 2015 might affect investors' future behavior (Chart
18). As for the third factor, dealers' risk tolerance will likely change depending on market
conditions.
Taking such factors into consideration, I will pay close attention not only to the effects of the
progress in the Bank's asset purchases on interest rate formation, but also to changes in
investors' and dealers' behavior, and closely monitor how policy effects will emerge in the
future.
C. Sustainability of the Bank's massive asset purchases
The second point that needs to be examined in continuing with QQE is the sustainability of
the Bank's massive JGB purchases (Chart 19). The Bank currently commits to purchasing
JGBs with medium- to long-term maturities so that their amount outstanding will increase at
an annual pace of about 80 trillion yen. On a gross basis, the Bank purchases JGBs at an
annual pace of about 110 to 120 trillion yen, which is equivalent to about 90 percent of the
total amount of JGBs' market issuance. If final investors were to reduce their holdings of
JGBs by redeeming the bonds each time they come to maturity and not reinvesting the
amount redeemed in JGBs, the Bank's massive JGB purchases would be sustainable.
However, in reality, there is a certain level of demand for JGBs, mainly for those used as
collateral. For example, the amount of JGB holdings by major banks, which had been
reduced at the time QQE was introduced, has been stable recently, and the same applies to
the amount held by regional financial institutions. In a situation where there appears to be a
certain level of demand by final investors to reinvest the amount redeemed at maturity, the
sustainability of the Bank's JGB purchases may become an issue if the Bank continues its
massive purchases at the current pace while final investors reduce their holdings of JGBs to
the least possible extent. This limit is dependent on the interest rate level and other factors at
each point in time, and thus is difficult to project at this point. Nevertheless, in continuing with
QQE, it is important to give consideration to its feasibility in terms of the Bank's market
operations.
D. Examination of side effects
The third point that needs to be examined in continuing with QQE is the side effects of the
Bank's massive asset purchases. It is true that policy effects and side effects are two sides of
the same coin, and positive effects cannot be expected from policies that have no side
effects. Having said that, in continuing with the unprecedented policy, it is essential to
compare its positive effects and side effects and examine whether the latter do not outweigh
the marginal effects from continuing the policy. With regard to how the increase in the share
of the Bank's holdings in the JGB market affects market functioning, I am somewhat
concerned about the results of the Bond Market Survey conducted by the Bank in February
2015, as recovery in market functioning is considered to be the key to a smooth exit from
QQE from a somewhat longer-term perspective (Chart 20). I also continue to pay careful
attention to the effects of the continued extremely low interest rates on financial institutions'
business, and to the stability of the broadly defined settlement system.
E. Importance of efforts toward fiscal consolidation
The Bank's massive purchases of JGBs are carried out only in the context of the conduct of
monetary policy and not in any way to finance the fiscal deficit. In order for this explanation to
be persuasive, the government's efforts toward fiscal consolidation are important. It also
should be noted that the massive JGB purchases, if continued over a long period, could lead
to extremely low interest rates being built into the fiscal plan, thereby affecting fiscal
discipline - although the continuation of such purchases aims at fulfilling the purpose of
monetary policy. Once market participants have concern about fiscal discipline, controlling
long-term interest rates will become difficult, even for the Bank. My assessment is that QQE
has generally been exerting its intended effects so far, but in order for QQE to gain success
- such as a smooth process of finding an exit from QQE from a somewhat longer-term
perspective - the government's initiatives toward fiscal consolidation are important. The
government looks to formulate a new fiscal consolidation plan by summer 2015 to maintain
its goal of generating a surplus in the primary balance for fiscal 2020. The Bank strongly
expects that the government will steadily promote measures aimed at establishing a
sustainable fiscal structure with a view to ensuring the credibility of the country's fiscal
management.