Yukitoshi Funo: Economic activity and prices in Japan, and monetary
policy
Speech by Mr Yukitoshi Funo, Member of the Policy Board of the Bank of Japan, at a
meeting with business leaders, Niigata, 31 August 2016.
* * *
I. Recent economic and price developments
A. Overseas developments
I would like to begin my speech by talking about developments in overseas economies. In
global financial markets, uncertainty over the global economy going forward heightened and
investors' risk aversion rapidly strengthened in response to the result of the United
Kingdom's referendum in late June, in which the majority voted to leave the European Union
(EU). However, global financial markets have been regaining calmness. In this situation,
overseas economies have continued to grow at a moderate pace as a whole, although the
pace of growth has somewhat decelerated, mainly in emerging and commodity-exporting
economies.
As for the outlook, overseas economies are expected to moderately increase their growth
rates, as it is likely that advanced economies will see steady growth, and emerging
economies in particular will gradually move out of their deceleration phase, mainly through
their policy measures. According to the World Economic Outlook (WEO) Update released in
July 2016 by the International Monetary Fund (IMF), global growth projections have been
revised slightly downward from the April 2016 WEO, particularly for Europe, but the
longerterm projection that the global growth rate will moderately increase from 2015 through 2017,
from 3.1 percent in 2015 and 2016 to 3.4 percent in 2017, is unchanged.
Looking at developments by major region, the U.S. economy has been on a recovery trend
on the back of firmness in household spending. As for the outlook, the industrial sector and
overseas demand will likely continue to show mixed developments for the time being, but the
economy is expected to continue to see firm growth driven by private demand under
accommodative financial conditions.
The European economy has continued to recover moderately as private consumption
continues to increase. As for the outlook, the economy is projected to see a temporary
slowdown in its pace of recovery as firms' and households' sentiment is becoming cautious
due to uncertainty, mainly associated with the United Kingdom's vote to leave the EU, but is
likely to return to a moderate growth path.
The Chinese economy has been slightly subdued, particularly in the manufacturing sector,
which faces an overhang of production capacities. As for the outlook, the economy is likely to
broadly follow a stable growth path as authorities have been proactively carrying out both
fiscal and financial measures to support economic activity.
Emerging economies have remained subdued, due mainly to developments in the Chinese
economy, although the effects of economic stimulus measures have materialized in some
economies. Commodity-exporting economies such as Brazil and Russia remain in a severe
state but have started to bottom out, mainly because commodity prices have hit the bottom.
As for the outlook, the growth rates of emerging economies are likely to increase gradually,
due mainly to the spread of the effects of the recovery in advanced economies and to the
effects of the economic stimulus measures, although differences across countries and
regions are likely to remain for the time being.
Risk factors to the overseas economic outlook are wide ranging, as exemplified by (1)
uncertainties associated with the United Kingdom's vote to leave the EU, (2) developments in
emerging and commodity-exporting economies including China, (3) developments in the U.S.
economy and the influences of its monetary policy, (4) the European debt problem among
banks, and (5) geopolitical risks such as those in the Middle East. Therefore, I consider it
necessary to closely monitor various risk factors from a broad perspective in making
projections regarding the outlook for overseas developments.
B. Japan's economy and prices
1. Economic activity
I will now discuss the economic situation in Japan given the overseas developments I have
just outlined. Japan's economy has continued its moderate recovery trend, although exports
and production have been sluggish, due mainly to the effects of the slowdown in emerging
economies. On an annualized basis, after the real GDP growth rate for the
OctoberDecember quarter of 2015 registered minus 1.7 percent, due partly to the effects of
irregularly warm weather, that for the January-March quarter of 2016 increased, registering
2.0 percent, and that for the April-June quarter, which was released in mid-August, registered
0.2 percent; this was broadly about the same level as the growth potential when fluctuations
are smoothed out.
Looking ahead, sluggishness is expected to remain in exports and production for some time,
and the pace of economic recovery is likely to remain slow. Thereafter, domestic demand is
likely to follow an uptrend, underpinned by a virtuous cycle from income to spending being
maintained in both the household and corporate sectors, and by large-scale economic
measures, and exports are expected to head toward a moderate increase as overseas
economies move out of their deceleration phase. Thus, Japan's economy is likely to be on a
moderate expanding trend. According to the Bank's July 2016 Outlook for Economic Activity
and Prices (hereafter the Outlook Report), the medians of the Policy Board members'
forecasts for the economic growth rate are 1.0 percent for fiscal 2016, 1.3 percent for fiscal
2017, and 0.9 percent for fiscal 2018, and the economy is expected to continue growing at a
pace above its potential through the projection period.
2. Prices
Next, I will talk about price developments. The year-on-year rate of increase in the consumer
price index (CPI) for all items less fresh food and energy has decelerated somewhat recently,
as firms' price-setting stance has become relatively cautious against the background of
relatively weak developments in some indicators of private consumption. The rate of change
for all items less fresh food has been slightly negative. Looking at annual price changes
across all CPI items less fresh food, the share of price-increasing items minus the share of
price-decreasing items has maintained its historically high level, but is declining slightly at
present.
With regard to the outlook, the year-on-year rate of change in the CPI (all items less fresh
food) is likely to be slightly negative or about 0 percent for the time being, due to the effects
of the decline in energy prices, and, as the underlying trend in inflation steadily rises,
accelerate toward 2 percent. Meanwhile, assuming that crude oil prices will rise moderately
from the recent level, the baseline scenario is that the timing of the year-on-year rate of
change in the CPI reaching around 2 percent will be during fiscal 2017, although this is
accompanied by considerable uncertainties including those surrounding overseas economies
going forward. Specifically, the medians of the Policy Board members' forecasts of the
yearon-year rate of increase in the CPI (all items less fresh food) presented in the July 2016
Outlook Report are 0.1 percent for fiscal 2016, 1.7 percent for fiscal 2017, and 1.9 percent
for fiscal 2018.1
II. Keys to assessing the outlook for economic activity and prices
In what follows, I will discuss several points that I think deserve particular attention in terms
of realizing the outlook that I mentioned earlier.
A. Employment and income situation
First, I will talk about developments in the employment and income situation. Supply-demand
conditions in the labor market have continued to improve steadily, and employee income has
increased moderately. According to the Labour Force Survey, the pace of increase in the
number of employees has been accelerating, and the labor force participation - especially
that of women and the elderly - has continued to rise. Against this backdrop, the active job
openings-to-applicants ratio has continued to see a steady rise, and a perception of labor
shortage suggested by the diffusion index (DI) for employment conditions (the proportion of
firms responding that employment was "excessive" minus the proportion of those responding
that employment was "insufficient") in the June 2016 Tankan (Short-Term Economic Survey
of Enterprises in Japan) has generally heightened; both indicators are almost at the same
levels as around 1991-1992. The unemployment rate has continued on a moderate
improving trend, albeit with some fluctuations, and has been in the range of 3.0-3.5 percent.
The supply-demand conditions in the labor market are expected to further tighten. On the
wage side, hourly cash earnings of part-time employees in particular, which are responsive
to labor market conditions, have continued to show relatively high growth at around 1.5-2.0
percent. With regard to the outlook, on the back of the heightening of inflation expectations
and the marked tightening of labor market conditions, wages are projected to rise
moderately.
In light of these prospects for employment and wages, employee income is expected to
continue rising moderately. Base pay for fiscal 2016 was revised upward for a third
consecutive year, but to a marginally smaller extent than last year. Attention therefore should
be given to how funds from profits in the corporate sector will circulate in the economy.
B. Private consumption
I will now discuss developments in private consumption, which has generally maintained its
resilience against the background of steady improvement in the employment and income
situation, although relatively weak developments have been seen in some indicators. The
Consumption Activity Index is heading toward a pick-up, mainly in durable and non-durable
goods, albeit with fluctuations. Looking at confidence indicators related to private
consumption, the Consumer Confidence Index has continued to be more or less flat, while
the Economy Watchers Survey and the DIs for business conditions of industries related to
private consumption in the Tankan have been declining, reflecting effects such as those
stemming from the wealthy being less motivated to spend on expensive goods and services,
and the sluggish increase in demand from foreign visitors to Japan. With regard to the
outlook, private consumption is expected to increase its resilience gradually, supported by an
improvement in real employee income and the effects of various policy measures. However, I
believe that it is necessary to pay attention to how the virtuous cycle from income to
spending - which has been showing lackluster performance recently - will operate in the
future.
C. Business fixed investment
Let me now explain developments in business fixed investment, which has been on a
moderate increasing trend from a somewhat longer-term perspective, as corporate profits
have been at high levels. According to the June 2016 Tankan, firmness is seen in business
fixed investment plans for fiscal 2016 as a whole, including those of large manufacturers, for
which profit projections have deteriorated as the expected exchange rate has shifted toward
appreciation of the yen. As for the outlook, business fixed investment is projected to continue
to see a moderate uptrend on the back of (1) corporate profits at high levels, (2) extremely
stimulative financial conditions such as low interest rates and accommodative lending
attitudes, (3) the effects of various policy measures from the fiscal side, and (4) moderate
improvement in growth expectations. Investment for maintenance and replacement of
equipment and investment in labor-saving machinery and equipment - both of which have
been increasing in recent years - as well as investment in growth areas, all tend to be
undertaken independently from temporary developments in corporate profits; therefore, the
effects on such investment of changes in the environment surrounding corporate profits,
such as the yen's appreciation and the rise in crude oil prices, are expected to be relatively
small. Nevertheless, I think that it is necessary to closely monitor whether firms will shift
production sites back to Japan for manufacturing products to be sold mainly in overseas
markets.
D. Prices
Next, I will discuss the aggregate supply and demand balance (the output gap) and inflation
expectations, which are the main factors that determine inflation rates. First, the output gap
has been more or less unchanged at around 0 percent recently. It is likely to remain so for
some time, but thereafter is projected to start increasing through the end of fiscal 2016, at
which time it is expected that the effects of the slowdown in overseas economies will wane
and that the effects resulting from the set of economic measures will become evident. From
fiscal 2017, the output gap is projected to continue expanding steadily in positive territory
owing to both the capital and labor factors, as domestic and foreign demand increase.
Second, medium- to long-term inflation expectations have weakened recently, although they
appear to be rising on the whole from a somewhat longer-term perspective. Against the
backdrop of relatively weak developments in private consumption, firms seem to be putting
off price increases - mainly those of goods such as food products and durable consumer
goods - since the turn of the fiscal year. As for the outlook, firms' price-setting stance is
expected to revert to raising prices accompanied by a pick-up in private consumption.
Turning to their wage-setting stance, the high corporate profits have continued to positively
affect employee income, and the mechanism in which inflation rises moderately
accompanied by wage increases has continued to operate. In such a situation, medium- to
long-term inflation expectations are also likely to return to an increasing trend and gradually
converge to around 2 percent - the price stability target.
III. Conduct of monetary policy
Let me now turn to the Bank's monetary policy.
At the Monetary Policy Meeting (MPM) held in January 2013, the Bank made a commitment
to achieving 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, and in April it decided to introduce Quantitative and
Qualitative Monetary Easing (QQE) as a necessary measure to underpin this commitment.
The main transmission mechanism of QQE is stimulating firms' investment and households'
consumption by lowering nominal interest rates through large-scale purchases of Japanese
government bonds (JGBs), and by transforming people's deflationary mindset through the
Bank's clear commitment and large-scale monetary easing to underpin the commitment.
Thereafter, the Bank decided to expand QQE at the MPM held at the end of October 2014. In
January 2016, it introduced QQE with a Negative Interest Rate, which is designed to enable
the Bank to make full use of possible monetary easing measures in terms of the three
dimensions of quantity, quality, and the interest rate, with the new option of a negative
interest rate being added.
In addition, at the MPM held in July 2016, the Bank decided on an increase in purchases of
exchange-traded funds (ETFs) and measures to ensure smooth funding in foreign
currencies, for two reasons: in order to prevent uncertainties that have been heightening
against the backdrop of the United Kingdom's vote to leave the EU and the slowdown in
emerging economies from leading to a deterioration in business confidence and consumer
sentiment, and to ensure smooth funding in foreign currencies by Japanese firms and
financial institutions, thereby supporting their proactive economic activities. Against the
backdrop of considerable uncertainty over the outlook for prices in view of uncertainties
surrounding overseas economies and global financial markets, the Bank - with a view to
achieving the price stability target at the earliest possible time - also decided that it would
conduct a comprehensive assessment of the developments in economic activity and prices
under QQE and QQE with a Negative Interest Rate, as well as the effects of these policies,
at the next MPM.
For the good of Japan's economy, it is necessary to make progress in the conversion of
people's deflationary mindset that has taken hold amid the prolonged deflation, and we are
only halfway to achieving the price stability target. The Bank will continue to steadily pursue
monetary easing, making full use of all possible measures in terms of the three dimensions
of quantity, quality, and the interest rate to achieve the price stability target of 2 percent at
the earliest possible time.
IV. Challenges for Japan's economy
I would now like to express my thoughts regarding the current situation of Japan's economy
from a longer-term perspective.
Japan's potential growth rate, as estimated by the Bank, has declined to the range of 0.0-0.5
percent, and this reflects that the economy has experienced deflation for a long period of
time.
Especially recently, it is common to hear that the future of Japan's economy is bleak because
of the decrease in population and other factors. Similar opinions that arouse anxiety are
expressed on an almost daily basis through various channels; as a result, a vague anxiety
hangs over the society.
However, I believe that we can be more reassuring about the future of the economy. It is true
that the population decline has a substantial impact on the regional and national economies.
Still, in this day and age, there is enough ground for being optimistic about the future.
In this age, it is possible to plan broad-based - cross-regional or even cross-border -
distribution and sales of goods and services. For example, having inbound customers means
that customers from abroad are being attracted. I believe that many firms in Niigata
Prefecture have customers not only inside but also outside the prefecture. The use of the
internet opens up the possibility of conducting business with overseas customers, in addition
to domestic customers outside the prefecture, of course. It should be noted that Japan is in
Asia, the world's most rapidly growing market. If Japanese firms manage to capture such
growth, it is reasonably possible to reduce the impact of the demand-side problem, or the
demand shortage, caused by the population decline.
Let me turn to the supply side. The proportion of the population that is young will surely
decrease, but firms are expected to increasingly make use of women and the elderly in the
workforce. In terms of utilization of human resources, Japan in fact still has room for better
use of personnel compared to the United States and Europe. In other words, there is enough
room for further improvement in productivity. Another option is to gradually increase the
number of foreign workers in many fields. It is likely that labor-saving initiatives, such as
through the use of industrial robots, will advance rapidly in factories and the like. Let me
remind you that Japan is a world-class manufacturer of robots.
As illustrated, if the demographic challenges are decomposed and examined in detail, it can
be said that there is no need to be completely pessimistic.
So, how should we address the demographic challenges to a better future? One possible
answer is that the private sector should actively pursue structural reforms by taking
advantage of the opportunity currently afforded by the bold economic measures of the
government and the accommodative financial conditions generated by the Bank.
In advancing structural reforms, firms, regardless of whether they are in manufacturing or
nonmanufacturing, will pursue changes in operational processes - i.e., scrap and build - in
various areas such as production and sales. As a result, substantial costs will be incurred
with, for example, new investment, worker retraining programs, and retirement allowances,
and it will be necessary to procure funds for such costs. On this basis, cooperation between
firms and financial institutions will become very important.
In closing, let me underline that firms' initiatives are essential to addressing these issues
facing Japan's economy. At the same time, the Bank, for its part, has established the Loan
Support Program, through which it provides long-term funds at low interest rates so that firms
can fully utilize accommodative financial conditions. Moreover, the Bank decided on
measures to support firms' investment in physical and human capital at the MPM held in
December 2015. Many firms have become proactive in making investment in physical and
human capital. I consider it desirable that these developments spread further.
Thank you for your attention.