Economic Activity, Prices,
and Monetary Policy in Japan
Speech at a Meeting with Business Leaders in Sapporo
Yukitoshi Funo
Member of the Policy Board
I. Recent Economic and Price Developments
A. Overseas Developments
I would like to begin my speech by talking about developments in overseas economies.
Business sentiment of manufacturing firms has been on an improving trend on a global
basis, and the world trade volume has been recovering. In this situation, overseas economies
have continued to grow at a moderate pace on the whole.
As for the outlook, the growth rates of overseas economies are expected to increase
moderately. According to the World Economic Outlook Update, released in July 2017 by the
International Monetary Fund (IMF), the global growth rate is projected to increase from 3.2
percent in 2016 to 3.5 percent in 2017, and to 3.6 percent in 2018.
Looking at developments by major region, the U.S. economy has continued to recover
firmly, mainly in household spending, owing to a steady improvement in the employment
and income situation. As for the outlook, the economy is expected to continue to see firm
growth driven by domestic private demand.
The European economy has continued to recover steadily, albeit at a moderate pace, mainly
in the household sector. As for the outlook, the economy is projected to follow a moderate
recovery trend, while uncertainty -- associated with political issues such as those regarding
negotiations on the United Kingdom's exit from the European Union (EU) and with the
European debt problem, including the financial sector -- is likely to be a burden on
economic activity.
The Chinese economy has continued to see stable growth on the whole, partly due to the
effects of authorities' measures to support economic activity. As for the outlook, the
economy is likely to broadly follow a stable growth path as authorities conduct fiscal and
monetary policy in a timely manner.
Emerging economies other than China and commodity-exporting economies have picked up
on the whole. As for the outlook, their growth rates are likely to increase gradually, due
mainly to the spread of the effects of steady growth in advanced economies and the effects
of the economic stimulus measures.
Risk factors to the overseas economic outlook are wide ranging, as exemplified by (1) the
U.S. economic policies and their impact on global financial markets, (2) developments in
emerging and commodity-exporting economies, (3) negotiations on the United Kingdom's
exit from the EU and their effects, (4) prospects regarding the European debt problem,
including the financial sector, and (5) geopolitical risks. I hold the view that it is important
to stay vigilant regarding these risk factors, especially now that the growth rates of overseas
economies are rising.
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 is expanding moderately, with a virtuous cycle from income
to spending operating. For the first time in about 11 years, real GDP registered positive
growth for five consecutive quarters, through the January-March quarter of 2017; by
component, demand both at home and abroad has increased and the economy has been
growing at a pace slightly above its potential, which is estimated to be in the range of
0.5-1.0 percent.1
With regard to the outlook, Japan's economy is likely to continue its moderate expansion.
Through fiscal 2018, domestic demand is likely to follow an uptrend, with a virtuous cycle
from income to spending being maintained in both the corporate and household sectors, on
the back of highly accommodative financial conditions and fiscal spending through the
government's large-scale stimulus measures. Meanwhile, exports are expected to continue
their moderate increasing trend as the growth rates of overseas economies increase
moderately. In fiscal 2019, the economy is expected to continue expanding, supported by
external demand, although the growth pace is projected to decelerate due to a slowdown in
domestic demand.2 According to the July 2017 Outlook for Economic Activity and Prices
(hereafter the Outlook Report), released by the Bank of Japan, the medians of the Policy
Board members' forecasts of the economic growth rate are 1.8 percent for fiscal 2017, 1.4
percent for fiscal 2018, and 0.7 percent for fiscal 2019.
2. Prices
Next, I will talk about price developments. The year-on-year rate of change in the consumer
price index (CPI) for all items less fresh food is in the range of 0.0-0.5 percent. The rate of
increase for all items less fresh food and energy had remained on a decelerating trend,
following the peak of 1.2 percent in winter 2015; recently, the rate of change has been at
around 0 percent.
With regard to the outlook, the year-on-year rate of change in the CPI for all items less fresh
food is likely to continue on an uptrend mainly on the back of the improvement in the
output gap and the rise in medium- to long-term inflation expectations. The rate will likely
reach around 2 percent in around fiscal 2019. Specifically, the medians of the Policy Board
members' forecasts of the year-on-year rate of change in the CPI for all items less fresh food
presented in the July 2017 Outlook Report are 1.1 percent for fiscal 2017, 1.5 percent for
fiscal 2018, and, excluding the direct effects of the scheduled consumption tax hike, 1.8
percent for fiscal 2019.3
2
It is assumed that the consumption tax will be raised to 10 percent in October 2019 and that a
reduced tax rate will be applied to food and beverages -- excluding alcohol and dining-out -- and
newspapers.
3
The consumption tax hike scheduled to take place in October 2019 -- to 10 percent -- and the
reduced tax rate to be applied to food and beverages -- excluding alcohol and dining-out -- and
newspapers are incorporated in the forecasts, but individual Policy Board members make their
forecasts of the CPI based on figures excluding the direct effects of the consumption tax hike. The
forecasts for the CPI for fiscal 2019 that incorporate the direct effects of the consumption tax hike
are constructed as follows. First, the contribution to prices from the tax hike is mechanically
computed on the assumption that the tax increase will be fully passed on for taxable items. The CPI
will be pushed up by 0.5 percentage point. Second, this figure is added to the forecasts made by the
Policy Board members.
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 tighten steadily and
employee income has increased moderately. The rate of increase in the number of
employees has remained at around 1 percent. Against this backdrop, the active job
openings-to-applicants ratio, which has followed a steady uptrend, has exceeded its highest
figure during the bubble period in the first half of the 1990s, and a perception of labor
shortage suggested by indicators related to employment has heightened. The unemployment
rate has continued on a moderate declining trend, albeit with some fluctuations, and has
been around 3 percent recently. It is expected that the number of employees will keep
increasing and that the supply-demand conditions in the labor market will further tighten.
On the wage side, the rise in hourly cash earnings has generally accelerated, albeit with
fluctuations. Specifically, the year-on-year rate of increase in hourly cash earnings of
part-time employees recently registered relatively high growth in the range of 2.0-2.5
percent. With regard to the outlook, the pace of increase in full-time employees' cash
earnings is expected to accelerate moderately, with that in base pay accelerating as the rise
in inflation expectations becomes more evident.
In light of these prospects for employment and wages, employee income is expected to
increase at a moderate pace, and its pace of increase is expected to be slightly above the
nominal GDP growth rate in the second half of the projection period of fiscal 2016-2019.
However, there is a risk that firms will remain cautious with their decisions, particularly on
wage setting. In this context, I am paying attention to firms' wage-setting stance going
forward.
B. Private Consumption
Next, I will discuss developments in private consumption, which has increased its resilience
against the background of steady improvement in the employment and income situation.
The consumption activity index has continued to increase. Looking at private consumption
by type, durable goods have been on a moderate uptrend, mainly due to replacement
demand for automobiles and household electrical appliances. Nondurable goods had seen
somewhat weak developments for a prolonged period, particularly in clothes, but have
started to pick up recently. Meanwhile, services consumption has continued to increase
moderately, albeit with fluctuations, reflecting a trend rise in communications charges as
well as medical, health care, and welfare fees.
With regard to the outlook, private consumption is expected to follow a moderate increasing
trend -- albeit with fluctuations due to the scheduled consumption tax hike -- supported
mainly by an increase in employee income and replacement demand for durable goods.
C. Business Fixed Investment
Let me now explain developments in business fixed investment, which has been on a
moderate increasing trend as corporate profits have improved. Business fixed investment
plans for fiscal 2017, especially those of large enterprises, show firms' solid stance.
Specifically, on a year-on-year basis, firms' fixed investment increased by 0.4 percent in
fiscal 2016, and investment plans for fiscal 2017 project an increase of 5.9 percent.
As for the outlook, business fixed investment is likely to continue increasing moderately on
the back of (1) an improvement in corporate profits, (2) extremely stimulative financial
conditions, such as low interest rates and accommodative lending attitudes, (3) the effects of
fiscal measures including projects conducted under the Fiscal Investment and Loan Program
and tax reductions for capital investment, and (4) moderate improvement in growth
expectations.
D. Prices
Next, I will discuss the output gap and inflation expectations, which are the main factors
that determine inflation rates. First, the output gap -- after turning slightly positive in the
July-September quarter of 2016 -- has continued to improve, and it has expanded somewhat
within positive territory recently. With regard to the outlook, it is projected to widen further
within such territory in fiscal 2017; thereafter, it is projected to continue expanding
moderately within positive territory both on the capital and labor sides, reflecting the
increase in demand at home and abroad. In the second half of fiscal 2019, although such
expansion is likely to pause due to the effects of the scheduled consumption tax hike, the
output gap is expected to remain substantially positive.
Second, medium- to long-term inflation expectations have remained in a weakening phase;
however, some indicators show a rise in such expectations recently. As for the outlook,
medium- to long-term inflation expectations are likely to follow an increasing trend on the
back of the following: (1) in terms of the adaptive expectation formation mechanism, firms'
stance is likely to gradually shift toward raising wages and prices with the improvement in
the output gap, and (2) in terms of the forward-looking expectation formation mechanism,
the Bank will pursue monetary easing through its strong commitment to achieving the price
stability target.
III. Conduct of Monetary Policy
Let me now turn to the Bank's monetary policy.
In January 2013, the Bank announced that it would aim 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, and in April of that year, it decided to introduce Quantitative and Qualitative
Monetary Easing (QQE) as a necessary measure to underpin this commitment. The Bank
took several measures thereafter, and in September 2016 it conducted a comprehensive
assessment of the developments in Japan's economic activity and prices as well as policy
effects since the introduction of QQE, and decided to introduce QQE with Yield Curve
Control.
The framework of QQE with Yield Curve Control consists of two major components. The
first is yield curve control in which the Bank facilitates the formation of short- and
long-term interest rates that are considered most appropriate for maintaining the momentum
toward achieving the price stability target, taking account of developments in economic
activity and prices as well as financial conditions. Specifically, at present, according to the
guideline for market operations, the Bank sets the short-term policy interest rate at minus
0.1 percent and purchases Japanese government bonds (JGBs) so that 10-year JGB yields
will remain at around 0 percent. The second component is an inflation-overshooting
commitment in which the Bank continues with the monetary easing framework, aiming to
achieve the price stability target, as long as it is necessary for maintaining that target in a
stable manner. On this point, the Bank makes clear that it will continue expanding the
monetary base until the year-on-year rate of increase in the observed CPI (all items less
fresh food) exceeds 2 percent and stays above the target in a stable manner.
As shown in the comprehensive assessment, I consider that the main factor that hampers
achieving the price stability target of 2 percent is as follows. In the course of the Bank's
attempt to raise inflation expectations, observed inflation rates declined due to a variety of
exogenous factors such as a substantial fall in crude oil prices. Under these circumstances,
inflation expectations declined, as the adaptive mechanism has been playing a relatively
large role in the formation of inflation expectations in Japan. Taking this into consideration,
the Bank decided to adopt a commitment that allows inflation to overshoot the price
stability target so as to strengthen the forward-looking mechanism in the formation of
inflation expectations, enhance the credibility of achieving the price stability target among
the public, and raise inflation expectations in a more forceful manner.
As for the future conduct of monetary policy, the Bank will continue with QQE with Yield
Curve Control, aiming to achieve the price stability target of 2 percent, as long as it is
necessary for maintaining that target in a stable manner. In Japan, there is some argument
that the Bank does not need to aim at 2 percent inflation. However, when adverse shocks hit
the economy, it becomes necessary to lower real interest rates sufficiently to support the
economy effectively. Therefore, it is important to aim at achieving the price stability target
of 2 percent in order to secure sufficient room for a reduction in real interest rates by
keeping the inflation rate stable at around 2 percent and anchoring inflation expectations at
2 percent. Currently, the momentum toward achieving the price stability target is being
maintained, and the year-on-year rate of change in the CPI is expected to increase toward 2
percent. Nevertheless, this momentum is not yet sufficiently firm, and we are only halfway
to achieving the price stability target. Considering the current developments in economic
activity and prices as well as financial conditions, I believe that it is important that the Bank
continue to steadily pursue powerful monetary easing under QQE with Yield Curve Control.
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.
The Bank aims to achieve price stability that is sustainable. I recognize that the inflation
rate consistent with sustainable price stability will rise as efforts by a wide range of entities
toward strengthening the competitiveness and growth potential of Japan's economy make
progress. Based on this recognition, the Bank sets the price stability target at 2 percent in
terms of the year-on-year rate of change in the CPI -- a main price index.
To strengthen the competitiveness and growth potential of the economy, a structural reform
that will lead to an increase in productivity is necessary. In implementing such a reform,
from the viewpoint of the management of firms, it is important to adjust supply to the trend
in demand. In an economy with a declining population, as is the case in Japan, demand is
expected to decrease for many goods and services; therefore, it will be important to
adequately adjust supply capacity; that is, employees and production capacity to meet such
a decreasing trend. In Japan, there is room for enhancing productivity relative to
international standards. Firms, regardless of whether they are in manufacturing or
nonmanufacturing, are faced with an uneven distribution of employees and production
capacity, as well as excessive inventories and discounts. It is necessary to adequately correct
such uneven distribution and reduce excessiveness in all areas.
In order to make progress with such a structural reform smoothly while easing the pain
arising from the reform, a growth strategy that will foster new areas with growth potential is
essential. That is, it is necessary to develop and provide goods and services that will explore
new demand, and at the same time expand the channels for capturing demand in
neighboring economies. Japan's economy has made progress toward this end for many years
despite the severe situation for the management of firms, and has exhibited strong
compatibility. It is expected to make continued progress in the future.
Currently, financial conditions are highly accommodative and labor market conditions are
tight. It is a good time to proceed with the structural reform and growth strategy, and we
should not miss this chance. I consider that the private sector, which plays the main role in
the economy, should take the initiative to enhance productivity and create demand in a more
proactive manner. Financial institutions are expected to provide consulting services to their
counterpart firms making these efforts. In particular, in rural areas, financial institutions,
which are endowed with information, knowledge, and experience, not to mention personnel,
are expected to take such initiative.
Moreover, it is a highly difficult task to increase labor input in the current situation where
labor shortages are becoming severe. However, given that the tightness in labor market
conditions varies by industry, the current moderate tightness can be regarded as a chance to
increase mobility in the labor market -- including inter-industry labor reallocation -- in
wider areas. Each firm will need to retrain its management staff to enhance their ability and
adjust their mindset. Also, measures should be taken to change the decision-making process
and reduce operations that do not produce value-added, such as duplicated operations, as
well as excessive services. Progress toward improving the operation process that will lead
to utilization of the workforce of women and the elderly also should be made. In this regard,
the Bank conducted a survey on firms' efforts toward promoting women's labor force
Regional Economic
participation by region and released the results as the annex to the
Report in June 2017.4 According to this annex, women's labor participation is increasing in
many regions and has led to improvement in business performance and productivity.
Thank you for your attention.