Miyako Suda: The current situation of and outlook for Japan's economy
and the conduct of monetary policy
Summary of a speech by Ms Miyako Suda, Member of the Policy Board of the Bank of
Japan, at a meeting with business leaders, Yamagata, 1 December 2010.
* * *
Introduction
It is a great pleasure to address this meeting on economic and financial matters. The topic I
would like to discuss today is the current situation of, and outlook for, Japan's economy and
the Bank of Japan's conduct of monetary policy. Let me begin by looking at developments in
economic activity and prices in Japan.
I. Economic activity and prices in Japan
A. The current situation
Japan's economy still shows signs of a moderate recovery, but the recovery seems to be
pausing. Exports and production, which had been increasing reflecting the improvement in
overseas economic conditions, have recently been decelerating as the pace of recovery in
overseas economies is slowing down. Private consumption had continued to recover mainly
due to the effects of various demand-boosting policy measures targeted at durable consumer
goods, but more recently has been decreasing following the spike in demand before these
policy measures expired. I will first look at developments in demand, economic activity, and
prices overseas, and then make a more detailed examination of domestic demand in Japan.
1. Overseas demand, economies, and prices
Breaking down Japan's real exports by destination, East Asia accounted for more than
50 percent, the United States and the European Union for slightly less than 30 percent, and
other countries for the remaining 20 percent. Until recently, Japan's real exports had been on
an upward trend, led by the increase in exports to emerging and commodity-exporting
economies. However, growth in exports has recently been decelerating due to a number of
factors, including measures by the Chinese government to prevent an overheating of the
economy, the effects of which have materialized with a time lag; inventory adjustments in
ITrelated goods, particularly with regard to those exported to the NIEs and ASEAN countries;
and the appreciation of the yen.
a. Overseas economies
I will now move on to developments in overseas economies as a whole, which underlie the
trends in Japan's real exports. With inventory restocking - the driving force of the recovery
after the Lehman shock - having run its course and the demand-boosting effects of fiscal
policy measures waning, the pace of economic growth has been slowing since summer
2010.
Looking at developments by region, the U.S. economy is continuing to recover moderately
although the pace has slowed. However, the situation in the housing market remains
uncertain, and with home sales, housing starts, and home prices all remaining at low levels,
there are persisting concerns about home foreclosures and buybacks brought about by
mortgage delinquencies. Many homeowners suffer from negative equity, and balance-sheet
adjustment pressures continue to weigh heavily on households. As for the employment and
income situation, neither the unemployment rate nor nominal wages have shown a notable
recovery. In these circumstances, private consumption on the whole lacks momentum.
Economic activity in the euro area as a whole is recovering moderately, with some
differences in growth by country. Although the pace has recently slowed, exports have
continued to increase, while private consumption has been rising gradually. However, market
concerns regarding sovereign risk in some euro area countries have resurfaced amid
uncertainty regarding the response of governments. Thus, financial markets in the United
States and Europe partially show signs of instability and warrant continued attention.
On the other hand, though the pace has slowed somewhat, emerging and
commodityexporting economies continue to grow at a relatively rapid pace, led mainly by domestic
demand. In China, economic growth has been accelerating again. The pace of increase in
China's exports has been slowing due to the deceleration in overseas economies, but growth
in private consumption has been firm due to households' higher income levels. Fixed
investment continues to show high growth despite a slowdown partly due to government
measures to rein in real estate transactions and energy consumption. With regard to
economic conditions in the NIEs and the ASEAN countries, although growth in exports and
production has slowed sharply due to the deceleration in overseas economies and
adjustments with regard to IT-related goods, the recovery trend remains intact supported by
firm domestic demand.
As for the outlook, though the pace of growth in overseas economies will probably continue
to slow for the time being, the recovery trend itself is likely to remain intact, and from 2011
the growth rate will start to increase again. Looking at developments by region, emerging and
commodity-exporting economies, including China, despite a temporary slowdown, will
continue to grow at a relatively rapid pace, supported mainly by robust domestic demand.
Meanwhile, the effects of balance-sheet adjustments will continue in the U.S. economy, but
growth there is expected to accelerate again from 2011 on the back of a rise in exports,
mainly to emerging and commodity-exporting economies, and a moderate recovery in
business fixed investment and private consumption. Economic activity in Europe on the
whole is likely to continue to recover moderately, although the pace of recovery will differ by
country.
b. Overseas prices
As for the price situation in overseas economies, a significant divergence can be observed
between advanced economies and emerging and commodity-exporting economies. The U.S.
and European economies continue to experience disinflationary tendencies due to the slack
in supply and demand conditions in the goods and service markets as well as in the labor
market. For example, in the United States, the rate of change in the core personal
consumption expenditure (PCE) deflator fell to 0.9 percent on an annual basis in October,
and the rate of increase in the consumer price index (CPI) is likely to remain low for the time
being. In this situation, following the speech made by Federal Reserve Chairman Ben
S. Bernanke on August 27,1 markets started to factor in possible additional monetary easing,
and transactions based on the anticipation of a reversal in the disinflation trend increased -
as evident from, for example, the rise in the breakeven inflation rate, which is a measure of
medium- to long-term inflation expectations. Moreover, concerns about the risk of inflation
have been raised following the Fed's decision on November 3 to conduct large-scale
purchases of longer-term Treasury securities totaling 600 billion U.S. dollars.
As for emerging and commodity exporting economies, inflationary pressure has been
increasing due to higher natural resource and food prices and greater utilization of production
factors. In fact, in some countries, including China, inflation has already started to pick up.
One reason is the acceleration of capital inflows to emerging economies caused by monetary
easing in advanced economies, especially the United States. This means that, given the
socalled "trilemma of international finance" - the impossibility of simultaneously pursuing a
stable exchange rate, free capital movements, and an autonomous monetary policy - in
some countries, the conduct of monetary policy may be affected by interventions in the
foreign exchange market to avoid a surge in the exchange rate, resulting in a delay of
necessary adjustments in monetary policy.
2. Domestic demand in Japan
Turning to domestic demand in Japan, business fixed investment is showing signs of picking
up, supported mainly by the improvement in corporate profits. Specifically, the aggregate
supply of capital goods, a coincident indicator of machinery investment, has registered a
moderate increase, while there has been a substantial increase in machinery orders, a
leading indicator of machinery investment. The employment and income situation, although
remaining severe, has eased somewhat, with a slight rise in the number of employees and in
wages, as well as a gradual improvement in the ratio of job offers to applicants. In this
situation, growth in private consumption until September turned out stronger than expected,
reflecting the last-minute rise in demand ahead of the expiration of subsidies for purchasers
of environmentally friendly cars and the increase in the tobacco tax, in addition to the boost
from the extremely hot weather. Since the beginning of October, however, private
consumption has dropped following the earlier spike in demand. Meanwhile, housing
investment has stopped declining, with the number of housing starts (a leading indicator of
housing investment) - especially those for the sale of real estate lots - generally picking up
and sales of apartments in the Tokyo metropolitan area increasing. On the other hand, public
investment has been declining since the second half of 2009.
Given this situation in domestic and overseas demand, domestic growth in production has
lost momentum. Production dropped in September, mainly due to the decline in production of
cars and semiconductor and related products reflecting the decrease in demand following the
expiry of government measures. The drop was also seen on a quarterly basis.2
Consequently, inventories have been increasing somewhat, mainly in durable consumer
goods and in electronic parts and devices.
3. Prices in Japan
With regard to price developments in Japan, the CPI excluding fresh food is declining on a
year-on-year basis due to the substantial slack in the economy as a whole, but the pace of
decline has continued to slow. In October, the year-on-year pace of decline in the CPI
slowed significantly due especially to the increase in the tobacco tax.
B. The Outlook
1. The October 2010 Outlook Report
As we have seen so far, Japan's economy is still showing signs of a moderate recovery,
although the pace of recovery seems to have temporarily slowed. The key issue is how to
come out of this temporary slowdown. Let us therefore consider the outlook for economic
activity and prices in Japan, which the Bank released in the October 2010 issue of the
Outlook for Economic Activity and Prices (hereafter the Outlook Report).
Starting with the outlook for the economy, the pace of recovery is likely to slow temporarily in
the second half of fiscal 2010 due to factors such as the slowdown in overseas economies
and the ending of the boost from policy measures targeted at durable consumer goods, as
well as the recent appreciation of the yen. The growth rate of the economy for the October-
December quarter of 2010, in particular, is highly likely to turn out negative following the
higher-than-expected growth in the July-September quarter. However, although the effects
of the appreciation of the yen may continue to linger, the economy is expected to return to a
moderate recovery path once we enter fiscal 2011, given that - with growth in overseas
economies expected to pick up again - exports are projected to continue increasing and
firms' sense of excessive capital stock and labor is likely to dissipate gradually. In fiscal
2012, Japan's economy is expected to continue growing at a pace above its potential amid
the continued relatively high growth in overseas economies, especially emerging and
commodity-exporting economies.
Although my view regarding the outlook is basically in line with the Bank's projection, I am
concerned about the extent to which Japan's economy will be able to benefit from global
economic growth. In fact, I have a growing sense that Japan has not yet enjoyed much
success in this regard, given that the pace of growth in Japan's exports has been more
moderate than that of other countries since the mid-1990s and that Japan's share in world
exports has been declining since the mid-1990s despite trade liberalization in countries such
as China. Moreover, Japan is likely to face an even tougher global competitive environment
due not only to the recent rapid appreciation of the yen - in a situation where domestic
capacity is yet underutilized - but also to factors unrelated to foreign exchange - such as the
technological catch-up of emerging economies and the increase in free trade agreements
concluded abroad - some of which I will discuss later. In addition, issues that directly affect
the competitiveness of Japanese firms, such as various environmental constraints, the tax
burden, and labor laws and regulations, still give cause for concern. Thus, attention should
be paid to the growing possibility that the Japanese economy and Japanese firms will not be
able to benefit from global demand to the extent commonly expected.
As for the price outlook, the year-on-year pace of decline in the CPI excluding fresh food is
expected to continue slowing as the aggregate supply and demand balance is projected to
continue improving gradually in a situation where medium- to long-term inflation expectations
are assumed to remain stable. In the Outlook Report, the Bank projected that the timing of
the year-on-year rate of change in the CPI entering positive territory would likely be
sometime in fiscal 2011, and that thereafter the rate of increase would start rising through
fiscal 2012. However, I have a more cautious view of future developments in prices. Let me
explain why this is the case.
2. Views on the expected rate of inflation
When examining the outlook for price developments, key aspects to be considered are the
size of the output gap, the expected rate of inflation, and import prices. In addition, empirical
studies show that the current rate of inflation is also affected by past inflation. Thus, empirical
analyses of inflation dynamics often use the following type of specification: Inflation rate for
the current term
γ
= × (the expected rate of inflation for the next term)
+ (1 - γ) × (the inflation rate for the previous term)
β
+ × (the output gap for the current term)
α
+ × the rate of change in import prices,
γ
where α, β, and are parameters.
A frequent criticism of this type of specification is that the inclusion of the inflation rate in the
previous term lacks microfoundations and its role is therefore difficult to interpret. However,
one possible interpretation is that the rate of inflation not only is determined by medium- to
long-term inflation expectations but also may be affected by short- to medium-term inflation
expectations that are influenced by actual inflation in the past. According to this
interpretation, the key question for Japan at the moment is which of the two influences is
stronger - positive medium- to long-term inflation expectations or negative inflation rates in
the past.3
It goes without saying that for Japan it is important to enhance the influence of medium- to
long-term inflation expectations on the actual rate of inflation. However, I believe it will not be
easy to do this given the prolonged deflation Japan has been suffering. Furthermore, it
seems that Japan is not the only country where the influence of medium- to long-term
inflation expectations is weak. Though the context differs, in the United Kingdom - where the
inflation rate has exceeded the ceiling of the target for almost a year - the possibility of a rise
in medium-term inflation expectations driven by past rates of inflation is considered a serious
risk.4 Furthermore, in the United States, concern has been voiced over the possibility of the
current disinflation depressing medium-term inflation expectations.5
Moreover, given that inflation rates in the past were influenced by the output gap at the time,
the fact that current inflation is affected by past inflation means that current inflation is
determined not only by the output gap at present but also that in the past. Given that the
utilization rate of Japan's economy remains low and growth in the third quarter of fiscal 2010
is expected to be negative, little improvement is likely in the output gap. The effect of this
output gap on future inflation cannot be ignored, and the influence of medium- to long-term
inflation expectations on current inflation is not likely to be very strong.
3. Japan's response to globalization
Needless to say, Japan's response to globalization is also an important factor when
considering the outlook for price developments. The Japanese economy has stagnated for
more than ten years and prices have been on a downward trend for much of that period, and
it is clear that globalization - through the increase in low-priced imports and intensified
competition - has played a role in this.6
3
The forecast for the medium- to long-term rate of inflation by economists has been stable at around 1 percent
for the past few years.
4
At a press conference in November 2010, Bank of England Governor Mervyn King stated, "And if the period of
above-target outturns causes medium-term expectations to drift up, then the inflation outlook could be
significantly higher" (Bank of England, Inflation Report Press Conference Opening Remarks by the Governor,
10th November 2010), and "If inflation expectations start to move away from target in a way that threatens the
behaviour of inflation in the medium term, then we certainly would be concerned. And that is obviously the
major upside risk and we talk about that at great length in the [Inflation] Report" (Bank of England, Quarterly
Inflation Report Q&A, 10th November 2010). Moreover, at the Monetary Policy Committee meeting in
November, it was stated that "some Committee members were concerned that recent inflation outturns and
the higher near-term profile meant that the risk to inflation expectations was somewhat greater than previously
thought" (Bank of England, "Minutes of the Monetary Policy Committee Meeting 3 and 4 November 2010").
5
See, for example, William C. Dudley's speech entitled "The Outlook, Policy Choices and Our Mandate," given
at the Society of American Business Editors and Writers Fall Conference at the City University of New York on
October 1, 2010. At the Federal Open Market Committee (FOMC) meeting held on June 22 and 23, 2010, it
was stated that "some participants judged the risks to the outlook for inflation as tilted to the downside,
particularly in the near term, in light of [. . .] the possibility that inflation expectations could begin to decline in
response to low actual inflation." Moreover, the minutes of the FOMC meeting held on November 2 and 3,
2010 stated that "participants citing downside risks noted concerns about the degree to which lingering
resource slack in the economy was putting downward pressure on inflation, or about the possible effects that
an extended period of low readings on actual inflation might have in reducing inflation expectations."
6
For details on structural issues in Japan that form the background to the prolonged deflation, see the speech I
delivered at the University of Tokyo on December 1, 2010 entitled "Seichoukiban Kyouka no Juuyousei to
Kin'yuseisaku (The Importance of Strengthening the Foundations for Economic Growth and Monetary Policy)"
(available in Japanese only).
With regard to globalization, one issue that I have recently been concerned about is the
effect on Japan's economy and prices of the rapid technological catch-up of emerging
countries with Japan. In recent meetings with corporate managers, I increasingly hear that
firms from emerging economies have, for example, been acquiring at low cost facilities made
redundant at Japanese firms through restructuring and absorbing production know-how by
employing expert technicians retired from Japanese firms, including from small and
mediumsized firms, enabling emerging economies to catch up rapidly with Japanese firms with
respect to production technology and skills. If the production technology of emerging
countries were to improve rapidly, this would not only further intensify global competition but,
from Japan's perspective, also increase the impact of exchange rate fluctuations on exports
due to the increased price elasticity of exports. In addition, the possibility of competitive
disadvantages due to factors other than the exchange rate, such as tariffs, is increasing, so
that exporting firms in particular will have no choice but to cut costs further in order to
maintain their competitiveness. Traditionally, Japanese firms have tended to raise
productivity through advances in labor-saving technology and cost cutting; however, given
that there still remain significant wage differentials with emerging economies, it is possible
that firms will seek to lower labor costs further by shifting more production bases overseas,
replacing full-time employees with part-timers, and shortening working hours. For this
reason, downward pressure on wages is likely to increase, in which case upward pressure
on prices - including prices of services, which are affected by wages - will weaken.
Considering the price-setting behavior of firms in a situation where competition with overseas
firms is expected to increase, I cannot help but be cautious with regard to the outlook for
prices.
In view of what I have described, I believe that the probability that the year-on-year rate of
change in the CPI will leave negative territory during fiscal 2011 is not high and that it will
take some time to attain conditions necessary to overcome deflation. The probability is
pushed down further by the scheduled change in fiscal 2011 of the base year for the CPI to
2010, as explained in the Bank's Outlook Report.7
C. Risk factors
As stated in the introduction of the October 2010 Outlook Report, a careful analysis of both
upside and downside risks is of great importance due to the high level of uncertainty in the
current economic situation and the considerable risk that the economy may deviate from the
scenario considered most likely by the Bank.
In the October 2010 Outlook Report, the following risk factors regarding economic activity
were identified: (1) developments in advanced economies; (2) developments in emerging
and commodity-exporting countries; (3) developments in business and household sentiment;
and (4) firms' medium- to long-term growth expectations. Risks regarding price
developments included (1) the materialization of upside and downside risks regarding
economic activity; (2) medium- to long-term inflation expectations of firms and households;
(3) the uncertainty in gauging the aggregate supply and demand balance and its impact on
prices; and (4) developments in import prices.
I personally am also conscious of these risk factors. In what follows, I will consider them in
greater detail.
1. Risks concerning overseas economic activity and prices
I will first look at risks concerning overseas economies. In advanced economies, room for
further fiscal stimulus measures is limited (and emphasis is in fact shifting to fiscal
consolidation), and downside risks such as balance-sheet adjustments in the United States
and Europe and a high level of uncertainty remain. On the other hand, in emerging and
commodity-exporting economies, where governments have room for further policy actions,
there are upside risks such as a further acceleration of the economy. Thus, at present, risks
concerning overseas economies seem to be well balanced, although the level of uncertainty
is high. However, as I mentioned earlier, considering the current economic situation and the
level of asset prices in emerging and commodity-exporting economies, adjustments to the
accommodative monetary policies there seem to be somewhat delayed. Against this
background, upward pressure on prices, including those of commodities and food, is
heightening. Thus, the risk of economic overheating and a subsequent rapid reversal
appears to have grown slightly.
Although I mentioned that emerging and commodity-exporting economies seem to have
fallen somewhat behind in adjusting accommodative monetary policies, it would be
inappropriate to focus on these countries alone. The sharp contrast in price developments
between advanced economies and emerging and commodity-exporting economies - with the
former facing disinflation and the latter inflation - combined with global external imbalances
poses great difficulties for policymakers in countries around the world. At the same time, I am
increasingly concerned that when policy actions are taken they might - contrary to intentions
- widen fluctuations in real economic activity and prices around the world. This is because
the economic size of emerging and commodity-exporting economies as a group is
approaching that of advanced economies as a group, and the closer the size of the
economies of the two groups, the more their policy actions affect each other. In terms of
policy effects, this means that the feedback effects of policies also increase accordingly
through this external economic impact. However, given the lack of adequate information on
the domestic economy and overseas economies, and due to differences in exchange rate
regimes and in capital mobility, it is difficult to accurately gauge the impact of such feedback
effects and the spillover effects from policies undertaken by other countries.8
2. Risks concerning the domestic economy
Next, I will talk about the risks concerning the Japanese economy. At present, financial
markets cannot be described as stable due to the great uncertainty surrounding the economy
and financial markets, and the volatility in the degree of risk tolerance in financial markets.
Given the low capacity utilization in the economy, the recent appreciation of the yen, and the
deterioration in corporate and consumer sentiment, there remains a high risk that the
expected temporary weakness in the economy will persist.
From a longer-term perspective, a downside risk of concern is that the expected growth rate
may fall much further than expected. Following the bursting of the bubble economy, Japan
was preoccupied with addressing the legacy of the bubble and failed to take sufficient
measures to deal with major issues such as the large fiscal deficit and the aging and
shrinking of the population. And this, I believe, is the fundamental reason why Japan has
been unable to raise the expected growth rate. Another major reason is that Japan has not
responded sufficiently, or has been slow to respond, to structural changes in the global
economy, in particular the rise of emerging and commodity-exporting economies. Put
differently, as I pointed out earlier, Japan has not been able to benefit fully from global
economic growth.9
Against this background, many Japanese firms have recently been developing new products
and expanding international sales networks in order to capture infrastructure and
consumption demand in emerging and commodity-exporting economies. Among these firms,
some are aiming to restructure their business strategies from a global viewpoint by acquiring
overseas firms, making use of the strong yen. Such a constructive approach could increase
corporate confidence and dispel the prevailing sense of gloom, leading possibly to an
increase in the expected growth rate. If, however, firms that are developing business
overseas place priority on strengthening overseas production by shifting production abroad
and/or closing down domestic bases altogether, the impact on the Japanese economy - and
especially the direct impact on subcontractors and sub-subcontractors - would be quite
severe because of the large spillover effects from exporters.10 In fact, the Bank's Regional
Economic Report released in October 2010, based on information gathered from its Head
Office and branches, highlighted the concern raised by some that increased overseas
production was restraining new hiring in Japan.11 Thus, there is a risk that Japan's expected
growth rate will decline unless all economic players take forward-looking action in their
respective fields.
3. Risks concerning prices
The last issue is risks concerning prices. An increase in commodity prices brought about by
high growth rates in emerging and commodity-exporting economies could cause prices in
Japan to rise more than expected. At present, international commodity prices are on an
upward trend, so it is necessary to carefully monitor the impact of import prices. However,
the risk of a downturn in the rate of inflation cannot be ruled out because of factors such as a
decline in medium- to long-term inflation expectations.
Regarding the outlook for prices, the crucial point, as I mentioned earlier, is how well current
inflation is anchored to stable medium- to long-term inflation expectations. I personally take a
cautious view on this issue. I am also wary about the effectiveness of the comprehensive
monetary easing policy that I will explain later, and therefore believe that, on balance, risks
concerning prices are weighted on the upside.
II. Conduct of monetary policy
A. Background to the Bank's decision to implement a comprehensive monetary
easing policy
Next, I will outline the Bank's current conduct of monetary policy. The Bank recognizes that
Japan's economy faces the critical challenge of overcoming deflation and returning to a
sustainable growth path with price stability. To this end, it will continue to consistently make
contributions as the central bank, namely, strive to pursue powerful monetary easing, ensure
financial market stability, and support strengthening the foundations for economic growth. At
the same time, it will carefully examine the outlook for economic activity and prices, and if
judged necessary, take policy actions in a timely and appropriate manner.12 The Bank
examined the outlook for economic activity and prices at the Monetary Policy Meeting on
October 4 and 5, 2010, and judged that it had become more likely that the return of Japan's
economy to a sustainable growth path with price stability would be delayed. Based on this
assessment, the Bank decided to implement comprehensive monetary easing as an
additional policy measure to further enhance monetary easing.13
In recent months, following the Monetary Policy Meeting in July 2010, at which the Policy
Board members conducted an interim assessment of the Bank's view presented in the April
2010 Outlook Report, I have been thinking in more detail about the outlook for economic
activity and prices through fiscal 2012. By September, I had become increasingly concerned
about the downside risks to the economic outlook, especially for fiscal 2011 and thereafter,
and concerned that the recovery in prices might be weaker than expected. Therefore, my
view was that the Bank should take drastic policy action using unprecedented measures.
Looking back, it seems that other Policy Board members, each from their own perspective,
have had a similar or acute view. It is these concerns that prompted the decision to introduce
the comprehensive monetary easing policy.
B. Objectives of the comprehensive monetary easing policy
The comprehensive monetary easing policy consists of three measures: a change in the
guideline for money market operations; a clarification of the commitment regarding the time
horizon for maintaining the virtually zero interest rate policy based on the "understanding of
medium- to long-term price stability" (hereafter "understanding"); and the establishment of
the Asset Purchase Program. Next, I will explain the objectives of these measures in detail.
For clarity, I have classified the objectives into four categories, which are to achieve (1) lower
interest rates, (2) quantitative easing, (3) qualitative easing, and (4) to affect market
expectations.
1. Change in the guideline for money market operations
The first measure was to change the guideline for money market operations. The Bank
decided to change the target for the uncollateralized overnight call rate from previously
"around 0.1 percent" to "around 0 to 0.1 percent." The Bank has pursued a virtually zero
interest rate policy since the policy change in December 2008, setting the target for the rate
at around 0.1 percent. However, because it was not necessarily clear by how much the Bank
would allow the rate to deviate from 0.1 percent in its daily market operations, it decided to
clarify this point. While the Bank has been committed to providing ample funds since the
Lehman shock, it will further enhance the provision of liquidity through measures such as the
implementation of the Asset Purchase Program, which I will explain later. In addition, given
that the transaction volume in the call market has declined as the ample provision of funds by
the Bank increasingly replaced priva