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, Fukushima, 22 July 2013.
* * *
I. Introduction
It has been two years and four months since the Great East Japan Earthquake took place.
First of all, I would like to offer my greatest appreciation and respect to everyone who has
continued to work devotedly to achieve restoration and reconstruction since the earthquake
disaster. I would also like to take this opportunity to express my sincere gratitude for your
cooperation with the activities of the Bank of Japan's Fukushima Branch.
Today, I will begin by focusing on the Bank's monetary policy and economic activity and
prices in Japan and abroad. I will then touch briefly on the economy of Fukushima Prefecture
in my closing remarks. Following my speech, I would like to hear your views on actual
conditions in the local economy, including the progress in reconstruction, as well as on the
Bank's conduct of monetary policy.
II. Recent conduct of monetary policy
A. Quantitative and qualitative monetary easing and market reactions
At the Monetary Policy Meeting (MPM) held on April 3 and 4, 2013, the Bank introduced
quantitative and qualitative monetary easing (QQE). This policy aims to achieve the "price
stability target" of 2 percent in terms of the year-on-year rate of change in the consumer price
index (CPI) at the earliest possible time, with a time horizon of about two years. To achieve
this, the Bank decided on new monetary easing measures. Specifically, the monetary base
and the amounts outstanding of Japanese government bonds (JGBs) as well as
exchangetraded funds (ETFs) will be doubled in two years, and the average remaining maturity of JGB
purchases will be more than doubled (Chart 1). Since these policy measures exceeded
market expectations, the initial reaction of the foreign exchange and stock markets was
positive. Thereafter, in the JGB market, long-term interest rates rose with some volatility and
these developments drew public attention (Charts 2 and 3).
From late May, there was an increase in investors' risk aversion worldwide reflecting
speculation that the Federal Reserve would reduce the pace of its asset purchases earlier
than expected, and the foreign exchange and stock markets were affected by these
developments. Investors' risk aversion was observed especially in emerging markets, but the
Japanese stock and foreign exchange markets, which are considered to be sensitive to
global economic fluctuations, were also affected to some degree. On the contrary, long-term
interest rates in Japan were generally stable despite the rise in U.S. long-term interest rates.
Summarizing these developments in financial markets, we can point to the following.
In general, the central bank needs to communicate carefully to financial markets in the early
stages of a policy change or in the course of discussion leading up to a change. This is
because the message delivered by policymakers tends to be misinterpreted and financial
markets tend to overreact in the early stages. Typical examples are (1) the case of the
Bank's policy change at the MPM on April 3 and 4; and (2) the case of Federal Reserve
Chairman Ben Bernanke's testimony to the U.S. Congress on May 22, 2013 and his press
conference after the Federal Open Market Committee (FOMC) meeting on June 19. In the
former case, some market participants misunderstood that the Bank of Japan had given up
its commitment to the stability of short-term interest rates. In the latter case, market reaction
was fairly large due to the reversal of movement until mid-May, when risk-taking activities in
asset markets were active, mainly in emerging markets, due partly to speculation that the
Federal Reserve would maintain the current pace of its asset purchases.
This type of initial market reaction generally becomes contained as the policy intention of the
central bank permeates financial markets through close communication between the central
bank and financial markets based on economic indicators. As financial markets gain better
understanding of the central bank's policy intention and find a new equilibrium point, market
volatility is usually contained even at the time of a policy change.
Currently, the Japanese financial markets are becoming stable on the whole as they gain
further understanding of the Bank's policy intention regarding the April decision. The reaction
by the U.S. financial markets is expected to moderate as they find a new equilibrium point as
a result of the Federal Reserve's intensive communication with them based on economic
indicators.
B. Stable bond market in Japan compared with that in the United States
When Japanese long-term interest rates rose with volatility after the policy change in April,
some regarded the new policy as a failure. But it is not appropriate to judge the validity of the
policy merely from the initial reaction of the rise in interest rates immediately after the
introduction of QQE. The market reaction after the policy change reflects the phenomenon of
"buying on rumor and selling on fact," which is observed frequently in financial markets.
Market developments since end-2012 show that there has been a positive correlation
between the JGB and stock markets - long-term interest rates rose when stock prices
surged and long-term interest rates plunged when stock prices dropped. It can be added that
Japanese long-term interest rates have been substantially contained despite the rising stock
prices and fluctuations in foreign exchange rates since end-2012, given the effects of the
increase in the Bank's purchases of JGBs. Moreover, the recent stability in the JGB market
compares favorably with the large fluctuations in the U.S. bond market since the end of May
(Chart 2).
C. Corporate and household sectors anticipate economic developments and
prices
As market participants anticipate a recovery in economic activity and prices, firms and
households also anticipate a recovery and change their investment and consumption
activities accordingly. In this sense, it would be unfair to disregard such changes in firms' and
households' activities when assessing the effects on the economy of the rise in nominal
interest rates.
In fact, firms' funding activities in the corporate bond market after the introduction of QQE
were more active than usual on the whole, although some firms avoided issuing new bonds
due to the high volatility in the JGB market. To put it another way, it was confirmed that
investor demand was steady (Chart 4).
In short, as market participants anticipate developments in economic activity and prices,
firms also anticipate changes in funding conditions as well as demand in the bond market to
seek investment opportunities, and investors anticipate the asset management environment
in their investment decisions. Households also anticipate conditions following the economy's
overcoming of deflation; this is evidenced by the increase in the proportion of fixed-rate
mortgages compared to the previously dominant floating-rate mortgages. These dynamics
show that the economy and financial markets are currently seeking a new equilibrium point.
Only three months have elapsed since the Bank introduced QQE. The Bank's previous
monetary policy was sometimes questioned by other countries, which later revised their
judgments after experiencing a situation similar to that faced by Japan after the bubble
economy burst in the 1990s. It might therefore be premature to assess the effectiveness of
QQE solely from the money market reaction since early April. What is important is whether
the underlying trend in Japan's economic activity and prices is heading toward a recovery
from a somewhat longer-term perspective after the introduction of QQE. As I will mention
later, I am more optimistic about the outlook for Japan's economy than in fiscal 2012, when
the Bank revised downward its outlook for economic activity and prices several times
because of the European debt problem and deceleration of the Chinese economy.
D. Toward a stable JGB market
It should be noted that QQE has contradictory, two-sided policy effects on the JGB market.
Massive bond purchases by the Bank lower the risk premiums in the JGB market, and this
contains nominal interest rates; at the same time, once the policy effect materializes, the
market's anticipation of a recovery in economic activity and prices exerts upward pressure on
nominal interest rates. After the introduction of QQE, interest rates fluctuated due to these
two contradictory factors, and the volatility in the JGB market rose as a result. Such high
volatility, if it is prolonged, tends to prompt market participants to sell bonds for the purpose
of risk management, and heavy bond sales could cause an unnecessary rise in interest
rates. Given the heightened volatility in the JGB market, at the May MPM the Policy Board
members discussed measures to stabilize long-term interest rates, and confirmed that for
JGB purchases it was important for the Bank to conduct operations flexibly. At the end of
May, the Bank clearly showed that it would conduct operations flexibly, for example by
adjusting as necessary the parameters of its JGB purchases, such as frequency and
allocation of purchase amounts by maturity (Chart 5).
Subsequently, at the June MPM, the Policy Board members discussed the possibility of
introducing funds-supplying operations against pooled collateral with a loan duration of more
than one year. Based on the discussion at the MPM, the Policy Board members concluded
that it was not necessary at that time for the Bank to extend the maximum duration of loans
provided through its funds-supplying operations against pooled collateral, because (1) the
effect of compressing risk premiums driven by the Bank's massive JGB purchases was likely
to strengthen steadily, and (2) flexible conduct of market operations was sufficiently ensured
under the current guideline for the operations to contain the volatility. In other words, the
current policy guideline allows a range of "about six to eight years" for the average remaining
maturity of the Bank's JGB purchases. By utilizing this guideline, it would be possible to
stabilize the entire yield curve by purchasing JGBs with a maturity of one to five years more
intensively. As the policy guideline allows a range of "about six to eight years," I see no need
for concern even if the actual remaining maturity of JGB purchases temporarily falls short of
six years.
Let me add that the Policy Board members judged that it was not necessary to introduce the
funds-supplying operations against pooled collateral with a loan duration of more than one
year, taking into account the following points. First, the introduction of such operations could
cause misunderstanding that the Bank is encouraging financial institutions to hold JGBs even
though the Bank has already introduced new measures to encourage portfolio rebalancing by
financial institutions and investors. Second, since such operations contain a message
regarding policy duration, the introduction of such operations could confuse market
participants about the relationship between this message and the policy duration under the
QQE framework - namely, to achieve the price stability target of 2 percent at the earliest
possible time, with a time horizon of about two years. And third, the fund-provisioning
measure to stimulate bank lending (the Stimulating Bank Lending Facility), whose first loan
disbursement was made on June 20, 2013 and whose original aim was to encourage
portfolio rebalancing by banks, works to reduce banks' duration risk for a maximum of three
years on their liability. The facility is in this sense substitutable to some extent with the
fundssupplying operations against pooled collateral with a loan duration of more than one year,
and thus it was necessary to reconsider the relationship between these two measures. The
Bank, however, does not completely exclude the possibility of introducing these operations,
since they could be an effective tool for stabilizing the market.
E. Policy change from comprehensive monetary easing to QQE
The Bank had pursued comprehensive monetary easing through March 2013, and in April it
carried out a policy change and introduced QQE soon after the new Governor and Deputy
Governors took office. Questions have been voiced regarding the Policy Board members
who voted unanimously to approve the policy change in April, even though comprehensive
monetary easing had been promoted through March.
My understanding is that like the decision made at the MPM held on April 3 and 4, 2013, it
was a major decision to introduce the 2 percent price stability target at the January MPM
(Chart 6). While details of the discussions at the February and March MPMs held in the
period after the price stability target was introduced but before the new Governor and Deputy
Governors took office are referred to in the minutes, the topic of discussion shifted to specific
measures to strengthen monetary easing with the aim of achieving the price stability target of
2 percent. In the discussions, issues were raised regarding purchases of JGBs with longer
remaining maturities, and consolidation of purchases of JGBs under the Asset Purchase
Program with those conducted in terms of money market operations (Chart 7).
Although the set of decisions made at the MPM held on April 3 and 4 is called a new phase
of monetary easing, some of the ideas largely reflect quantitative easing and comprehensive
monetary easing, adopted from March 2001 to July 2006 and from October 2010 to March
2013, respectively. For example, the setting of the main operating target for money market
operations to the monetary base instead of the uncollateralized overnight call rate is similar
to the framework of quantitative easing - in which the main operating target was the Bank's
current account balances - on the premise that the outstanding balance of banknotes issued
does not fluctuate significantly. Moreover, most of the financial assets currently being
purchased are the same as those purchased during the period of comprehensive monetary
easing - such as JGBs, ETFs, and Japan real estate investment trusts (J-REITs) (Chart 8).
The extension of the average remaining maturity of the Bank's JGB purchases to around
seven years has consequently increased the scale of monetary easing. However, during the
last phase of comprehensive monetary easing, the Bank had set the amount outstanding of
the Asset Purchase Program at around 111 trillion yen by end-2014. In terms of the
monetary base, this would be equivalent to around 200 trillion yen (although a range should
be allowed for this number). The amount is less than the targeted amount outstanding under
QQE, which is 270 trillion yen at end-2014, but one can argue that the Bank had already
committed to considerably increasing the size of the monetary base. In this sense, the
Bank's policies over the years should be understood as being consistent.
F. What it means to avoid an incremental approach
Since late May 2013, expectations for further monetary easing had increased in the market,
in a situation where instability had been observed in financial markets at home and abroad.
However, QQE differs completely from the Bank's other monetary easing policies adopted in
the past in the sense that (1) the Bank had adopted the stance of pursuing bold monetary
easing all at once to achieve the price stability target of 2 percent in about two years and to
avoid an incremental approach; and (2) by doing so, the Bank aims to exert influence on the
expectations of firms and households as well as financial markets.
The former policy stance of avoiding an incremental approach is based on the lessons
learned from the fact that Japan's economy could not overcome deflation, even though the
Bank had continued to fine-tune its policies under the framework of comprehensive monetary
easing in accordance with the economic cycle. Therefore, this policy stance should be
regarded as a serious one. The latter policy stance of aiming to exert influence on the
expectations of firms and households as well as financial markets is associated with the
former policy stance. The Bank aims to drastically change such expectations by
implementing all possible measures called for at the time. To do so, it is important to first
implement bold monetary easing measures that go beyond market expectations and then
carefully monitor their effects, rather than adopting measures in a piecemeal manner, which
would have adverse effects. At the same time, the Bank does not exclude the
implementation of additional measures and will not hesitate to fine-tune its policies flexibly
when unexpected tail risks materialize.
The policy stance of the Bank that I have just described is not necessarily fully understood
yet by market participants. Therefore, the Bank should provide a thorough explanation to the
public of its policy stance through various communication channels, including dialogue with
market participants.
G. The meaning of the 2 percent price stability target
I will now discuss my understanding of the price stability target of 2 percent. Generally,
inflation-targeting policy is a flexible monetary policy framework and countries adopting it do
not change their monetary policy stances mechanically in accordance with the achievement
or undershooting of their targets. This understanding is widely shared by central banks that
have adopted such a policy framework. I understand that the Bank's monetary policy
framework - in which the Bank sets the 2 percent price stability target - is a flexible one, in
the sense that it focuses mainly on maintaining the 2 percent target in a stable manner rather
than merely on achieving the target exactly (Chart 9).
In terms of maintaining the target in a stable manner, it is almost impossible to stably
maintain the inflation rate specifically at 2 percent, given the time lag required for the
permeation of monetary policy effects and the uncertainty of such permeation. Rather, it is
natural to think that there is an allowance of a certain range for upward and downward
deviations of the actual inflation rate from the target. Of course, the degree of acceptable
allowance varies depending on the view of each Policy Board member, but I think that if the
inflation rate is projected to stabilize within a certain range with a median of 2 percent, then
the main objective of QQE will have been fulfilled. Taking into account the trend of the
inflation rate in Japan, unless inflation expectations rise soon, the possibility of achieving the
price stability target of exactly 2 percent with a time horizon of about two years is not
necessarily high. However, if we take the price stability target as a flexible framework with a
certain range of allowance for inflation deviations, then the 2 percent target is reasonable
and achievable.
I would like to emphasize that the Bank's aim under QQE is "achieving price stability, thereby
contributing to the sound development of the national economy," as stipulated in the Bank of
Japan Act. Specifically, the economic situation the Bank aims to bring about is not one in
which prices simply rise. Rather, it is one where a virtuous circle operates in which fixed
investment and private consumption grow and corporate profits increase in line with the
improvement in the economic situation as a whole, and prices rise in a balanced manner in
line with the improvement in the employment and income situation. The sound development
of the national economy must not be put at risk in achieving 2 percent inflation merely in a
superficial sense.
H. How to achieve the 2 percent inflation target
To achieve the 2 percent price stability target, the Bank assumes three channels, as follows.
First, the Bank's purchases of financial assets will encourage a further downward pressure
on interest rates across the yield curve and lower risk premiums of asset prices. Second,
there will be a portfolio rebalancing effect. And third, the Bank's commitment to achieving the
price stability target and the continuation of massive asset purchases are expected to
fundamentally change the inflation expectations of firms and households as well as financial
markets. I will now discuss each of these three channels in turn.
Regarding the first channel, as I mentioned earlier, risk premiums of asset prices have
already been relatively contained due to the Bank's purchases of JGBs, ETFs, and J-REITs.
In this regard, some market participants have mistakenly assumed that the Bank's
commitment to stabilizing short-term interest rates weakened because the Bank changed its
main operating target from the uncollateralized overnight call rate to the monetary base.
However, the Bank's commitment to maintaining short-term interest rates at a low level by
generating a massive amount of financial institutions' excess reserves has not changed at
all. Purchases of medium- to long-term JGBs amounting to about 50 trillion yen at an annual
pace alone are not sufficient to meet the policy guideline of increasing the monetary base at
an annual pace of about 60-70 trillion yen. Therefore, it is implied that to fill the gap the Bank
will purchase a certain amount of treasury discount bills (T-Bills) and/or conduct short-term
funds-supplying operations. The scale of T-Bill purchases is not mentioned in the guideline
for money market operations, because the Policy Board members consider that, given the
experience of comprehensive monetary easing, the provision of short-term funds should be
left to the discretion of the Bank's staff, so that it can respond flexibly to potential fluctuations
in short-term interest rates.
When the Bank announced immediately after the MPM held on April 3 and 4 that it would
introduce QQE and aim to achieve the price stability target of around 2 percent in about two
years, market participants anticipated that short-term interest rates two years ahead might
not be around 0 percent, and this affected medium- to long-term interest rates. Such a
phenomenon may be observed again. On this issue, I expect that the effects of the automatic
adjustment function of QQE will emerge and financial markets will be able to cope with price
developments on their own. To elaborate on this, once the probability of achieving the
2 percent price stability target rises, this will inevitably be incorporated in medium- to
longterm interest rates to some extent; on the other hand, if the probability of achieving the target
remains low, such interest rates will continue to be contained. The important point is that the
Bank should contain the level of medium- to long-term interest rates at a level below that
consistent with market participants' outlook for economic activity and prices by proceeding
with JGB purchases and lowering risk premiums. So far, massive JGB purchases by the
Bank have contained various factors that have exerted upward pressure on interest rates,
and the effect of reducing risk premiums is expected to strengthen cumulatively as the
amount of purchases increases (Chart 10).
As for the second channel, the portfolio rebalancing effect is aimed at stimulating economic
activity and asset markets. The Bank generates large amounts of financial institutions'
excess reserves through its massive purchases of JGBs from them and induces them to
rebalance their portfolios from JGBs to risk assets with higher expected returns. The Bank
decided to extend the average remaining maturity of JGB purchases at the MPM held on
April 3 and 4 so that the portfolio rebalancing effect can strengthen.
The portfolio rebalancing effect works as follows. The Bank's asset purchases do not change
the size of private financial institutions' balance sheets, but the composition of their balance
sheets changes on the asset side. In other words, private financial institutions' holdings of
JGBs and other assets decrease, and their current account balances at the Bank increase
accordingly. From the viewpoint of private financial institutions' asset management, the
profitability of their portfolios as a whole decreases since their assets under management
decline and their current account balances at the Bank increase. Private financial institutions
are then expected to shift their portfolios to assets with higher expected returns such as risk
assets and to increase lending to secure profits (Chart 11).1
In this way, the Bank aims to generate massive excess reserves of financial institutions to
encourage a change in the investment behavior of banks, life insurance companies, and
pension funds. It is no simple matter to discuss whether portfolio rebalancing will spread
among all investors, as there are also individual regulatory and accounting factors at work. In
addition, such changes would not occur immediately. Nevertheless, I look forward to the
progress in rebalancing despite the institutional constraints.
Finally, for the third channel, inflation expectations are generally formed with an element of
adaptive expectations (that is, expectations are formed by adjusting them based on previous
data) and inflation expectations of firms and households as well as financial markets are
likely to be low in a situation of persistent low inflation or deflation, as in Japan. However, the
year-on-year rate of change in the CPI (all items less fresh food) in Japan is currently
0 percent due to (1) cost-push factors such as rises in fuel prices due to the recent
weakening of the yen and in electricity charges, as well as (2) a halt in the decline in prices of
TVs and IT-related goods such as personal computers. In this situation, the year-on-year rate
of change in the CPI (all items less fresh food) is expected to turn positive this summer from
the current level of around 0 percent.
If actual inflation remains in positive territory, inflation expectations of firms and households
as well as financial markets might shift upward accordingly. Some reports - such as the
Consumer Confidence Survey released by the Cabinet Office, the Opinion Survey on the
General Public's Views and Behavior released by the Bank, and surveys conducted on
economists and market participants - already suggest a rise in inflation expectations,
although it is hard to gauge the extent to which this is caused by the scheduled consumption
tax rate hikes. The Bank expects a mechanism of a feedback loop between inflation
expectations and the actual inflation rate - in which a rise in inflation expectations causes a
rise in actual inflation and vice versa - to operate and medium-term inflation expectations to
rise accordingly.
I. Wages and prices
In considering channels more in line with economic activity, a wage increase - as well as the
narrowing of the output gap - is indispensable for achieving the 2 percent price stability
target (Chart 12). At a meeting with business leaders in Gunma Prefecture on February 6,
2013, I stated that a significant wage increase of approximately 4 percent was consistent
with achieving 2 percent inflation. However, considering the slowdown in the pace of
increase in labor productivity in recent years, I came to realize that the wage increase
needed might be lower - approximately 2 percent. The reason is that a wage increase
consistent with achieving a certain inflation rate is higher when the pace of increase in labor
productivity is high, and lower when the pace is low (Chart 13).
As for the supply and demand conditions in the labor market consistent with achieving a
wage increase of 2 percent, judging from the wage Phillips curve - with the unemployment
rate on the x-axis and the rate of wage inflation on the y-axis - which excludes a rise in
inflation expectations, the unemployment rate would be roughly 3.0 percent to 3.5 percent.
As the most recent unemployment rate is 4.1 percent, achieving the range of approximately
3.0 percent to 3.5 percent is not impossible.
It is still uncertain whether such a situation close to full employment can be reached within
about two years - the period in which the Bank aims to achieve the price stability target
under QQE. Developments in employment and wages tend to lag behind economic growth,
and therefore, once the economy returns to a moderate recovery path, a considerable time
lag is expected for its effects to spread to wages. Nevertheless, as I mentioned, an
inflationtargeting policy is generally a flexible monetary policy framework. As mentioned, what I think
is important is not mechanically achieving the inflation rate specifically of 2 percent in two
years, but creating a situation in which 2 percent inflation is in sight in about two years, as a
result of the tightening of supply and demand conditions in the labor market.
J. Creating a more favorable environment for firms to increase their base salary
As the importance of a wage increase in overcoming deflation has become widely
recognized, the government has taken the unprecedented action of appealing to the
business community, urging its members to raise wages. In fact, increases in bonus
payments have already been observed in particular industries and firms, and some
nonmanufacturing firms are giving indications of raising their base salary, as their
employment situation has tightened reflecting a drive to obtain new personnel. However,
many firms remain hesitant to increase their base salary due to concerns about a rise in fixed
costs. For the nonmanufacturing firms just mentioned, the increase in base salary has been
limited to full-time employees and a majority of the workers who are part-timers have not yet
received such benefits.
The issue of widespread achievement of such an increase in base salary is deeply
connected to the issue of ensuring flexibility in the employment systems and practices, and
thus it might not be easy to form a consensus on these matters. Nevertheless, Japan's
economy has recently increased its robustness, and therefore economic developments are
expected to support such structural reforms in the labor market. I will now discuss Japan's
economy.
III. Economic activity and prices in Japan and abroad
A. The current state of and outlook for Japan's economy
Even after the Lehman shock, Japan's economy faced a series of headwinds such as the
Great East Japan Earthquake and the flooding in Thailand in 2011, as well as the
deceleration of the Chinese economy from 2012. However, it has overcome such shocks and
a path toward a self-sustained recovery is finally in view. A high degree of uncertainty
remains concerning the global economy, and I see risks to the economic outlook as
somewhat tilted to the downside. However, the external environment as a whole is expected
to exert positive effects on Japan's economy unless a tail risk affecting the global economy
emerges. Therefore, I believe that the present offers a window of opportunity for Japan's
economy to overcome deflation (Chart 14).
Exports had lagged behind domestic demand, which has started to increase its resilience,
but have been picking up led by exports of automobiles to the United States. Production of
manufacturing firms followed a moderate increasing trend in the April-June quarter of 2013,
and is expected to continue to do so in the July-September quarter judging from interviews
with firms (Chart 15). Although the deceleration of the Chinese economy - which I will
discuss later - is a major concern, it is not a serious obstacle to the recovery of Japan's
economy as long as the robustness of the U.S. economy is maintained.
Private consumption for the January-March quarter of 2013 seemed to be supported by an
improvement in sentiment and wealth effects. Private consumption is expected to continue
increasing, as household sentiment has remained firm on the whole even amid the recent
turmoil in financial markets, and as the employment and income situation improves
moderately (Chart 16). According to anecdotal information, negative effects on consumption
of high-end goods and services have not been observed to a large degree despite the recent
turmoil in financial markets. The contribution of public investment to the economy is expected
to increase again from the July-September quarter, supported by the effects of various
economic measures (Chart 17). In these circumstances, coincident indicators of machinery
investment - such as shipments of capital goods and the aggregate supply of capital goods -
suggest that business fixed investment, which had been sluggish, is finally showing some
signs of picking up from the Apri