Haruhiko Kuroda: Japan's economy and monetary policy - toward
overcoming deflation
Speech by Mr Haruhiko Kuroda, Governor of the Bank of Japan, at a meeting held by the
Naigai Josei Chousa Kai (Research Institute of Japan), Tokyo, 29 July 2013.
* * *
Introduction
It is a great honor to have this opportunity to address you today at the Naigai Josei Chousa
Kai.
The Bank of Japan introduced a new regime of monetary easing called "quantitative and
qualitative monetary easing" (QQE) this April with a view to achieving 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. It has been three months
since the introduction of the QQE, and there have been favorable developments spreading to
financial markets and the real economy, and the public's expectations for economic activity
and prices are improving. At the same time, we have received various questions regarding
the policy effect of the QQE. Today, I will first summarize developments in Japan's economy
and financial markets for the past three months, explain the outlook for economic activity and
prices, and then provide my answers to questions regarding the QQE.
I. Progress of the QQE and three positive developments
A. Progress of the QQE
Under the QQE, introduced in April, the Bank will increase the total amount of money it
directly supplies to the economy - the monetary base - at an annual pace of about
60-70 trillion yen. As a result, the monetary base will be doubled in two years, increasing
from 138 trillion yen at end-2012 to 200 trillion yen at end-2013 and to 270 trillion yen at
end2014 (Chart 1). As a means to increase the monetary base, the Bank will purchase Japanese
government bonds (JGBs) so that their amount outstanding will increase at a pace of about
50 trillion yen annually. On a gross basis, this corresponds to purchasing a large amount of
JGBs at a pace of over 7 trillion yen monthly. As a result of such purchases, the amount
outstanding of JGBs held by the Bank will be more than doubled in two years, increasing
from 89 trillion yen at end-2012 to 140 trillion yen at end-2013 and to 190 trillion yen at
end2014. In addition, the Bank decided to more than double its average remaining maturity of
JGB purchases from slightly less than three years to about seven years. This monetary
easing measure has both a quantitative aspect - such as increasing the monetary base and
the amount outstanding of the Bank's JGB holdings - and a qualitative aspect - such as
extending the average remaining maturity of the Bank's JGB purchases. Hence the name
"quantitative and qualitative monetary easing."
Over the past three months, the Bank has pursued the QQE as initially planned (Chart 2).
The monetary base has expanded from 146 trillion yen at end-March to 173 trillion yen at
end-June, at a somewhat front-loaded pace toward 200 trillion yen by end-2013. The amount
outstanding of JGBs held by the Bank has also increased to more than 110 trillion yen
recently from 91 trillion yen at end-March, at a steady pace toward 140 trillion yen by
end2013. Also, the average remaining maturity of the JGBs purchased has extended to about
seven years.
Next, I would like to examine the changes that have been observed in financial markets and
economic activity as the Bank has pursued the QQE. Starting with the conclusion, a
favorable turn has been observed in financial conditions, in expectations, and in economic
activity and prices (Chart 3). These changes include positive developments that had already
begun to operate before the introduction of the QQE, on the back of expectations for
monetary easing, and some also reflect expectations for the government's so-called "three
arrow" strategy as well as developments in the global economy. Therefore, not all of these
favorable developments are attributable to the QQE; nevertheless, it most certainly is an
important factor.
B. Favorable turn in financial conditions
Let me explain the three positive turnarounds, respectively. First, a favorable turn in financial
conditions - in other words, financial markets and corporate finance are improving.
First, stock prices are rising (Chart 4). To be specific, these rose from around 9,000 yen in
autumn 2012 to the 15,000-16,000 yen level in mid-May on the back of heightened
expectations for economic improvement and of the depreciation of the yen. While there have
been declining phases in order to adjust to a rapid rise, stock prices have shown some
resilience, recovering to around 14,000 yen once again. The rate of increase since the
beginning of 2013 has marked around 35 percent, far higher than those registered in the
United States (just under 20 percent) and Europe (over 6 percent). As I have consistently
said, even during the period when stock prices fell temporarily, Japan's economy is steadily
improving, and financial markets - including stock prices - will reflect such fundamental
movements in the real economy.
Next is the developments in long-term interest rates (Chart 5). As the new policy framework
has outdone prior market expectations both in terms of quantity and quality, it has taken time
for market participants to digest the content and its effects, and this led to increased
uncertainty in the JGB market. Such developments came to a pause toward end-April, but
long-term interest rates in the United States rapidly rose from the beginning of May due to
increased speculation that the Federal Reserve might taper the pace of its asset purchases,
and the effects of this started to spread to Japan. Against this background, the Bank, while
continuing with its massive JGB purchases, held an enhanced dialogue with market
participants and conducted flexible market operations, such as making the maximum amount
of those purchases per bidding smaller as well as increasing the frequency of purchases.
Due mainly to such massive JGB purchases and flexible market operations, long-term
interest rates in Japan have recently been almost flat, at around 0.8 percent, even in the
midst of rising overseas rates.
Meanwhile, in the foreign exchange market, the yen's exchange rate against the U.S. dollar
has been depreciating since autumn 2012, when it was around 80 yen to the dollar, and has
recently been around 100 yen (Chart 6). Monetary easing aims at overcoming deflation and
by no means intends to maneuver the exchange rate. Nonetheless, monetary easing will
exert pressure toward depreciation ceteris paribus.
Lastly, firms' and households' financial conditions have been accommodative. That is, with
regard to funding conditions, the diffusion index (DI) for financial institutions' lending attitudes
Tankan
as perceived by firms was on an improving trend in the survey (Short-Term
Economic Survey of Enterprises in Japan), and issuing conditions for CP and corporate
bonds have remained favorable on the whole. While the year-on-year rate of increase in
bank lending had been at about 1 percent up to around last autumn, the pace of increase
has gradually picked up since then and has been slightly above 2 percent most recently
(Chart 7). The amount of corporate bonds issued in the April-June quarter registered the
largest level since the Lehman shock. In terms of funding costs, bank lending rates, in terms
of the average contracted interest rates to businesses and households, have continued to
decline and remain at historically low levels.
C. Favorable turn in expectations
The second favorable turn is that in the public's sentiment and expectations.
First of all, consumer sentiment has been improving markedly (Chart 8). According to the
Consumer Confidence Survey, which is a questionnaire survey on consumer perception
conducted by the Cabinet Office, while there is discontinuity due to the change in the survey
method, the DI has improved to a pre-Lehman shock level. By generation, sentiment
improved not only among the elderly, who hold large amounts of stocks and are likely to
benefit from stock price rises, but also for young people. It appears that expectations for
improvement in economic activity and income have started to emerge across a wide range of
generations.
On top of this, business sentiment has also been improving (Chart 9). The DI for business
conditions (all industries, all enterprises) in the June Tankan survey improved by
6 percentage points from the March survey to reach minus 2. It has now reached a level as
high as that registered in the December 2007 survey. Moreover, the number of industries
responding that business sentiment has improved has also increased, and now stands at
26 out of 31 industries.
Lastly, the public's inflation expectations are rising. Looking at various indicators related to
businesses, the DI for output prices in the June survey improved irrespective of firm size and
category (Chart 10). The forecast DI of large firms has now come close to zero. This has
happened only twice in the last 30 years - once toward the end of the bubble period and the
other just before the Lehman shock, when international commodity prices surged. As far as
indicators related to households are concerned, according to the Opinion Survey on the
General Public's Views and Behavior, the share of respondents who expected that prices will
go up one year from now exceeds 80 percent (Chart 11). A number of surveys collecting
views among economists also indicate that the expected rate of inflation is rising. With regard
to market indicators, break-even inflation - that is, the yield spread between fixed-rate
coupon-bearing JGBs and inflation-indexed JGBs, and representative of the expected rate of
inflation in the market - rose rapidly toward mid-May. While it has declined thereafter,
breakeven inflation has clearly heightened compared with the beginning of the year (Chart 12).
Based on these developments in the various indicators, it can well be judged that inflation
expectations on the whole are picking up.
D. Favorable turn in economic activity and prices
The third favorable turn is in economic activity and prices reflecting the improvement in
financial markets and the public's sentiment.
Private consumption remains resilient on the back of sharp improvement in household
sentiment and the wealth effect from the stock market rally (Chart 13). As I mentioned earlier,
in addition to spreading favorable expectations for the economic outlook, given that the
cohort of the senior generation that holds a large amount of stocks tends to enjoy a higher
propensity to consume - that is, they have an inclination to spend more money - than other
generations, it is likely that a stronger wealth effect from the stock market rally is at work.
Business fixed investment has stopped weakening as business sentiment and corporate
profits have improved, and it is showing some signs of picking up (Chart 14). Indeed, in the
June Tankan survey, the projections for fiscal 2013 show that firms intend to increase
investment steadily on the back of improvement in sales and current profits.
On the price front, while the year-on-year rate of change in the CPI (all items excluding fresh
food) had been negative, it reached 0 percent in May and turned positive in June, at
0.4 percent, reflecting improvement in the economy and the yen's depreciation (Chart 15).
In sum, there have been favorable turns in financial conditions, in expectations, and in
economic activity and prices. All these developments suggest that the aim of the QQE - to
lead Japan's economy toward overcoming the deflation that has lasted for nearly 15 years -
is right on track so far.
II. The outlook for economic activity and prices (an interim assessment of the
outlook report)
Next, I will move to the outlook for Japan's economy. As for the baseline scenario, the
economy is expected to recover moderately on the back of the resilience in domestic
demand and the pick-up in overseas economies. While the economy is likely to be affected
from next year onward by the front-loaded increase and subsequent decline in demand prior
to and after the two scheduled consumption tax hikes, it is likely to continue growing at a
pace above its potential - which is considered to be around 0.5 percent - as a trend, as a
virtuous cycle among production, income, and spending operates. In terms of the median of
the Bank's Policy Board members' forecasts of the growth rates, this is 2.8 percent for fiscal
2013, 1.3 percent for fiscal 2014, and 1.5 percent for fiscal 2015, averaging almost 2 percent
(Chart 16). The year-on-year rate of change in the CPI, excluding the direct effects of the
consumption tax hikes, is likely to follow a rising trend, mainly reflecting an improvement in
the aggregate supply and demand balance as well a rise in the expected rate of inflation. In
terms of the median of the Policy Board members' forecasts of prices, the year-on-year rate
of change in the CPI is expected to be 0.6 percent for fiscal 2013, 1.3 percent for fiscal 2014,
and 1.9 percent for fiscal 2015. It is highly likely to reach the price stability target of about
2 percent toward the latter half of the Bank's projection period through fiscal 2015.
Three key factors toward realizing the outlook
For the above outlook to materialize, there are three key factors (Chart 17).
First, the sustainability of firmness in domestic demand. It is important that the
aforementioned current improvement in business and household sentiment lead to sustained
spending in tandem with an increase in income.
In the corporate sector, a virtuous cycle from income to spending appears to be gradually
starting to operate. In terms of "income," corporate profits have been improving, and in terms
Tankan
of "spending," the June survey results revealed solid business fixed investment
plans. Since the Lehman shock, firms have long restrained business fixed investment, and
thus there seems to be large potential demand, mainly for maintenance and repair as well as
replacement of existing equipment. As for the outlook, business fixed investment is likely to
follow a moderate increasing trend, and we will confirm this with the actual data to be
released.
In the household sector, despite the absence of a marked increase in labor income, private
consumption has been resilient, mainly due to an earlier improvement in consumer sentiment
and wealth effects brought about by the rise in stock prices. Hereafter, it is important that the
increase in private consumption and housing investment continue, backed by firmness on the
"income" front, such as an improvement in employment and wages. In this regard, the supply
and demand conditions in the labor market are improving moderately, with the ratio of job
offers to applicants having risen to 0.90 - a level observed for the first time since June 2008
- and the unemployment rate heading toward a decline. In terms of wages, the year-on-year
rate of decline in nominal wages per employee has slowed recently to minus 0.1 percent due
to an improvement in the number of unscheduled hours worked and in bonus payments. It
will be necessary to make sure that such improvements in employment and wages continue
into the future, thereby supporting an increase in private consumption.
Second, among factors that determine prices, I would like to point to developments in
inflation expectations. The inflation rate is determined mainly by two factors. One is the
aggregate supply and demand balance of the economy - the so-called output gap - and the
other is medium- to long-term inflation expectations. In order to achieve the price stability
target of 2 percent, both factors need to operate toward raising prices.
As for the first factor - namely, the output gap - the intuitive view is that prices will rise if
economic activity improves and the supply and demand balance tightens. In other words, as
the level of economic activity increases, the capacity utilization rate would rise and the
number of employees would increase, leading to a decline in the unemployment rate. The
supply and demand balance would then tighten in the labor market and for products and
services, thereby leading to a rise in wages and in prices of products and services. In the
baseline scenario, which I mentioned earlier, the output gap will turn from negative to positive
and gradually widen as the economy continues growing at a pace above its potential. In this
way, upward pressure on prices will operate through developments in the output gap.
What warrants more attention is the second factor that determines prices - that is, medium-
to long-term inflation expectations. When firms and households make decisions on
investment and consumption, they take actions based on their outlook for future inflation. For
example, if a view spreads among the public that prices will rise in the future, firms would
likely raise the prices of products and services accordingly, and wages would also be raised.
Consequently, consumer prices would be pushed up. In this regard, inflation expectations
have already begun to rise, and I expect the expected rate of inflation to gradually converge
toward the global standard of 2 percent, due to the effects of the Bank's strong commitment
to meet the price stability target as well as the effects of its bold monetary easing.
The third factor is developments in overseas economies. We consider a downturn in
overseas economies to be the largest risk factor to the outlook for economic activity and
prices I have outlined so far. The baseline scenario is that overseas economies are expected
to pick up against the backdrop that the U.S. economy would stay firm and the European
economy would start to bottom out. However, there are also risks that warrant attention in the
European economy, emerging and commodity-exporting economies, and the U.S. economy,
respectively. With regard to the European economy, although the tail risk of substantial
financial market turmoil having a global impact has receded due to efforts made thus far by
policymakers, the European debt problem is yet to be fundamentally resolved. The Bank is
paying close attention to whether the prolonged fiscal austerity measures and a receding
economy would lead to political turbulence or instability in financial markets. Next is
developments in the Chinese economy. There is a view that is becoming widely held that the
economy will not return to the level of high growth observed earlier, as policymakers are
enforcing their stance of emphasizing "quality-based" rather than "speed-based" growth. It is
also likely that the over-capacity issue mainly seen in manufacturing, such as materials,
could restrain growth for the time being. As developments in the Chinese economy have
substantial effects not only on Japan's economy but also on commodity-exporting economies
and other emerging economies, whether the Chinese economy will be able to make a soft
landing to achieve economic growth at a cruising speed warrants vigilance. Lastly, we have
the effects of the Federal Reserve's tapering of its asset purchases. The discussion about
such a move is based on the backdrop that the U.S. economy is recovering steadily, albeit
moderately, which in itself has positive implications for the world economy as a whole,
including emerging economies. Nevertheless, it is necessary to continue to pay close
attention to developments in global financial markets, including capital flows to emerging
economies.
III. Q&A about the policy effects of the QQE
I have so far described the Bank's QQE, the state of Japan's economy, and its outlook. Let
me next respond to some of the questions regarding the policy effects of the QQE.
A. Effects of putting downward pressure on long-term interest rates
Effect of containing nominal interest rates
First is the effects on long-term interest rates. Following the introduction of the QQE, as
longterm interest rates rose compared with those immediately before the introduction, some
questioned whether the policy transmission mechanism of putting powerful downward
pressure on long-term interest rates was working effectively.
Before examining this point, let me summarize factors that put upward and downward
pressure on long-term interest rates. Long-term interest rates are formed based on
expectations for future short-term interest rates and on risk premiums (Chart 18). For
example, in the case of 10-year government bond yield, this will be the sum of the short-term
interest rate path for the next ten years and various risk premiums associated with holding
government bonds. Of those, given that expected short-term interest rates will be determined
according to economic and inflation outlooks, if economic activity improves and expectations
for future price increases spread, there will be upward pressure on long-term interest rates.
Risk premiums will increase, reflecting such factors as a rise in interest rate volatility or in
interest rates overseas, thereby putting upward pressure on long-term interest rates. In
response, the Bank's massive purchases of government bonds under the QQE will put a
powerful squeeze on the risk premiums, thereby having the effect of putting downward
pressure on long-term interest rates.
Let us confirm whether this effect has actually materialized, based on two facts. First is the
comparison with last autumn, when long-term interest rates were almost at the same level as
today. Comparing the situation of financial markets and the outlook for economic activity and
prices, stock prices have risen about 60 percent from about 9,000 yen last autumn and the
yen rate against the U.S. dollar has depreciated about 25 percent from 75-79 yen. When
looking at the outlook for economic activity and prices using the ESP Forecast Survey, which
compiles economists' forecasts, the outlook for the real GDP growth rate for fiscal 2013 has
improved substantially from 1.54 percent as of October 2012 to 2.75 percent as of July 2013,
and the outlook for the year-on-year rate of change in consumer prices has also increased
from 0.11 percent to 0.36 percent during the same period. The economic and inflation
outlooks for the longer term have also been revised upward. While such improvement in
financial markets and the outlook for economic activity and prices naturally create upward
pressure on long-term interest rates, actual long-term interest rates have nevertheless been
contained at almost the same level as last autumn.
Second is the comparison with developments in long-term interest rates overseas. As
mentioned earlier, since May this year, interest rates overseas have been rising due in part
to increased speculation that the Federal Reserve might taper the size of its asset
purchases. Looking at changes since mid-May, the U.S. long-term interest rate has risen by
0.5 percentage point from 2.0 percent to 2.5 percent. In contrast, Japan's long-term interest
rate has been roughly flat.
These facts suggest that the Bank's massive purchases of government bonds have
effectively compressed risk premiums and powerfully contained upward pressure on
longterm interest rates. Hereafter, although there is likely to be upward pressure on long-term
interest rates as the outlook for economic activity and prices improves, downward pressure
to contain interest rates is expected to further increase as the Bank's purchases of JGBs
progress.
Effect of lowering real interest rates
So far I have provided an explanation from the viewpoint of downward pressure on nominal
interest rates. In terms of stimulating an effect on economic activity, what is important is "real
interest rates," which affect decision-making on spending, including business fixed
investment and housing investment. The real interest rate is the interest rate that has been
adjusted for the effects of rises and falls in prices, and can be calculated by subtracting the
expected inflation rate from the nominal interest rate. As real interest rates cannot be
observed directly, you may wonder how firms will make decisions based on real interest
rates. Suppose you are making a decision regarding business fixed investment. If you
consider that prices will rise in the future and prices of your products will also rise, business
fixed investment to that extent should pay off even if the nominal borrowing rate is high. This
illustrates the importance of real interest rates.
The QQE aims at lowering real interest rates both in terms of putting downward pressure on
nominal interest rates and raising expected rates of inflation. As I have been explaining,
judged from various indicators, expected rates of inflation have been rising on the whole. As
nominal interest rates have been more or less flat, real interest rates seem to have been
declining. Also in this regard, the QQE has been exerting its intended effects.
B. Increase in bank lending
Next, we have sometimes been presented with the view that, even though the Bank provides
massive money to the financial markets, such money might not be channeled from financial
institutions to firms and households. In relation to this, what I want to focus on is the
development in bank lending. As mentioned earlier, the year-on-year growth rate of bank
lending has been increasing moderately since last autumn, and has recently been slightly
above 2 percent. The backdrop to this is that the behavior of firms, households, and financial
institutions could have become positive, reflecting various policy measures by the Bank,
including the QQE.
In addition to putting powerful downward pressure on long-term interest rates, the QQE - as
a result of the Bank's massive purchases of government bonds - exerts effects on investors
and financial institutions that used to invest their funds in government bonds in order to shift
their investment in lending and other assets - the so-called portfolio rebalancing effect. In
addition, the QQE has the effect of generating proactive demand for funds, including
business fixed investment and housing investment, by converting households' and firms'
"deflationary sentiment" - in other words, a natural way of thinking that prices will not rise.
Furthermore, in order to support financial institutions' efforts to increase lending, the Bank
has established such facilities as the "Fund-Provisioning Measure to Support Strengthening
the Foundations for Economic Growth" and the "Fund-Provisioning Measure to Stimulate
Bank Lending." The amount provided through these facilities has reached about seven trillion
yen, supporting financial institutions' efforts to tap firms' proactive demand for funds.
Due to prolonged deflation, many firms now hold massive cash and deposits. As firms can
make business fixed investment and other investment by first using such cash and deposits,
there is some uncertainty as to what extent firms' demand for investment might lead to an
increase in demand for borrowing from financial institutions. In that sense, while it will not be
desirable to solely focus on the growth rate of lending, be it based on own funds or external
borrowing, it is important to prepare an environment that enables firms' positive actions.
C. Relationship between wages and prices
Lastly, we often have been asked whether, in achieving the 2 percent "price stability target,"
if only prices rise and wages do not, this might have a costly impact on people's lives. In this
regard, the Bank does not consider it sufficient if only prices go up. With Japan's economy
growing in a well-balanced manner amid a virtuous cycle among production, income, and
spending, the Bank aims to create a situation in which a gradual rise in the inflation rate is
accompanied by an increase in employment and wages. For wages to increase against the
backdrop of such positive developments in the economy, it becomes necessary for firms to
anticipate future increases in the growth rate and to become confident with regard to
increasing new hiring. In addition, as mentioned earlier, if people's "deflationary sentiment" is
converted thanks to the Bank's monetary policy, decisions on wages will be changed such
that they are based on the assumption that prices will rise. Looking at the developments in
the growth rate of hourly cash earnings and that of the CPI, one can confirm that, when
prices actually rise, wages increase almost simultaneously (Chart 19). It is therefore
important that the environment I have just described be put in place, whereby wages can be
raised, and to realize an economy in which a rise in inflation rates is accompanied by an
increase in wages, as in the past.
Concluding remarks
I have so far described the policy effects of the QQE, based on the situation in financial
markets as well as in economic activity and prices over the past three months. The QQE
itself is an extremely powerful policy, but it will exert maximum effects when combined with
the various measures by the government. In relation to this, I would like to note two points in
particular.
First is the government's growth strategy. I have explained the transmission channel of
monetary easing in terms of the funding costs, particularly of firms, mainly based on
expected inflation rates and real interest rates. In more accurate terms, the degree of
monetary easing is determined by the spread between return on assets and funding costs. In
other words, if firms' outlook for profitability improves due to the growth strategy, the effects
of monetary easing will further strengthen. Also, as touched upon earlier, a rise in firms'
expectations for growth forms the basis for wages to rise. The government has formulated
concrete measures such as the "Japan Revitalization Plan," and we expect their steady
implementation.
Second is securing confidence in public finance. The Bank's measures, including JGB
purchases, are conducted with the purpose of achieving the price stability target, but if this is
perceived as financing the fiscal deficit, the effects of the QQE could be hampered as
longterm interest rates rise due to an expansion in risk premiums. The joint statement released
by the government and the Bank of Japan in January stated that the government will steadily
promote measures aimed at establishing a sustainable fiscal structure with a view to
ensuring the credibility of fiscal management. It is essential that this be put into action in
order for Japan's economy to overcome deflation and achieve sustainable growth.
I would like to finish my speech today by stating that the Bank of Japan is committed to
achieving the price stability target of 2 percent at the earliest possible time, by steadily
continuing with the QQE, and to overcoming deflation, which is the greatest challenge facing
Japan's economy.
Thank you.