Economic and Financial Developments
and Monetary Policy in Japan
Speech at a Seminar Hosted by the Embassy of Japan
in Switzerland (Zurich)
Takako Masai
Member of the Policy Board
Introduction
It is a great honor to have the opportunity today to be invited to this seminar hosted by the
Embassy of Japan in Switzerland, and to exchange views with such a distinguished
gathering of people representing the economic and financial communities in Switzerland.
Today, I will first touch on economic and financial developments in Japan. After that, I
would like to explain the Bank of Japan's monetary policy and then share my views on the
challenges and future for the economy.
I. Economic and Financial Developments in Japan
I will start by presenting my overview of the current economic and financial situation in
Japan, in order to provide a broad picture. Then, I will give a summary of the latest Outlook
for Economic Activity and Prices, or the Outlook Report, published in January 2017. The
Outlook Report presents the Bank's assessment of the current situation and the outlook for
economic activity and prices, and is published quarterly.
A. My Overview of Economic and Financial Developments
1. Household sector
Favorable employment situation and household sentiment
The current situation for Japan's economy is characterized by tight labor market conditions.
The average unemployment rate for 2016 declined to 3.1 percent, a level close to so-called
full employment. The active job openings-to-applicants ratio for 2016 rose to about 1.4
times on average, which is the highest level in 25 years. It has risen, for example, not only
in metropolitan areas but also in all other regions (Chart 1).
I believe that such a favorable employment situation undoubtedly has supported household
sentiment. Individuals can feel great confidence when they do not need to be concerned
about whether their wages will be cut, even if corporate performance underperforms to
some extent, or whether they can find another job. This sense of reassurance is crucial in
Japan, where the mobility in the labor market is said to be relatively lower than in other
countries. Such improvement in household sentiment can be seen, for instance, in the
remarkable improvement in the Nippon Research Institute (NRI) Consumer Sentiment
Index, which measures the outlook among consumers for financial conditions over the next
one year from now. Looking back at 2016, Japan's economy continually faced several
destabilizing factors, such as the turbulence in global financial markets from early in the
year and situations at home -- namely, the Kumamoto Earthquake and irregular weather in
summer. Despite these circumstances, household sentiment showed resilience. I consider
that one of the factors of this is likely to have been the tightening of labor market conditions
(Chart 2).
Private consumption has shown some signs of improvement, driven by a moderate increase
in employee income.
On the back of tightening labor market conditions, a modest increase in employee income
has been seen (Chart 3). In Japan, the action of increasing annual wage levels by revising
the pay table is referred to as "base up." This is a general wage increase made across all
employees, apart from wage increases due to promotion, based on age, and/or the number of
working years. This is a practice that was introduced during the rapid economic growth
period. However, from the late 1990s, firms stepped up their efforts to contain labor costs.
As a result, most firms stopped using base up from the 2000s. Meanwhile, in the wage
negotiations in 2014 and thereafter, this practice has been widely resumed among firms for
the first time in more than a decade. This year is the fourth one since such trends have been
visible, but some are concerned that the results of the negotiations this year would be
disappointing given that the year-on-year rate of change in the consumer price index (CPI,
all items less fresh food) has been slow to increase recently, due mainly to the fall in energy
prices. Even so, now that employees' concerns are not over a wage cut, but rather how much
wages will increase, we are at least heading in the right direction considering the fact that
hardly anybody had talked about base up as an issue for nearly 20 years until a few years
ago.
Private consumption has shown some signs of improvement recently, given household
sentiment being supported and improved employee income. My impression is that a
virtuous cycle from income to spending has been maintained in the household sector.
However, there are the following points to consider: (1) wage increases are weak despite
tightening labor market conditions, and (2) consumption is rather lackluster despite the
steady improvement in employee income. That is to say, consumption has shown some
signs of improvement but has lacked momentum. Therefore, the virtuous cycle from income
to spending should become a little more promising.
2. Corporate sector
Corporate profits have been at record high levels, but firms have been taking a cautious
view on the outlook.
Corporate profits in Japan reached record highs from fiscal 2013 through fiscal 2015, and
have remained at high levels thereafter. Under these circumstances, business fixed
investment has been on a moderate uptrend, and the virtuous cycle from income to spending
seems to be maintained in the corporate sector as well. That being said, despite the
expansion in profits, it is true that the growth in business fixed investment is slower. As
background to this, it has been pointed out that the expansion in corporate profits in the
current recovery largely owes to the improvement in the terms of trade rather than the
increase in sales volume, which tends to lead to a rise in growth expectations. As a result,
the business fixed investment expansion was not strong enough.1 However, it also has been
pointed out that, even if the increase in corporate profits was based on the improvement in
the terms of trade, there would likely be a positive impact on business fixed investment if
such an improving trend is confirmed. In addition, highly accommodative financial
conditions have been encouraging firms to invest. As with the household sector, it is
important to raise growth expectations to further reinforce the virtuous cycle in the
corporate sector. I will go into the details on this point later.
The stabilization of energy prices has a positive impact on Japan's economy. The high
volatility of exchange rates, if it continues, can deteriorate business sentiment.
Let me make two additional points with regard to the corporate sector.
First, it is important to note that the outlook for energy prices, including crude oil prices,
improved since late 2016 -- namely, that they would remain stable. This should have a
positive impact on the global economy as well as Japan's economy. Given this, my view is
that the downside risks to the economy have been reduced compared to the second half of
2016.
Second, large swings in foreign exchange rates can be a cause for concern. Looking at the
dollar/yen exchange rate fluctuations in 2016, volatility was a bit high and exchange rate
levels fluctuated markedly up and down, with the yen appreciating roughly in the first half
of the year and depreciating in the second half. Looking back, 2016 was a year in which
there tended to be infrequent trading at around the yearly average exchange rate. I assume
that these marked exchange rate fluctuations within a relatively short period have made it
difficult for firms to steer management. I believe that this is readily imaginable among
people representing the economic and financial communities in Switzerland, which tend to
be affected significantly by fluctuations in foreign exchange rates, as with Japan. There is
concern that these kinds of large swings in the exchange rates, if they continue, might have
a negative impact on business sentiment.
So far, I have given a broad picture of Japan's economy. In short, both employee income
and corporate profits have been increasing and the virtuous cycle from income to spending
has been maintained both in the household and corporate sectors; however, more should be
done to further strengthen it. Next, I will look more closely at the current situation and the
outlook for Japan's economy by presenting the main contents of the latest Outlook Report.
B. Current Situation and Outlook
1. Current situation
The Bank's assessment is that Japan's economy has continued its moderate recovery trend.
On the domestic demand side, business fixed investment has been on a moderate uptrend as
corporate profits have been at high levels and business sentiment has improved somewhat.
Against the background of steady improvement in the employment and income situation,
private consumption has been resilient, and housing investment has continued its pick-up. A
rise in exports seems to have been even more persistent recently. Amid an improvement in
business sentiment of manufacturing firms on a global basis, there is a steady rise in the
number of items for which export volume increased, particularly backed by expansion in
IT-related demand and by inventory and capital stock adjustments in emerging economies.
Industrial production has shown signs of improvement, reflecting these developments in
demand both at home and abroad, as well as inventory adjustments.
On the price front, the year-on-year rate of change in the CPI (all items less fresh food)
has been at around 0 percent on the whole, as the negative contribution of energy prices
that reflect past developments in crude oil prices and the positive contribution of prices
other than energy largely offset each other.
2. Outlook
I will now look at the outlook for Japan's economy during the projection period, which
covers from fiscal 2016 through fiscal 2018. The Bank's assessment is that Japan's economy
is expected to turn to a moderate expansion. Domestic demand is likely to follow an uptrend
on the back of highly accommodative financial conditions and fiscal spending through the
government's large-scale stimulus measures. Meanwhile, exports are expected to follow a
moderate upward trend on the back of improvement in overseas economies. Reflecting this
outlook, Japan's economy is likely to continue growing at a pace above its potential through
the projection period. Looking at the medians of the Policy Board members' forecasts in the
January 2017 Outlook Report, the real GDP growth rate is projected to be 1.4 percent for
fiscal 2016, 1.5 percent for fiscal 2017, and 1.1 percent for fiscal 2018 (Chart 4).
Let me explain the outlook in detail by major component. As for business fixed investment,
with some time lag, the past slowdown in emerging economies and yen appreciation are
likely to exert downward pressure for the time being, mainly in manufacturing firms.
However, throughout the projection period, it is likely to continue to see a moderate uptrend.
This is because, in a situation where extremely stimulative financial conditions -- such as
low interest rates and accommodative lending attitudes -- have been maintained, fixed
investment will be positively affected by the effects of fiscal measures including projects
conducted under the Fiscal Investment and Loan Program and tax reductions for capital
investment, as well as by moderate improvement in growth expectations. Moreover,
corporate profits are projected to improve, but even if they become weaker than expected to
some degree, business fixed investment is likely to be supported in particular by investment
(1) in redevelopment projects in view of the 2020 Tokyo Olympics, (2) in research and
development for growth areas, (3) in labor-saving machinery and equipment in order to deal
with labor shortages, and (4) for maintenance and replacement of equipment to address
deterioration from aging. Private consumption is expected to increase moderately, supported
by a steady improvement in employee income, as well as the wealth effects stemming from
a rise in stock prices and the effects resulting from the set of stimulus measures. Housing
investment is likely to continue improving. Exports will likely continue their pick-up trend
for the time being, as the effects of the slowdown in emerging economies wane, and
thereafter are projected to increase moderately. This is because it is forecasted that the
growth rate of the world trade volume will accelerate gradually with the further recovery in
overseas economies, and that Japan's share of exports will increase moderately, due in part
to a worldwide recovery in the sector of capital goods. Industrial production is projected to
increase modestly, reflecting a rise in demand at home and abroad, with the effects of the
slowdown in emerging economies waning and those of the set of stimulus measures
becoming evident.
(all items less fresh food) is likely
As for prices, the year-on-year rate of change in the CPI
to increase from about 0 percent and become slightly positive, due mainly to the negative
contribution of energy prices dissipating. Thereafter, it is expected to increase toward 2
percent as the aggregate supply and demand balance improves and inflation expectations
rise. Looking at the medians of the Policy Board members' forecasts in the January 2017
Outlook Report, the year-on-year rate of change in the CPI (all items less fresh food) is
projected to be minus 0.2 percent for fiscal 2016, 1.5 percent for fiscal 2017, and 1.7
percent for fiscal 2018 (Chart 4).
II. The Bank's Monetary Policy
Next, I will talk about the Bank's monetary policy. I would like to start with a brief review
of the Bank's monetary policies, which have been conducted in various unconventional
ways for nearly 20 years.
A. The Bank's Monetary Policy under Deflation
Japan's economy had been suffering from deflation for more than 15 years, since the late
1990s, with the year-on-year rate of change in the CPI being about zero or slightly negative.
Of course, the Bank did not merely stand by during that period. In 1998, Japan's policy
interest rate -- which at that time was the uncollateralized overnight call rate -- already had
been lowered to close to zero, at 0.25 percent. Given that economic activity and prices did
not improve even in this situation, in February 1999, the Bank introduced a zero interest
rate policy, and in April of that year, introduced what is now called forward guidance,
stating that it would continue with the zero interest rate policy until deflationary concern is
dispelled. Thereafter, in March 2001, it introduced a quantitative easing policy, in which the
operating target was the outstanding balance of current accounts at the Bank. I would note
that, at the same time, the Bank introduced forward guidance that was linked to the
observed CPI. Later, it also implemented a comprehensive monetary easing policy in
October 2010, in which it purchased assets such as CP, corporate bonds, exchange-traded
funds (ETFs), and Japan real estate investment trusts (J-REITs). The Bank continues to
make these asset purchases to the present, and with respect to ETFs and J-REITs, it has
significantly increased the amount of purchases since 2013. Meanwhile, it also introduced
the Fund-Provisioning Measure to Support Strengthening the Foundations for Economic
Growth as well as the Fund-Provisioning Measure to Stimulate Bank Lending, and these
also continue to this day. As illustrated, the Bank has pursued monetary easing by making
full use of various means. As a result, accommodative financial conditions have been
realized in Japan, as seen in, for example, the fact that long-term interest rates since the
2000s had generally been at a low level of around 1-2 percent and that the rates during the
one year before Quantitative and Qualitative Monetary Easing (QQE) began in 2013 were
around 0.8 percent on average. Such accommodative financial conditions have underpinned
the economy, and the Bank's large-scale fund-provisioning measures have contributed -- in
certain phases -- to maintaining financial system stability and preventing the economy from
falling into a deflationary spiral. Nevertheless, it is true that at the same time there
continued to be mild deflation. Therefore, the Bank made a strong and clear commitment to
ensuring the economy's exit from deflation -- which had lasted for nearly 15 years -- and
began large-scale monetary easing to fulfill the commitment. This is QQE, which continues
through to the present.
B. Introduction of the Price Stability Target of 2 Percent and QQE
The Bank introduced the price stability target in January 2013 and set it at 2 percent in
terms of the year-on-year rate of change in the CPI. Until then, it had judged the "price
stability goal in the medium to long term" to be in a positive range of 2 percent or lower in
terms of the year-on-year rate of change in the CPI, and had set a goal of 1 percent for the
time being. At the same time, the government and the Bank released a joint statement, in
which they emphasized their policy coordination. I view this as extremely important,
because it indicated the determination by the government and the Bank to work together in
order to overcome deflation and achieve sustainable economic growth. The Bank then
introduced QQE in April 2013. After increasing the amount of its asset purchases further in
2014, it adopted a negative interest rate policy in January 2016 and introduced QQE with
Yield Curve Control in September of that year.
1. Basic mechanism of monetary easing
Since the introduction of QQE in April 2013, the basic mechanism of monetary easing itself
has not changed; that is, (1) pushing down the entire yield curve through the Bank's
large-scale purchases of Japanese government bonds (JGBs), and (2) raising inflation
expectations through the Bank's strong commitment to the 2 percent price stability target.
The transmission mechanism envisaged by the Bank is that these factors will lead to a
reduction in real interest rates, thereby producing positive effects on Japan's economic
activity and prices (Chart 5).
2. Positive effects of QQE
In 2016, the Bank conducted a comprehensive assessment of the developments in Japan's
economic activity and prices as well as policy effects since the introduction of QQE. The
findings of the assessment are that the mechanism just described has been operating firmly,
such that even long-term real interest rates have been in negative territory, and that
economic activity and prices have largely improved. The underlying trend in the CPI (all
items less fresh food and energy) turned positive and has been in such territory for more
than two and a half years; this also leads to the judgment that, through the achievement of
highly accommodative financial conditions, Japan's economy has reached a state of being
no longer in deflation, which is commonly defined as a sustained decline in prices (Chart 6).
It is reasonable to regard this as achievements accomplished under QQE.
3. Aims of QQE with Yield Curve Control
Despite the fact that QQE has proven to be effective in this manner, why did the Bank
introduce last year QQE with Yield Curve Control as a means of strengthening the
framework for monetary easing?
My understanding is that there are two points as the background to this. First, although
QQE has produced its intended effects, the price stability target of 2 percent has not been
achieved, and therefore a more effective framework was necessary.
Second, while it was confirmed that the combination of large-scale purchases of JGBs and
the negative interest rate policy was effective in influencing the entire yield curve, there was
concern over a possibility that this combination could in some cases push down the yield
curve more than necessary, thereby having a negative impact on financial functioning.
Let me briefly elaborate on this second point. In Japan, because the level of interest rates --
including long-term ones -- has remained low, as I mentioned earlier, and lending
competition has been severe amid a decreasing trend in loan-to-deposit ratios, financial
institutions' loan-deposit interest margins have been on a declining trend since the 1990s. In
that sense, this has been a challenge faced by financial institutions' management even before
the introduction of the negative interest rate policy. Since the introduction, it is true that the
decline in deposit rates has been smaller than the decline in lending rates. Therefore, the
excessive declines in long-term and super-long-term rates should have spurred on the
declining trend in interest margins. It was confirmed that, if the situation were to continue,
financial institutions' profits could be affected to some extent. The excessive declines in
long-term and super-long-term rates lower the rate of return on insurance and pension
products; therefore, it is possible that such developments can cause uncertainty regarding
the sustainability of financial functioning in a broad sense, thereby having a negative impact
on economic activity through a deterioration in people's sentiment. Given such issues to be
considered, the Bank decided that it was appropriate to shift to a policy framework that
would enable it to conduct monetary policy in a flexible manner.
4. Yield curve control
Under "yield curve control," which is the major component of the new framework, the Bank
is able to conduct monetary policy in an effective and flexible manner by taking account of
the economic, price, and financial conditions, as it directly targets long-term interest rates.
To put it simply, nothing has changed in terms of the Bank's commitment, in that it is
continuing with large-scale JGB purchases; however, while the Bank used to set the paces
of increase in the monetary base and the amount outstanding of its JGB holdings as its
operating targets, in the new framework it has set the short-term policy interest rate and the
target level of the 10-year JGB yields as its operating targets. Under the past framework, it
was clear how JGB purchases are conducted, but there was a possibility that the purchases
could push down yields either insufficiently or excessively, in comparison with an
appropriate yield curve. I would note that the new framework enables the Bank to conduct
monetary policy while also paying due attention to the impact on the financial functioning.
5. Inflation-overshooting commitment
Another component of QQE with Yield Curve Control is an "inflation-overshooting
commitment." With this commitment, the Bank aims to raise inflation expectations by
demonstrating its strong determination.
Inflation expectations are formed through the following two mechanisms: (1) an adaptive
formation mechanism, in which the formation is influenced by the course of the past
inflation rate, and (2) a forward-looking formation mechanism, in which the formation is
based on the idea that the observed inflation rate will, in due course, meet the price stability
target set by the central bank. On this point, the mechanism of formation of inflation
expectations in Japan tends to be adaptive, and considerably more so than in other countries
(Chart 7). The Bank has attempted to make expectation formation more forward-looking
through QQE. In reality, however, before the forward-looking expectation formation fully
took hold, the observed inflation rate declined, due mainly to the fall in crude oil prices. As
a result, people's inflation expectations also declined in an adaptive manner. Therefore, I
consider that, in order to achieve the price stability target of 2 percent, it is absolutely
necessary to raise inflation expectations and promote a shift in expectation formation
toward a more forward-looking direction. The inflation-overshooting commitment is a
means to this end.
Although the momentum toward achieving the 2 percent price stability target has been
maintained, it continues to lack firmness. The Bank will make policy adjustments as
appropriate, taking account of developments in economic activity and prices as well as
financial conditions, with a view to maintaining the momentum toward achieving the price
stability target.
III. Reinforcement of the Virtuous Cycle
As I mentioned earlier, the challenge facing Japan's economy is to further reinforce the
virtuous cycle from income to spending in both the household and corporate sectors.
Let me reiterate that consumption has not increased as much in the household sector,
considering the tight labor market conditions and the increase in employee income. Several
factors have been pointed out as the cause of such sluggishness in private consumption; for
example, (1) temporary factors such as the effects of a decline in stock prices and the effects
of irregular weather, and (2) pressure from stock adjustments of durable goods. In addition,
my impression is that a vague uneasiness among people about the future cannot be ignored.
This uneasiness has a great impact on private consumption in Japan, where the population is
aging rapidly and consumption by elderly households whose heads are aged 60 years and
older is estimated to account for about half of total consumption.
Turning to a related but different subject now, I would like to introduce a survey result,
which reveals that concerns among the elderly about their living during retirement are
noticeable in Japan compared to some other countries. According to a survey on the daily
lives and attitudes of the elderly conducted by the Cabinet Office in 2015, nearly 60 percent
of the elderly in Japan consider that they do not have enough savings and assets to provide
for retirement. This percentage is the highest among countries surveyed (Chart 8).
Meanwhile, the percentage of the elderly in Japan who responded that they had made no
special effort to prepare for retirement until they reached 60 years old was more than 40
percent, which is also remarkably high compared to other countries (Chart 9). I think what
is necessary to relieve such anxiety is to enhance the sustainability of a wide range of social
security systems, including pension and medical systems, as well as change the attitudes of
the people and step up their financial literacy.
Meanwhile, I believe that an increase in growth expectations is what it takes to drive the
virtuous cycle from income to spending in the corporate sector. In this context, the
government decided the Japan Revitalization Strategy 2016 in June 2016 and launched the
10 strategic public-private joint projects, in which the public and private sectors share
knowledge and strategy, and cultivate new promising markets (Chart 10). Looking at the list
of projects may leave an impression that it is an all-around list of challenges facing Japan's
economy. I believe that what the economy needs now is to implement various initiatives
simultaneously to overcome many such challenges. These challenges are closely
interrelated, and working on one often plays an essential part in dealing with another. For
instance, efforts toward realizing the fourth industrial revolution, which is the first of the
key policy measures, are likely be centered on bringing about innovations by using
technological breakthroughs from the Internet of Things (IoT), big data, and artificial
intelligence. Needless to say, this is also an essential element for improving productivity in
the service industry and bringing about an industrial revolution among small and
medium-sized firms, as well as micro firms. Furthermore, the working-style reform,
promoted under the Japan Revitalization Strategy, will help facilitate smooth movements of
human resources into growth areas. In addition, this reform is also important from the
viewpoint of stimulating domestic demand for tourism by facilitating the taking of long
enough holidays. What I mean is that, while these initiatives may look like "a little bit of
everything," firmly promoting them in order to achieve economic revitalization in an
omnidirectional manner, and thereby revitalizing Japan's economy, is necessary. I think that
this will lead to an increase in growth expectations, and ultimately to a rise in inflation
expectations.
For Japan's economy, the third largest in the world, ending deflation and returning to a
sustainable growth path will also have significant meaning for the global economy. The
Bank will maintain highly accommodative financial conditions, with a view to achieving
the price stability target of 2 percent, and ensure the overcoming of deflation. I believe that
highly accommodative financial conditions, combined with the initiatives of the public and
private sectors just mentioned, will give a boost to firms' investment and efforts for
improving productivity. Let me conclude by emphasizing that ensuring the exit from
deflation in Japan will lead to a more dynamic and stronger economy.
Thank you for your attention.
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80 70 60 50 40 30 20 10
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