Toshihiko Fukui: On stabilisation policies - a central banker's reflection
Remarks by Mr Toshihiko Fukui, Governor of the Bank of Japan, at The Bank of Korea International
Conference 2005, Seoul, 27 May 2005.
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1. Introduction
Good morning, ladies and gentlemen. It is my privilege to speak at the beginning of the Bank of
Korea's international conference.
At the outset, please allow me to strike a personal note. I meet with BOK Governor Park rather
frequently, maybe four or five times a year. At the end of each of our conversations, I am impatient for
our next meeting. Therefore, it is a tremendous pleasure to see him again this morning, although it is
only a month since we had lunch together on a southern Japanese island.
Like our personal relationship, official ties between our two central banks are also close. To avoid
using up the time accorded to me, I just point out the fact that, for the first time in many years, the
Bank of Japan posted one official at the Japanese embassy in Seoul to cultivate better communication
with the Bank of Korea and other contacts here.
Today's symposium covers a broad range of aspects of macro-economic stabilization policies - that is,
monetary and fiscal policies. While the phrase "stabilization policies" has been popular for nearly half a
century, we can interpret this in a variety of ways. Believing that the profundity of this topic will be
revealed in the sessions today, I would rather like to present my personal reflections on Japan's
economic policy management over the past two decades when we struggled to stabilize our economy.
2. Japan's success and failure
Let me begin with a brief sketch of what Japan's economy went through after World War II.
We began the post-war reconstruction by creating a uniquely Japanese system. It was built on a tight
nexus of the social, political and economic apparatus, with top priority given to attaining high economic
growth. Among the striking features of this system were political stability, strong bureaucracy, and
lifetime employment. The so-called "iron triangle" between politicians, bureaucrats, and business
people was very powerful in promoting growth-oriented business models and building an export-led
industrial structure. As it turned out, this was a marvelous success.
Unfortunately, success creates inertia - an intrinsic resistance to change, even when the old system
begins to falter. From the early 1980s, globalization and technological innovation began transforming
the world economy, posing new challenges for Japan's economy. External imbalances and trade
friction led to the currency re-alignment of the Plaza Accord in 1985. This put deflationary pressures
on Japan's economy, while making traditional segments of our economy obsolete.
In order to fend off the deflationary forces, Japan made full use of macro-economic policies. The
government stepped up fiscal spending to boost domestic demand. The Bank of Japan (BOJ) eased
monetary policy for an extended period of time, consequently fuelling the rapid boom in the economy.
Together with various structural factors, these expansionary policies spawned distortions in Japan's
economy. To name just a few examples, we saw a nation-wide surge in resort area development at
the expense of our green environment. We embarked on the re-development of metropolitan Tokyo to
make it an international financial hub, but with little coherent strategy in hindsight. Fiscal profligacy by
the government, which I referred to just a few seconds ago, resulted in the building of local roads and
ports barely used by travelers - a classical faux pas of pork-barrel politics.
Such economic frenzy generated irrational growth expectations, further prompting excessive
investment in both real and financial assets. As you know, the upshot of this euphoria was the asset
bubbles and their subsequent bursting.
All these episodes point to one thing: despite the substantial changes in its external circumstances,
Japan was not able to depart from the development model it cherished during the economic catch-up
period. We had many discussions about how to reform our system in the face of the headwind against
Japan's economy after the Plaza Accord, but we did not follow our words with action. Put differently, it
was a reform by word, not in deed.
After the collapse of the economic bubbles in the early 1990s, we finally learned that every boom must
evaporate some time. An aging population and declining birth rate also forced us to acknowledge the
need to revamp our modus operandi so that we could remain viable in global competition. This
perception shift marked the beginning of the long adjustment phase from the mid-1990s - a harrowing
decade when Japan's private and public sectors tried to reinvent themselves.
The corporate sector tried hard to get rid of the negative legacies of the bubble era - that is, excesses
in production capacity, labor, and debt. Although hard hit by falling employment and wages, the
household sector endured relatively well during this painful adjustment.
As the old financial system suffered setbacks amid the bubble burst, Japanese financial institutions
faced a mountain of non-performing assets. In the process of cleaning them up, banks not only
exhausted the wealth they had accumulated during the high-growth years, but also had to rely upon
government bailouts.
In the 1990s, the Japanese government provided large fiscal stimuli to prevent economic stagnation
from worsening. But it also pursued deregulation, as a supply-side measure, to foster business
formation and innovation.
What did the Bank of Japan do in this adjustment process? We began to ease monetary policy in July
1991, when the consumer price index still registered an increase of around 3%. In September 1995,
the official discount rate dropped to 0.5%, the lowest ever recorded in the history of central banks in
the world. In February 1999, the BOJ adopted the zero interest rate policy, followed eventually by the
quantitative easing policy - again unprecedented in central bank history - that has been in place since
March 2001.
Monetary easing in this unprecedented fashion cushioned depressive ramifications from the structural
adjustment in the corporate and personal sectors. Also, the ample provision of funds by the BOJ was
effective in reducing liquidity squeeze in financial markets at a time when systemic instability and
credit crunch were the real threats to the Japanese financial system.
After 13 years of policy struggles, progress has begun to materialize in unwinding past excesses.
Major Japanese banks are now in much better shape. Corporations are posting brighter earnings
outcomes than ever, and household incomes have begun to improve.
Against this backdrop, we removed the blanket deposit insurance on April 1st, 2005. Considering that
the blanket guarantee was maintained as a financial emergency measure, Japan's economy has
passed a critical milestone. The next milestone will be passed when Japan brings its economy back on
a sustainable growth path.
From the medium-term perspective, Japan needs to carry out the structural overhaul of its public
sector, too. For instance, the legacy of an activist fiscal policy throughout the 1990s is still with us, as
shown by the huge public debt nearing 160% of our GDP. This leads us to conclude that fiscal
consolidation should be examined in a well thought-out manner. Re-designing our social security
system in the context of demographic adversity is another policy imperative. No doubt, these are large
challenges.
3. Policy lessons from Japan's experience
At this juncture when Japan's structural adjustment has come quite a distance, it might be informative
to take stock of some monetary policy implications from our decade-long struggle.
First, in connection with the leitmotif of today's conference, we should not restrict central banks'
stabilization policy to a narrow domain of macroeconomic management. There could be circumstances
where a central bank needs to play a critical role in safeguarding the stability of the financial system.
In addition, the effectiveness of monetary policy hinges crucially on the proper functioning of financial
markets and the financial system. This is because monetary policy is implemented through central
banks' lending, deposit-taking, money-market operations, and other activities in financial markets. If
financial stability is at risk, central banks' policy would be severely constrained.
Throughout the 1990s, the BOJ conducted its policy while paying close attention to the condition of the
financial markets and the financial system. This was especially true in the late 1990s when the
systemic dysfunction of our banking system was apparent.
Second, central banks need to tackle two elusive but inter-related questions: how do asset price
fluctuations affect economic stability; and how should a central bank respond to big swings in asset
prices?
A de-coupling of asset prices and general prices is not necessarily rare. Besides Japan's anomalous
experience in the bubble period, recent examples of this sort have been seen in the United States,
Britain, and Australia. In many advanced economies, asset prices tend to rise in sync with a cyclical
economic upturn, while general price indices are becoming less responsive due to productivity growth
and firms' cost retrenchment amid global competition.
However, Japan's painful experience tells us that central banks should keep a close watch on asset
prices, for they could have a material impact on the economy and inflation in the medium to long run.
Central banks should also be alert to the excessive growth in money and credit which often
accompanies asset bubbles. I presume such vigilance should somehow be blended into our
conventional wisdom that central banks contribute to economic stabilization by ensuring price stability.
4. Concluding remarks
Now, let me conclude.
As I said earlier, the most pressing task for the Bank of Japan at this moment is to achieve sustainable
growth on the basis of price stability. Towards that goal, the BOJ is firmly committed to maintaining the
current easing policy.
I am impressed at how Korea has pushed forward structural reform in a wide range of areas following
the economic crisis in 1997. I am sure the Bank of Korea has made a significant contribution to this
economic revival, and will continue to build more on its success. I would like to express my respect for
the decisive leadership of Governor Park.
This conference brings together many eminent scholars and central bankers. I am sure that, based on
analysis of the bitter experiences of both Japan and Korea, the confluence of their expertise and
insights will provide a thought-provoking discussion of this complex issue of stabilization policies.
Thank you for your attention.