Economic Activity, Prices,
and Monetary Policy in Japan
Speech at a Meeting with Business Leaders in Shizuoka
Yukitoshi Funo
Member of the Policy Board
I. Recent Economic and Price Developments
A. Overseas Developments
I would like to begin my speech by talking about developments in overseas economies. An
improvement in business sentiment of manufacturing firms has become evident on a global
basis, mainly on the back of an increase in IT-related demand and of the progress observed
in emerging economies in inventory adjustments of materials. In this situation, overseas
economies have continued to grow at a moderate pace.
As for the outlook, the growth rates of overseas economies are expected to increase
moderately, as it is likely that advanced economies will continue growing steadily and a
recovery in emerging economies will take hold gradually. According to the World Economic
Outlook (WEO) Update, released in January 2017 by the International Monetary Fund
(IMF), global growth projections have factored in the effects of expansionary fiscal policy
expected to be taken in the United States and other elements compared to those made in the
October 2016 WEO, and the global growth rate is projected to increase from 3.1 percent in
2016 to 3.4 percent in 2017, and to 3.6 percent in 2018.
Looking at developments by major region, the U.S. economy has continued to recover
firmly, mainly in household spending, owing to a steady improvement in the employment
and income situation. As for the outlook, the economy is expected to continue to see firm
growth driven by domestic private demand.
The European economy has continued to recover moderately, mainly in the household
sector. As for the outlook, the economy is projected to follow a moderate recovery trend,
while uncertainty -- associated with political issues and the European debt problem,
including the financial sector -- is likely to be a burden on economic activity.
The Chinese economy has continued to see stable growth on the whole, supported by policy
effects resulting from such factors as a rise in public investment. As for the outlook, the
economy is likely to broadly follow a stable growth path as authorities proactively carry out
measures to support economic activity.
Emerging economies other than China and commodity-exporting economies have continued
to pick up on the whole, reflecting in particular a bottoming out of commodity prices and
the effects of economic stimulus measures of those economies, although some economies
have remained subdued. As for the outlook, the growth rates of emerging economies other
than China and commodity-exporting economies are likely to increase gradually, due
mainly to the effects of the economic stimulus measures and the spread of the effects of
steady growth in advanced economies.
Risk factors to the overseas economic outlook are wide ranging, as exemplified by (1)
developments in the U.S. economy and the impact of its monetary policy on global financial
markets, (2) developments in emerging and commodity-exporting economies, particularly
China, (3) the consequences stemming from the United Kingdom's vote to leave the
European Union (EU) and their effects, (4) prospects regarding the European debt problem,
including the financial sector, and (5) geopolitical risks. Therefore, I consider it necessary to
closely monitor various risk factors from a broad perspective in making projections
regarding overseas developments.
B. Japan's Economy and Prices
1. Economic activity
I will now discuss the economic situation in Japan given the overseas developments I have
just outlined. Japan's economy has continued its moderate recovery trend. On an annualized
quarter-on-quarter basis, the real GDP growth rate for the October-December quarter of
2016 registered 1.2 percent, representing an increase for four consecutive quarters. The rate
continued to rise, due mainly to an increase in external demand, although domestic demand
was somewhat sluggish.
With regard to the outlook, Japan's economy is likely to turn to a moderate expansion.
Domestic demand is likely to follow an uptrend, with a virtuous cycle from income to
spending being maintained in both the corporate and household sectors, 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
increasing trend as the growth rates of overseas economies increase moderately. According
to the Bank's January 2017 Outlook for Economic Activity and Prices (hereafter the Outlook
Report), the medians of the Policy Board members' forecasts for the economic growth rate
are 1.4 percent for fiscal 2016, 1.5 percent for fiscal 2017, and 1.1 percent for fiscal 2018,
and the economy is expected to continue growing at a pace above its potential through the
projection period of fiscal 2016-2018.1
2. Prices
Next, I will talk about price developments. The year-on-year rate of change in the consumer
price index (CPI) for all items less fresh food has increased, reflecting a rise in energy
prices, and has been about 0 percent. The rate of increase for all items less fresh food and
energy had remained on a decelerating trend, following the peak of 1.3 percent in
November 2015; thereafter, the rate of change has been fluctuating. Looking at annual price
changes across all CPI items less fresh food, the share of price-increasing items minus the
share of price-decreasing items has continued on a moderate declining trend, although it
remains in positive territory.
With regard to the outlook, as the positive contribution of energy prices increases, albeit
with fluctuations, and as the aggregate supply and demand balance (the output gap)
improves and inflation expectations rise, the year-on-year rate of change in the CPI (all
items less fresh food) will likely reach around 2 percent in around fiscal 2018; nevertheless,
it is necessary to closely monitor downside risks. Specifically, the medians of the Policy
Board members' forecasts of the year-on-year rate of change in the CPI (all items less fresh
food) presented in the January 2017 Outlook Report are minus 0.2 percent for fiscal 2016,
1.5 percent for fiscal 2017, and 1.7 percent for fiscal 2018.2
1
Under a specific methodology, Japan's potential growth rate is estimated to be around 0.5 percent,
revised upward from being in the range of 0.0-0.5 percent due to the comprehensive revision to GDP
statistics. However, the estimate of the potential growth rate varies depending on the methodologies
employed and could be revised as the sample period becomes longer over time. Thus, it should be
regarded as being subject to a considerable margin of error.
2
From the January 2015 interim assessment through the October 2016 Outlook Report, each Policy
Board member made their forecasts based on the same assumption about crude oil prices due to the
fact that such prices had been exerting a considerable impact on consumer prices. In the January
2017 Outlook Report, each member made an assumption about crude oil prices individually in
making their forecasts in light of the fact that the contribution of energy prices to the year-on-year
rate of change in the CPI (all items less fresh food) had lessened. The contribution was estimated to
be approximately minus 0.6 percentage point for fiscal 2016 and reach around 0 percentage point in
early 2017, becoming slightly positive thereafter.
II. Keys to Assessing the Outlook for Economic Activity and Prices
In what follows, I will discuss several points that I think deserve particular attention in
terms of realizing the outlook that I mentioned earlier.
A. Employment and Income Situation
First, I will talk about developments in the employment and income situation.
Supply-demand conditions in the labor market have continued to improve steadily and
employee income has increased moderately. According to the Labour Force Survey, the rate
of increase in the number of employees has remained at a high level of about 1.5 percent.
Against this backdrop, the active job openings-to-applicants ratio has followed a steady
uptrend, and a perception of labor shortage suggested by the diffusion index (DI) for
employment conditions (the proportion of firms responding that employment was
"excessive" minus the proportion of those responding that employment was "insufficient")
Tankan
in the December 2016 (Short-Term Economic Survey of Enterprises in Japan) has
heightened further; both indicators show a tightening at almost the same levels seen around
1991-1992. The unemployment rate has continued on a moderate declining trend, albeit
with some fluctuations, and has been about 3 percent recently. The supply-demand
conditions in the labor market are expected to further tighten.
On the wage side, the rise in hourly cash earnings has accelerated moderately, albeit with
fluctuations. Specifically, the year-on-year rate of change in hourly cash earnings of
part-time employees, which are responsive to labor market conditions, has seen a relatively
high increase, being in the range of around 1.5-2.0 percent when fluctuations are smoothed
out. With regard to the outlook, the pace of increase in full-time employees' cash earnings is
expected to accelerate, as corporate profits improve and a heightening of inflation
expectations becomes evident. The rate of increase in hourly cash earnings of part-time
employees is also likely to accelerate steadily in response to the marked tightening of labor
market conditions and an increase in minimum wages.
In light of these prospects for employment and wages, the rate of increase in employee
income is expected to continue rising at around the same rate as nominal GDP growth.
However, there is a risk that firms will remain cautious with their decisions, particularly on
wage setting. In this context, how the labor-management wage negotiations in spring 2017
will develop warrants particular attention.
B. Private Consumption
I will now discuss developments in private consumption, which has been resilient against
the background of steady improvement in the employment and income situation. The
Consumption Activity Index (CAI) had continued to be somewhat weak in part since the
beginning of 2016, against the background of the negative wealth effects brought about by
the decline in stock prices and of irregular weather; however, the CAI has picked up
recently. As the employment and income situation has continued to improve, factors such as
the wealth effects resulting from a rise in stock prices and the dissipation of the effects of
irregular weather are considered to be supporting the pick-up in the CAI.
With regard to the outlook, 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.
C. Business Fixed Investment
Let me now explain developments in business fixed investment, which has been on a
moderate increasing trend as corporate profits have improved. According to the December
2016 Tankan, firmness has continued to be seen in business fixed investment plans for fiscal
2016 as a whole, although developments such as delays in the construction progress and
postponement of opening new shops, both triggered by labor shortages, have been observed
in some small nonmanufacturing firms.
As for the outlook, business fixed investment is likely to continue to see a moderate uptrend,
mainly on the back of (1) an improvement in corporate profits, (2) extremely stimulative
financial conditions, such as low interest rates and accommodative lending attitudes, (3) the
effects of fiscal measures including projects conducted under the Fiscal Investment and
Loan Program and tax reductions for capital investment, and (4) moderate improvement in
growth expectations.
D. Prices
Next, I will discuss inflation expectations and the output gap, which are the main factors
that determine inflation rates. First, medium- to long-term inflation expectations have
remained in a weakening phase since summer 2015 as the adaptive formation mechanism
has played a large role, reflecting the observed inflation rate having been slightly negative.
As for the outlook, firms' price-setting stance is expected to revert to raising prices as
private consumption is expected to continue increasing moderately, and their wage-setting
stance is likely to shift toward raising wages driven by the tightening of labor market
conditions; against this backdrop, medium- to long-term inflation expectations are likely to
follow a sustained increasing trend.
Second, the output gap had been more or less unchanged at around 0 percent, but has shown
some improvement recently. It is projected that it will turn slightly positive toward the end
of fiscal 2016, and from fiscal 2017 continue expanding moderately in positive territory
owing to both the capital and labor factors, as domestic and foreign demand increase in a
well-balanced manner.
III. Conduct of Monetary Policy
Let me now turn to the Bank's monetary policy.
At the Monetary Policy Meeting (MPM) held in January 2013, the Bank made a
commitment to achieving the price stability target of 2 percent in terms of the year-on-year
rate of change in the CPI at the earliest possible time, and in April of that year, it decided to
introduce Quantitative and Qualitative Monetary Easing (QQE) as a necessary measure to
underpin this commitment. In January 2016, the Bank decided to introduce QQE with a
Negative Interest Rate in order to pursue monetary easing in terms of the three dimensions
of quantity, quality, and the interest rate. Furthermore, in September 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, and decided to introduce
QQE with Yield Curve Control as a means of strengthening the two previous policy
frameworks I just mentioned.
The framework of QQE with Yield Curve Control consists of two major components. The
first is yield curve control in which the Bank facilitates the formation of short- and
long-term interest rates that are considered most appropriate for maintaining the momentum
toward achieving the price stability target, taking account of developments in economic
activity and prices as well as financial conditions. Specifically, at present, in the guideline
for market operations, the Bank sets the short-term policy interest rate at minus 0.1 percent
and the target level of the 10-year Japanese government bond (JGB) yields at around 0
percent, conducting JGB purchases so as to achieve this target level. The second component
is an inflation-overshooting commitment in which the Bank continues with the monetary
easing framework, aiming to achieve the price stability target, as long as it is necessary for
maintaining that target in a stable manner. On this point, the Bank makes clear that it will
continue expanding the monetary base until the year-on-year rate of increase in the
observed CPI (all items less fresh food) exceeds 2 percent and stays above the target in a
stable manner.
As shown in the comprehensive assessment, I consider that the main factor that hampers
achieving the price stability target of 2 percent is as follows. In the course of the Bank's
attempt to raise inflation expectations toward 2 percent, observed inflation rates declined
due to a variety of exogenous factors such as a substantial fall in crude oil prices. Under
these circumstances, inflation expectations declined, as the adaptive mechanism has been
playing a relatively large role in the formation of inflation expectations in Japan. Taking this
into consideration, the Bank decided to adopt a commitment that allows inflation to
overshoot the price stability target so as to strengthen the forward-looking mechanism in the
formation of inflation expectations, enhance the credibility of achieving the price stability
target among the public, and raise inflation expectations in a more forceful manner.
As for the future conduct of monetary policy, the Bank will continue with QQE with Yield
Curve Control, aiming to achieve the price stability target of 2 percent, as long as it is
necessary for maintaining that target in a stable manner. Currently, the momentum toward
achieving the price stability target is being maintained, and the year-on-year rate of change
in the CPI is expected to increase toward 2 percent. Nevertheless, the momentum is not yet
sufficiently firm, and we are only halfway to achieving the price stability target. Some
market participants, taking account of a rise in interest rates overseas, argue that the Bank
might consider raising the target level of the long-term interest rate in the near future, but
considering the current developments in economic activity and prices as well as financial
conditions, I believe that it is important that the Bank continue to steadily pursue powerful
monetary easing under QQE with Yield Curve Control.
IV. Challenges for Japan's Economy
I would now like to express my thoughts regarding the current situation of Japan's economy
from a longer-term perspective.
In order to achieve the Bank's price stability target in a stable manner, one of the necessary
requirements is to raise the potential growth rate, which indicates the "basal metabolism" of
an economy. Japan's economy has achieved growth through the process of securing
resources and making full use of them, as well as developing high-quality products and
services and providing them to markets. Through this process, Japan has contributed to
global economic growth as well. I believe it is possible to further expand Japan's growth
and contribution to global economic growth in various areas. We should continue with
proactive efforts to increase Japan's growth potential, rather than being overly pessimistic
about structural changes such as the population decline.
To secure and make use of resources, measures have been taken in the public sector, for
example, to tackle the problem of the population decline -- such as support for childcare and
for women and the elderly to become part of the workforce. In the private sector, in addition
to the efficient use of human resources, it is vital to enhance the training of managers and
the efficiency of administrative operations. From a global viewpoint, expanding the network
for securing such resources as raw materials is highly desirable. Moreover, increasing the
number of foreign workers in many fields could be an option.
With regard to developing and providing products and services, Japan needs to develop
high-value-added products and services with good reputations and explore new sources of
domestic demand through initiatives such as advancing financial technology. It also is
important to expand the channels for capturing overseas demand in neighboring economies,
mainly in Asia, where high growth is expected. This includes attracting inbound demand.
In light of the current situation, I believe that Japan should secure demand necessary for its
economic growth, both at home and abroad in a balanced manner. At a time of uncertainty
regarding such factors as developments in overseas economies, it also is vital to enhance the
autonomy of Japan's economy while paying due attention to overseas risk factors. One good
example is the situation for exports in 2016, when they remained resilient despite the
appreciation of the yen. I see this as evidence that the autonomy of Japan's economy has
strengthened, reflecting the heightened non-price competitiveness in which the volume of
exports is not directly affected by foreign exchange movements. Going forward, continued
efforts are needed to establish a system for developing and providing unique products and
services that are not susceptible to economic developments at home and abroad, nor to
foreign exchange movements, and to further accelerate innovation that promotes
establishment of such a system.
In closing, let me underline that these initiatives toward raising Japan's potential growth rate
require a comprehensive approach that includes structural reforms in addition to monetary
and fiscal policies. Structural reforms of Japan's economy have been progressing to a
certain extent, but further acceleration is required. I expect that growth strategies will bear
fruit as smooth procurement of funds proceeds under accommodative financial conditions,
and as these are invested in labor-saving machinery and equipment, research and
development, and mergers and acquisitions at home and abroad.
Thank you for your attention.