Tadao Noda: Recent economic and financial developments and the
conduct of monetary policy
Speech by Mr Tadao Noda, Member of the Policy Board of the Bank of Japan, at a meeting
with business leaders, Kumamoto, 3 March 2011.
* * *
I. Overseas economies
I will begin by outlining overseas economies.
Overseas economies are continuing to recover from the downturn following the global
financial crisis after the failure of Lehman Brothers in the autumn of 2008. Although there
have been inventory adjustments in IT-related goods since summer 2010, this has not
exerted much downward pressure on economic activity. Looking ahead, overseas economies
are expected to continue to recover, but while emerging economies are likely to continue to
show relatively high growth fueled by growth in domestic demand, the recovery in advanced
economies is likely to lack strength. This divergence in growth trends has been referred to as
the "two-speed recovery" or "two-track recovery."
A. Recovery in advanced economies lacks strength
Let me first talk about advanced economies.
The U.S. economy continues to recover. Led by increases in exports, corporate profits have
been on a recovery trend, and business fixed investment has been rising moderately. In
particular, private consumption, the main demand component, is growing quickly at present.
Growth in consumption is currently outpacing increases in disposable income, and
household saving rates, which rose after the failure of Lehman Brothers, have begun to
decline. These developments can be attributed in part to the rise in stock prices fueled by
additional stimulus measures, both from the monetary and fiscal sides. The recovery trend is
expected to continue against the background of increasing exports, especially to emerging
economies, and the accommodative financial environment. Firms, however, remain cautious
about hiring new employees, and it will take time to resolve household balance-sheet
problems, which were partly responsible for the financial crisis. While the recent rise in stock
prices should accelerate the pace of balance-sheet adjustments, the resumption of the
decline in home prices will act as a brake. As Japan's experience after the bursting of the
bubble economy shows, balance-sheet adjustments impede the virtuous circle of growth in
production, income, and spending. Therefore, the pace of recovery in the U.S. economy is
likely to remain moderate.
Economic activity in the euro area as a whole has been recovering moderately, with some
differences in pace by country. In particular, the German economy has been growing notably,
with exports boosted by a weak euro. Going forward, Germany is expected to enjoy steady
growth led mainly by buoyant exports. However, due to the effects of fiscal austerity,
economic growth in some peripheral countries is likely to remain sluggish as both the public
and private sectors are mired in excessive debt.
B. Continued high growth in emerging economies
Next, I will talk about emerging economies. On the whole, business fixed investment has
been increasing reflecting higher capacity utilization rates, and private consumption has been
boosted by the improvement in the employment and income situation resulting from
increased production. Since emerging economies do not face the kind of structural problems
weighing down on advanced economies such as balance-sheet adjustments and
deteriorating fiscal conditions, the virtuous circle of growth in production, income, and
spending operates normally and emerging economies are expected to continue to show
relatively high growth.
China, which takes center stage among emerging economies, continues to enjoy high
yearon-year growth in excess of 9 percent. Growth in exports temporarily slowed in the middle of
2010 due to the completion of global inventory restocking following the recovery from the
global financial crisis. At present, however, exports have regained their upward momentum.
As for the outlook, the Chinese economy is expected to continue to grow at a rapid pace,
with infrastructure-related investment remaining on an increasing trend, and private
consumption continuing to expand due to increases in household incomes.
II. Japan's economy
Next, I will outline the current situation of and outlook for Japan's economy and prices.
A. Economy emerging from a temporary pause
Since the early autumn of 2010, there has been a temporary pause in Japan's economic
recovery, partly due to the slowdown in overseas economies and the decline in the demand
for some types of consumer goods following the previous sharp increase. As a result of the
recovery in overseas economies, however, the economy seems to have been emerging from
its temporary pause.
Exports have resumed their upward trend amid the reacceleration of growth in overseas
economies and the progress in inventory adjustments in IT-related goods I just mentioned.
Specifically, real exports declined in January from the previous month, partly reflecting the
large increase in December - the first in five months - but are showing signs of resuming
their uptrend. As for private consumption, while demand for some goods has fallen back
following the sharp, last-minute increase in demand ahead of the expiration of subsidies for
purchases of environmentally friendly cars and of the eco-point system for household
electrical appliances, consumption of other goods and services has generally been firm.
Under these circumstances, production has been showing signs of improvement since
November.
As for the outlook, exports are likely to continue to trend upward on the back of the
improvement in overseas economies. Private consumption is likely to pick up gradually as
the effects of the decline in demand following the previous sharp increase gradually
dissipate. With corporate profits showing solid improvements, business fixed investment is
also likely to start picking up. Thus, led by the recovery in exports, Japan's economy is likely
to return to a recovery path with clear signs of a self-sustaining recovery trend.1 That being
said, however, private consumption is likely to remain subdued given that the employment
and income situation - although easing somewhat - remains severe. Furthermore, the pace
of improvement in business fixed investment is likely to remain moderate since it will take
time until firms' sense of excessive capital stock is dispelled, and the relative share of
overseas investment has been increasing reflecting the widening gap between the economic
growth potential at home and abroad.
B. Weaker downward pressure on prices
As for prices, the year-on-year pace of decline in the consumer price index (CPI), excluding
fresh food and the effects of the special subsidies for high school tuition introduced in April
2010 as part of the government's economic stimulus measures to reduce the cost of high
school education, is slowing moderately due to the gradual improvement in the aggregate
supply and demand balance in the economy as a whole.2 Regarding the outlook, this
mechanism whereby the improvement in the aggregate supply and demand balance exerts
upward pressure on prices is likely to continue as a trend.
However, it is also likely that the year-on-year rate of growth in the CPI will be revised
downward due to the base-year revision for the CPI scheduled for August 2011.3 Needless to
say, regardless of the extent of the revision, prices themselves will remain unaffected and, in
conducting monetary policy, such statistical artifacts need to be borne in mind.
C. Upside and downside risks
So far, I have talked about the scenario I consider to be the most likely. I will now consider
both upside and downside risks that may impinge on the above outlook.
1. Emerging economies
First, I will look at upside and downside risks to emerging economies. The rapid growth of
emerging economies, which contrasts sharply with the weak momentum for recovery in
advanced economies, continues to lure capital from investors seeking higher returns.4 The
inflows appear to have been amplified by the continued large-scale monetary easing in
advanced economies as well as the fixed or semi-fixed exchange rate regimes adopted by
some emerging economies with the aim of keeping their currencies from appreciating. The
further expansion of emerging economies will - for the time being - exert large positive
effects on the economies of advanced countries, including Japan, through higher exports.
However, if emerging economies continue with easy monetary policies, they may fall behind
the curve.5 This could cause their economies to overheat, and any adjustment that follows
could result in a rapid unwinding of excesses, leading to a contraction of economic activity.
2. Global commodity markets
Next, I will talk about the rise in overall commodity prices. There is no doubt that the
fundamental cause is a tighter supply and demand balance caused by robust demand from
emerging economies and decreasing supply due to unseasonable weather in some
2
The year-on-year rate of change in the CPI excluding fresh food - the core CPI - has remained negative (with
a value of minus 0.4 percent in December 2010, and minus 0.2 percent in January 2011). However, when the
effects of the special subsidies for high school tuition introduced in April 2010 are excluded to gauge the trend
changes in consumer prices, the year-on-year rate of change in the core CPI has turned positive, registering
0.1 percent in December 2010 and 0.3 percent in January 2011.
3
At present, calendar year 2005 is used as the base year for calculating the year-on-year rate of change in the
CPI. In August, the base year will be changed to 2010 and year-on-year figures as far back as January 2011
will be revised retroactively.
4
At present, the pace of capital inflows to emerging economies is decelerating due to concerns about rising
inflationary pressures in emerging economies and heightened uncertainty regarding the situation in the Middle
East.
5
With regard to emerging economies with de facto fixed exchange rate systems, there appears to be a
tendency for monetary tightening to fall behind. In open economies, it is said that three objectives are not
attainable simultaneously: (1) independent monetary policy; (2) fixed exchange rate systems; and (3) free
international movement of capital. Many advanced countries, including Japan, have adopted independent
monetary policy and free movement of capital, while in principle the foreign exchange rate is determined by
the market mechanism.
commodity-exporting economies. In addition, the recent political unrest in North Africa and
the Middle East, triggered by the riots in Tunisia, has been adding to the uncertainty over the
supply of crude oil, sending prices sharply higher. Furthermore, the nature of commodity
transactions has changed with the introduction of commodity futures trading. In the past, the
price of each commodity moved independently of other commodities, reflecting the differing
supply and demand structures. However, since around the mid-2000s, advances in the
infrastructure for commodity futures trading have led to the creation of products such as
commodity indexes and exchange-traded funds (ETFs) that combine exchange-traded
futures on commodities and financial assets. The growing use of these products has resulted
in the price movements of various commodities, as well as the prices of commodities and
financial assets such as stocks, to be more closely linked. Against this background of
"financialization" of commodities, it cannot be denied that accommodative monetary
conditions around the world have fueled expectations of higher commodity prices and
accelerated the rise in global commodity prices.
Inflationary pressures have increased in emerging economies due to higher food and raw
material prices reflecting the rise in global commodity prices, coupled with higher utilization
rates of production factors such as labor and facilities.6 If global commodity prices continue to
rise beyond what is warranted by fundamentals such as the increase in demand in emerging
economies, resource-importing economies - both advanced and emerging - will see a
decrease in consumption expenditure through a decline in real purchasing power. If the
increases in costs cannot be passed on to prices of final products, corporate profits will be
squeezed, resulting in a negative impact on consumption through a deterioration in the
employment and wage environment.7
3. Industrialized economies
The third risk concerns advanced economies. As I mentioned earlier, the U.S. economy is
burdened with balance-sheet adjustments. Dealing with them will take time, and U.S.
economic activity therefore still looks unlikely to accelerate and remains vulnerable to
downside risks. I personally have remained cautious about the outlook for the U.S. economy
throughout. However, forecasts by private-sector economists have fluctuated greatly since
the beginning of 2010.8 The divergent views regarding the outlook have probably been
caused by differing opinions regarding the time it will take to resolve the balance-sheet
problems.
A risk common to many advanced economies is the sharp growth in public debt. When the
market's confidence in fiscal sustainability declines, economic activity is negatively affected
due to the adverse feedback loop between financial and economic activity. In some
peripheral European countries, such a negative feedback loop has already materialized,
creating persistent tensions in financial markets. However, this has not spread to other
regions so far thanks to the establishment and expansion of support mechanisms to maintain
stability in the region such as the European Financial Stability Facility.
III. Growth potential of the Japanese economy
So far, I have talked about the outlook for the Japanese economy from a cyclical perspective.
I would now like to discuss it from a longer-term perspective.
Since 1990, following the bursting of the bubble economy, Japan's average annual growth
has hovered at a low level of around 1-2 percent. The sustained economic expansion from
fiscal 2002 to 2007 was in reality supported by a global financial bubble. With the benefit of
hindsight, I am afraid I have to say that it is clear the self-sustaining growth mechanism
during that period was not sufficiently robust.
In the high-growth era during the 1960s and the stable growth period from 1970 to the 1980s,
the Japanese economy was blessed externally with an international competitive environment
that was beneficial to Japan's economic model designed to catch up with advanced
economies, and internally, with an upward trend in the working-age population.9 From the
1990s onward, however, international competition intensified and the working-age population
started to decrease. As a result, growth had to be based increasingly on a "pioneering spirit,"
that is, the ability to discover hitherto unknown demand and create new markets. Thus, the
main reason for Japan's decline in productivity and in the economic growth trend has been
an inability to cope with fundamental structural changes in the world economy. How should
Japan address these challenges?
It is clear that the expanding global economy provides ample potential demand, particularly
in emerging economies. Though less obvious, it is also true that there are no limits to
demand at home. Statistics show that there remains an output gap in Japan. This gap,
however, only shows the size of the shortage in demand relative to the current supply
capacity. Looked at from a different angle, this simply means there is a shortage of the kind
of supply that meets the kind of latent demand which is there. Let me be more specific.
Although the aging of society has generated wide-ranging potential demand for medical and
nursing care as well as demand in other related areas, a regulatory framework that is rooted
in Japan's traditional economic system has hindered potential demand from materializing.
Thus, it could be said that the ability to "pioneer" I mentioned earlier requires economic
actors capable of tapping potential demand and a nation that provides an institutional
environment encouraging the production of valuable goods and services through free market
competition.
With regard to overseas markets, it is important for Japan to open up and steer boldly toward
the objective of integrating domestic and overseas markets. Needless to say, this challenge
needs to be tackled immediately so as not to miss out on the enormous demand for goods
and services in expanding global markets. At the same time, this greater integration with the
global economy would allow the free movement not only of goods and services but also of
human resources and capital, and would both require and promote deregulation. While it
may sound a bit hyperbolic, such integration could further advance the international division
of labor to an extent where the distinction between domestic and foreign demand becomes
irrelevant except for statistical expedience.
Another pressing issue is the improvement of the fiscal balance. Restoration of the fiscal
balance is necessary not only from the perspective of fiscal sustainability but also from the
perspective of restoring economic growth. The public debt being accumulated under the
current social security system increases intergenerational differences in lifetime incomes,
and the growing burden for future generations is weighing down income expectations and
restraining consumption by the working-age population.
IV. Conduct of monetary policy
A. Policy responses by the Bank of Japan
Next, I will explain the policy measures implemented by the Bank so far.
1. Pursuing powerful monetary easing
In October 2010, the Bank introduced a policy of "comprehensive monetary easing"
consisting of three measures. First, the Bank lowered the target for the uncollateralized
overnight call rate to around 0 to 0.1 percent and clarified that it was pursuing a virtually zero
interest rate policy. Second, the Bank announced its commitment to maintaining the virtually
zero interest rate policy until it judged, on the basis of the "understanding of medium- to
longterm price stability" (hereafter the "understanding"), that price stability was in sight. The
"understanding" is the inflation rate level that each of the nine Policy Board members
understands as being consistent with price stability over the medium to long term. On the
basis of a year-on-year rate of change in the CPI, each Policy Board member's
"understanding" falls in a positive range of 2 percent or lower, and the midpoints of most
Policy Board members' "understanding" are around 1 percent. In other words, the Bank
provided clarification of the time horizon of the virtually zero interest rate policy. And third,
given that there was little room for a further decline in short-term interest rates, the Bank
established a program on its balance sheet to purchase various financial assets, such as
government securities, ETFs, and Japan real estate investment trusts (J-REITs), to
encourage a decline in longer-term interest rates and various risk premiums.
Developments in financial markets since the implementation of the "comprehensive monetary
easing policy" reveal that, in the money market, interest rates on term instruments have
declined, spreads on corporate bonds have narrowed, and various risk premiums have
generally been declining, as seen in the rise in prices of stocks and J-REITs. The
environment for corporate financing has been favorable, with issuing conditions for CP and
corporate bonds improving, as illustrated, for example, by the decline in lending rates and the
increased variety of corporate bond issuers. Long-term interest rates, however, have risen
somewhat. The reason is that although the Bank continues to steadily implement the
comprehensive monetary easing policy and remains firmly committed to pursuing powerful
monetary easing, it is fundamentally difficult for interest rate policy to directly influence
longterm interest rates, and the rise in overseas interest rates seems to be affecting Japanese
long-term interest rates to some extent.10
The outlook for Japan's economy I presented earlier - the scenario considered to be the
most likely - is based on the assumption that financial markets will fully factor in the Bank's
monetary policy measures taken so far. That is, I judge that, under the Bank's monetary
policy, Japan's economy will likely continue to make steady progress toward overcoming
deflation and returning to a sustainable growth path with price stability.
2. Providing support to strengthen the foundations for economic growth
Following the implementation of the above measures, in June 2010 the Bank introduced a
new fund-provisioning framework, the "Fund-Provisioning Measure to Support Strengthening
the Foundations for Economic Growth." Given the decline in the economic growth trend
mentioned earlier, the Bank established the new framework in order to play its part in
addressing this challenge by making use of its central bank functions. The framework
provides long-term funds at a low interest rate to financial institutions in accordance with their
efforts in terms of lending and investment toward strengthening the foundations for economic
growth.
The outline of the fund-provisioning measure is as follows: (1) the total amount of loans shall
not exceed 3 trillion yen; (2) the total amount of loans to each counterparty shall not exceed
150 billion yen; and (3) the last disbursement of new loans shall take place by June 30, 2012.
The Bank is aware that it is not possible to raise Japan's growth potential solely through this
fund-provisioning measure. Rather, the aim is for the measure to act as a catalyst to bring
about a shared awareness among financial institutions and firms on the need to raise
Japan's growth potential and to make various efforts of their own accord to raise the potential
economic growth rate and productivity. On March 7, 2011, the Bank will carry out the third
new loan disbursement under the fund-provisioning measure to support strengthening the
foundations for economic growth, and the total outstanding balance is expected to exceed
2 trillion yen as of March 7. The number of borrower financial institutions11 has increased to
149 as of the end of February 2011, and the breakdown of these institutions reveals that
loans will be provided to various types of institutions across wide regions. Individual
investments and loans under the measure cover all of the 18 areas suggested by the Bank
as possible investment areas, with investment in "environment and energy business" in the
lead. In this context, what has particularly caught my attention is that a large number of
financial institutions, on participating in the Bank's disbursement of loans, started to actively
make a range of efforts such as establishing new dedicated funds and lending schemes for
investments and loans to support strengthening the foundations for economic growth. The
Bank believes that this situation suggests that the Bank's measure is producing positive
effects as a catalyst, its intended purpose.
B. Future monetary policy conduct and communication
In order for Japan's economy to overcome deflation and return to a sustainable growth path
with price stability, I believe it is important for the Bank to steadily continue to carry out the
measures I mentioned earlier. In addition, the Bank will continue to carefully examine new
economic data and information, so that appropriate policy measures can be taken flexibly if
the probability rises of a significant deterioration in the outlook for economic activity and
prices or it becomes uncertain that Japan is on the road to overcoming deflation.
In order for these measures to be fully effective, it is vital that they are properly and widely
understood by the public. To this end, the Bank holds meetings such as the present one
between Policy Board members and business leaders and press conferences by the
Governor after Monetary Policy Meetings, and promptly publishes the minutes of the
Monetary Policy Meetings. In addition, the Bank makes use of various other communication
channels such as its web site as a means of providing information to the public. I think that
these efforts do not compare unfavorably with those of other central banks. Moreover, the
Bank is doing its utmost to further improve the quality of such forms of communication.12 For
example, as part of such efforts, the Bank launched a renewed web site in January.13 We
would be delighted to hear your opinions and views regarding the Bank's dissemination of
information.