The situation in the Japanese economy calls for urgent structural reforms. Authorities have made some progress in addressing the fundamental weaknesses and a reform strategy has been set out. First, banking sector reform has been appropriately focused on strengthening loan classification practices and accelerating the disposal of non-performing loans (NPLs). However, while progress has been made on the former issue, financial institutions still hold large amounts of NPLs in their portfolios and more progress would be desirable. Second, a strategy to promote deregulation in the product and labour markets has been set up. The successful implementation of structural measures in the Japanese product and labour markets would have the benefit of not only increasing potential output and employment, but also decreasing the vulnerability of the Japanese economy to economic shocks. BIS Review 39/2003  3  Concluding remarks Let me conclude by first addressing the economic policy-makers in the euro area. I am convinced that economic activity in the euro area can only be lifted to a new, structurally higher, level by far-reaching and progressive structural reforms. In this respect, the major contribution that monetary and fiscal policy can make is to maintain a stable macroeconomic environment, entailing price stability and sound public finances. Moreover, as I have already argued, the effectiveness of both monetary and fiscal policy in bringing about macroeconomic stability hinges on the microeconomic functioning of the euro area economy, which can only be enhanced by embarking on structural reforms.

Theory suggests that there are delays and risks associated with the latter - getting the timing wrong may result in pro-cyclical polices and make a monetary policy orientated towards price stability more difficult. In the medium term, fiscal policies can best contribute to sustaining non-inflationary growth by pressing ahead with fiscal consolidation. Ultimately, over the economic cycles, growth will reflect conditions on the supply side of the economy. It is therefore microeconomic, and not macroeconomic, policies that can promote the supply of labour and capital and their efficient allocation, further innovation and the diffusion of new technologies, and as a result, mitigate problems such as structural unemployment. Structural reforms in the labour and goods markets are a key element of any long-term strategy to improve investment, growth and employment prospects. First, more flexible markets increase the speed with which countries can adapt to economic shocks, thereby speeding up economic recovery. Second, increased competition in labour and product markets is conducive to a high level of innovation and the rapid spread of technological progress. This in turn supports long-term growth, without contributing to inflationary tendencies. Third, structural reform may facilitate the transmission of monetary policy. In more rigid economies, interest rate changes are transmitted to prices after a longer delay, and structural barriers can prevent the economic efficiency gains of the primary objective of monetary policy - price stability - from being fully realised.