july 22, 2019 bank of japan overcoming deflation : japan's experience and challenges ahead speech at the 2019 michel camdessus central banking lecture, international monetary fund haruhiko kuroda governor of the bank of japan introduction it is my great pleasure to have the opportunity today to give a speech in honor of michel camdessus. in my speech today, i would like to share some thoughts on japan's deflation that started from the late 1990s, when mr. camdessus served as the managing director of the international monetary fund ( imf ). the inflation rate in japan started to decline after the burst of the asset bubble in the early 1990s. the economy fell into deflation in the late 1990s, in the sense of a sustained decline in prices, and this deflation persisted for about 15 years. such chronic deflation used to be regarded as a phenomenon unique to japan. however, most advanced economies have been experiencing low inflation and low interest rates since the global financial crisis. many central banks now face a common challenge of how to raise inflation rates. i believe that japan's experience of a long battle against deflation would provide a case study for other central banks in conducting monetary policy going forward. keeping this in mind, i would like to discuss two topics today. the first is the reasons behind chronic deflation in japan and the effects of quantitative and qualitative monetary easing ( qqe ) that the bank of japan introduced in 2013 as a measure to overcome deflation. as i will explain later, japan's economy is finally no longer in deflation owing to the powerful monetary easing, and it is reconfirmed that monetary policy is effective even in overcoming chronic deflation. however, it is taking time to achieve the bank's price stability target of 2 percent. after explaining the reasons behind this, i will move on to the second topic of the bank's initiatives to overcome the current persistent low inflation. the bank introduced the new policy framework, " qqe with yield curve control, " in 2016 and strengthened it in 2018. i will elaborate on the bank's thinking behind the new initiatives and its experience. i. chronic deflation and qqe a. decline in the natural rate of interest and chronic deflation now, let me start with japan's experience of deflation. in japan, after the burst of a large - scale asset bubble in the early 1990s, the economy decelerated significantly and the inflation rate declined

fundamental elements of monetary policy conduct, and in particular, forward guidance regarding the future policy stance plays an important role under the low interest rate environment. in a standard economic model, even when short - term interest rates reach the effective lower bound, if a central bank announces that it will maintain accommodative financial conditions for a long time, the behavior of each economic entity could change, thereby producing significant monetary easing effects. in reality, however, people's behavior does not seem to change as much as the theory suggests, especially when the forward guidance horizon becomes longer. one of the reasons behind this " forward guidance puzzle " is the difficulty in assuring people's understanding of the central bank's guidance for the distant future. the central bank's guidance cannot gain confidence unless people perceive it as realistic and time consistent. however, if the central bank focuses too much on such consistency and makes the guidance complicated, it becomes more difficult to convey its thinking to the public. as suggested by recent studies on the " rational inattention, " households and firms do not always pay close attention to monetary policy or price developments. so, the central bank needs to clearly explain its thinking in plain language in order to manage their expectations. on this basis, the bank of japan has adopted two types of forward guidance. the first is an " inflation - overshooting commitment " introduced in september 2016. this is a commitment that the bank will continue expanding the monetary base until the observed inflation rate exceeds 2 percent and stays above that level in a stable manner. by linking to the price stability target, the bank clearly shows its determination to maintain accommodative financial conditions for longer than assumed in a standard economic model. the second is " forward guidance for policy rates " introduced in july 2018. this shows the bank's intention to maintain the current extremely low levels of short - and long - term interest rates for an extended period of time, at least through around spring 2020, taking into account uncertainties regarding economic activity and prices. through this forward guidance, the bank has made clear that it considers it appropriate to maintain the current low levels of interest rates for such a long time. it also has clarified the time frame to make its intention easy to understand. since the introduction of forward guidance for policy rates, the survey results show that an increasing number of market participants consider that interest rates will remain low ( chart 5 ). this indicates the effectiveness of such guidance. b. securing effective policy measures