masaaki shirakawa : the recent economic and financial developments and their outlook, and the conduct of monetary policy in japan summary of a speech given by mr masaaki shirakawa, governor of the bank of japan, to the naigai josei chousa kai ( research institute of japan ), tokyo, 18 july 2008. * * * introduction i am honored to be invited to speak here today to the naigai josei chousa kai. as you are all aware, the outlook for the world economy is currently extremely uncertain and policy making has become increasingly difficult. the recent upsurge in energy and materials prices is increasing inflationary pressures globally and, at the same time, putting downside pressures on the economy in many countries consuming these resources. in addition, turmoil in global financial markets stemming from the subprime loan problem in the united states has in no way subsided. central banks are facing the difficult challenges of maintaining stability in economic activity and prices and also in financial markets. the bank of japan is also facing these challenges. confronted with downside risks to the economy and upside risks to prices at the same time, which is unusual, the bank must appropriately steer monetary policy. in addition, given the difficult situation, it is becoming increasingly important for us as policy makers to accurately communicate to market participants and to the general public our assessment of the situation and issues facing japan's economy. in the first half of my talk today, i would like to discuss the bank's view on the current situation and the outlook for japan's economy and then to elaborate on the thinking behind our monetary policy under such circumstances. in the latter half of my talk, i would like to discuss how we are trying to convey our assessment of the economic situation and the thinking behind our conduct of monetary policy, in other words, the role and the framework of communication regarding the conduct of monetary policy. 1. outlook for economic activity and prices and the conduct of monetary policy current economic situation and the outlook i would first like to discuss the current situation of japan's economy. since 2002, japan's economy has enjoyed a moderate but prolonged period of economic expansion. the basic background for the expansion has been the high growth of the world economy, mainly of emerging economies, and the efforts of japanese firms to restructure their businesses. although an average of around 2 percent gdp growth between 2002 and 2007 does not seem remarkable, it was somewhat above the potential growth rate and has closed the

other data, there seems to be no sign that the " second - round effect " is taking hold in japan. therefore, it is likely that future inflation will depend mainly on developments in energy and materials prices and the degree of pass - on of these cost increases to sales prices. as the main scenario, we assume that cpi inflation is likely to become somewhat elevated in the coming months but gradually moderate thereafter. however, for the time being, this scenario is not without upside risks that we must be aware of. the major risk is developments in energy and materials prices. we also cannot rule out the possibility of changes in economic agents ’ inflation expectations, which so far have remained stable. with recent increases in prices of daily necessities such as food, the rate of inflation actually felt by households seems to have shifted upward. according to the bank ’ s quarterly opinion survey on the general public's views and behavior conducted in june, more than 90 percent felt that prices have gone up. since the public's perception of inflation affects the actual inflation rate through inflation expectations and changes in the price - setting behavior of firms, it needs to be monitored carefully along with developments in energy and materials prices. the conduct of monetary policy with this outlook for economic activity and prices as well as the risk factors in mind, i would now like to turn to the subject of the conduct of monetary policy. since the termination of the so - called quantitative easing monetary policy in march 2006, the bank had been conducting monetary policy based on the idea that the level of the policy rate, the uncollateralized overnight call rate, should be raised gradually in accordance with improvements in the economic and price situation. since the end of last year, however, economic growth has entered a phase of deceleration while the rate of inflation has increased. in addition, uncertainties in global financial markets and overseas economies have heightened. in view of these developments, the bank is currently taking the stance that future monetary policy should not be predetermined and should be implemented in a flexible manner through careful assessment of the outlook for economic activity and prices, closely considering the likelihood of the bank ’ s projections as well as factors posing upside or downside risks. in the current circumstances, what is important is how monetary policy should deal with the so - called " supply shocks, " or increases in energy and materials prices. there are two orthodox principles shared by central banks in advanced economies based on their experience of such problems, particularly oil shocks.