central bankers ’ speeches amounts of purchases in exchange - traded funds ( etfs ) and japan real estate investment trusts ( j - reits ) in order to reduce risk premiums. while the qqe consists of these two pillars, as far as its transmission channels are concerned, the most important factor of all in terms of affecting the economy is lowering expected real interest rates. the effect the qqe has of reducing nominal interest rates, coupled with the effect of lifting inflation expectations, will exert powerful downward pressure on expected real interest rates, which are derived from subtracting expected rates of inflation from nominal rates in financial markets. while nominal rates are visible, expected real rates are based on the public ’ s expectations, taking account of changes in prices. these expectations are akin to asking “ how much would my effective purchasing power go up if i buy jgbs? ” they also can be viewed as equivalent to borrowers ’ expectations regarding their real costs of borrowing, taking into account price changes, when they borrow money at a certain nominal interest rate. consequently, the lower the expected real rates, the more subdued their real cost of borrowing. the decline in expected real rates will stimulate demand in economic activity in a number of ways. for example, by encouraging the decline in those rates, investment in cash, deposits, and fixed - income securities becomes less attractive ; thus, people will shift their portfolios from those financial assets to equities and tangible assets such as land and houses, or to foreign - denominated assets with higher returns. the rise in equity prices and the appreciation of foreign currencies will stimulate private consumption through the wealth effect. in addition to the decline in expected real rates, other factors – including an increase in consumption and the depreciation of the yen – will encourage firms to be more aggressive in their business fixed investment. furthermore, exports will be expected to increase on the back of the yen ’ s depreciation. through an increase in a range of demand components such as private consumption, business fixed investment, exports, and public investment, the output gap of the economy will improve by closing its negative gap, and japan will then find its way out of deflation. the economy is also expected to maintain the virtuous cycle in which the household sector will further increase its spending on the back of a better labor supply and demand condition and higher employee income, and the corporate sector will increase its business fixed investment, supported by higher corporate profits, as an

increase in demand will trigger more production. b. working on expectations : what does it mean? as i explained earlier, one of the bank ’ s challenges under the qqe is to change the way the public forms its view on inflation for the future. to work on the public ’ s expectations sounds somewhat ambiguous and may leave an impression with you that monetary policy is not entirely reliable. in fact, it is not only monetary policy but also other economic policies that influence the way people form their expectations. this is because human beings decide their current behavior by forming expectations for the future. as a result, it is very important to conduct policy by taking account of their expectations. likewise, concerning expectations about economic phenomena, it is important to understand that expectations can be self - fulfilling. a simple example is as follows. if many investors buy stocks of a company based on a belief that these stocks will go up, the actual price will rise. self - fulfilling expectations have a big impact on the actual economy. bis central bankers ’ speeches up until recently, many people shared the view that deflation or declining prices would continue, and based on such expectations they refrained from spending and investment. this may have aggravated the deflationary environment. put differently, deflationary expectations have generated actual deflation ; hence, the situation of persistent self - fulfilling deflation. in order to overcome deflation and achieve price stability in a stable manner, it is vital to change the public ’ s mindset from having “ deflationary expectations ” to adopting “ inflationary expectations. ” this is why the bank has been aggressively pursuing the qqe in order to shift their expectations. changing the public ’ s expectations as a main challenge on monetary policy is surely unprecedented in the history of central banking. it is for this reason that the bank is pursuing this policy with a strong determination to cultivate the frontier of monetary policy making. c. the qqe and increase in lending so far, i have explained that the main challenge of the qqe is to generate aggregate demand by reducing the expected real interest rates, which will lead to the overcoming of deflation. related to this, we sometimes hear people say that lending by financial institutions has not increased no matter how much money the bank provides by expanding the monetary base. they further point out that this may be a sign that monetary easing is not working. let me offer my thoughts on these views. faced with prolonged deflation, many firms including smes have