toshiro muto : recent conduct of japanese monetary policy speech by mr toshiro muto, deputy governor of the bank of japan, at the yomiuri international economic society, tokyo, 21 july 2006. * * * introduction at the monetary policy meeting ( mpm ) held on july 13 and 14, 2006, the bank of japan changed the guideline for money market operations and decided to keep the uncollateralized overnight call rate at around 0. 25 percent. this was the first policy change since march this year when we abandoned the quantitative easing policy and announced the " introduction of a new framework for the conduct of monetary policy. " this action demonstrates that the bank has returned to pursuing a monetary policy in which it controls interest rates both in name and in deed. today, i would like to explain the background to the policy change and, by picking up on some key issues, discuss in detail the framework of interest rate control and how its effects feed through into the economy. i. the current state and outlook for the japanese economy a. sustained economic recovery the bank publishes its economic outlook that covers a period of about one year and a half to two years in its semiannual outlook for economic activity and prices ( hereafter the outlook report ). in the april 2006 outlook report, we presented our view that, through fiscal 2007, the japanese economy is likely to experience a sustained period of expansion under price stability. economic developments since then seem to indicate that the economy is moving broadly in line with this projection. the expansion of overseas economies is broadening in extent. in the united states, the pace of economic expansion has moderated somewhat, reflecting recent decreases in housing investment and slowing growth in household expenditure and employment. these developments, however, can be seen as part of the process of adjustment toward stable growth. in europe, the momentum for economic recovery is picking up gradually, as exports and production are growing and household expenditure has also firmed. in china and other newly industrialized countries in east asia, strong economic expansion is continuing on the back of further progress in the international division of the production process, in terms of both scale and quality, as a result of economic globalization. against this background of overseas economic expansion, japan's exports are increasing at a steady pace. turning to developments in domestic demand, business fixed investment is showing steady growth. according to the june tankan ( short - term economic survey of enterprises in japan ), corporate profits have increased for the

for the next three years is produced and published. at the ecb, the staff release their outlook for the economy and prices over the next two years. behind the time frames of these reports lies the idea that the transmission of monetary policy through to the economy takes place with a long lag. furthermore, the length of the lag differs substantially not only depending on the structure of the economy but also depending on other factors such as the phase of the business cycle. for this reason, producing accurate economic and price projections that incorporate the transmission lag is no easy task. in recent several years, especially, productivity growth and wage restraint in the corporate sector have made prices less sensitive to economic recovery. the situation has, so far, contributed favorably to economic developments, in the sense that economic expansion has been relatively compatible with price stability. viewed from a medium - to long - term perspective, however, the implication is that short - term projections of inflation will prove inadequate as guideposts for steering monetary policy toward price stability and that past relationships between economic conditions and prices will no longer hold. it is, therefore, becoming more important to act with appropriately increased sensitivity to risks affecting economic activity and prices over longer horizons. concluding remarks i have so far explained the background to the recent change in the bank's monetary policy and discussed in some depth issues related to interest rate control and the path by which its effects are transmitted to the economy. let me raise one important point before i conclude. that is, for the effects of monetary policy to filter through into the economy in the way i have discussed today, both financial markets and financial institutions have an important intermediary role to play. strengthening the monetary policy transmission mechanism by improving the functioning of various financial markets and financial institutions is also very important in supporting the infrastructure of a dynamic japanese economy in the long run. in this regard, the bank has been encouraging the fostering and growth of market transactions geared toward improving the functioning of the financial markets. improving the practice of money market operations, the introduction of a next - generation real - time gross settlement system, and the improvement of business continuity plans in times of disaster are some examples. we, along with market participants, intend to strive to further improve the functioning of financial markets. as for enhancing financial institutions'performance of their intermediary functions, we will be working toward creating an environment where financial institutions, through discussions during on - site examinations or interviews, are able to build new business models and upgrade frameworks