toshihiko fukui : recent developments in economic activity and prices and the bank of japana€™s conduct of monetary policy summary of a speech by mr toshihiko fukui, governor of the bank of japan, at a meeting with business leaders, osaka, 29 september 2005. * * * introduction today i plan to focus on recent developments in economic activity and prices and the basic thinking behind the bank of japan's conduct of monetary policy. the current situation and the outlook for economic activity and prices the japanese economy has recently emerged from a pause that started during the summer of 2004 and continues to recover. the current economic expansion has lasted three years and eight months as of this september, based on the cabinet office's reference dates of business cycles, thus recording the third longest expansion phase in the post - world war ii period. the economy is expected to continue to recover, albeit at a moderate pace. real gdp growth has been strong so far this year with a large annualized increase from the previous quarter of 5. 8 percent in january - march 2005, followed by a 3. 3 percent increase in the april - june quarter, although it either remained unchanged or dipped slightly over the three quarters from april - june 2004. this favorable performance can be attributed to the stronger - than - expected domestic private demand, such as business fixed investment and private consumption, along with moderate export growth due to the expansion in overseas economies. in this environment, positive effects stemming from the increased corporate profits have gradually spread to household income, feeding back to the corporate sector via the increase in private consumption : in other words, there is a positive interaction between the corporate and household sectors. industrial production is on the increase with the completion of adjustment in it - related sectors. overall, the current economic recovery appears moderate in pace, but sustainable. the economy is thus unlikely to fall into recession due to domestic factors. in the corporate sector, profitability has substantially improved, as the adjustment in excess capacity and employment has finally come to an end. according to financial statements statistics of corporations by industry, current profits of japanese firms have increased for three consecutive years from fiscal 2002, with both profits and the ratio of current profits to sales for fiscal 2004 exceeding those during the height of the bubble era. in fiscal 2005, profits are forecast to grow for the fourth consecutive year, signifying buoyancy in corporate performance. backed by high corporate profitability, business fixed investment is growing steadily in a wide range of industries.

to increase thereafter, as the 2 / 4 japanese economy is likely to continue growing at above its potential rate, causing the gap between supply and demand to shrink further, and also the recent uptrend in wages is likely to exert upward pressures on prices. the bank's conduct of monetary policy based on the above assessment of economic activity and prices, i will explain the bank's thinking on the conduct of monetary policy. the bank has been implementing the quantitative easing policy to achieve sustainable economic growth under price stability. the framework consists of two key elements. first, the bank provides ample liquidity to the money market far in excess of required reserves. second, the bank is firmly committed to maintaining such ample provision of liquidity until the year - on - year rate of change in the core cpi registers zero percent or higher on a sustainable basis. this framework underpins expectations, based on inflation projections among market participants, that the quantitative easing policy will continue for some time. as a result, market interest rates remain steady at low levels, including those with relatively longer maturities. with regard to the first element, the bank's provision of ample liquidity greatly contributed to maintaining financial system stability and an accommodative corporate financing environment by responding to precautionary demand for liquidity of financial institutions when there were strong concerns about financial system stability. since then, concerns about financial system stability have largely subsided, as evidenced by the smooth implementation of the full removal of blanket deposit insurance in april 2005. as a result, the quantitative easing policy is effectively becoming closer to a maintenance of zero interest rates. in the current situation, the quantitative easing policy contributes to maintaining an accommodative financial environment by stabilizing market interest rates, thus allowing firms to continue to enjoy low funding costs. as for the conduct of monetary policy, the bank will continue to maintain the quantitative easing policy based on the commitment mentioned earlier since the core cpi is still registering a slight year - on - year decline. the bank formulated this commitment when it introduced the quantitative easing policy in march 2001. at the time, following the bursting of the global it bubble, and the resultant sharp fall in aggregate demand, the economy had fallen into recession and prices were declining. the bank decided to employ an unprecedented measure, linking its commitment in terms of policy duration to the observed cpi, to create further monetary easing effects even under zero interest rate conditions. thereafter in october 2003, the bank clarified its commitment to maintaining the quantitative