bank of japan ’ s december report of recent economic and financial developments1 bank of japan, 20 december 2001. * the bank ’ s view * * japan ’ s economy is deteriorating broadly, as private consumption is weakening in addition to a decline in exports and business fixed investment. with regard to final demand, net exports ( real exports minus real imports ) continue to decline and business fixed investment is also decreasing. housing investment remains sluggish and public investment is on a downward trend. moreover, private consumption is weakening recently. industrial production continues to decline considerably, reflecting these developments in final demand and the still strong excessiveness in inventories mainly in materials. corporate profits are falling and business sentiment keeps on worsening. the weakness in household income is becoming noticeable amid the decrease in the hours worked and the rise in unemployment, and consumer confidence is becoming cautious. turning to the outlook, as for exporting conditions, inventory adjustments in it - related goods worldwide are showing steady progress, and this has strengthened the view that adjustments will be mostly completed by around next spring. however, as final demand of it - related goods still remains stagnant, a distinct recovery in exports of the sector is unlikely for the time being. moreover, the world economy has decelerated further since the terrorist attacks of september 11, and there is considerable uncertainty about future economic developments especially for the u. s. therefore, such concern still exists that downward pressure may be exerted on japan ’ s exports and production once again depending on the developments in overseas economies such as the u. s. meanwhile, with respect to domestic demand, business fixed investment is expected to follow a downward trend amid the fall in corporate profits. private consumption will also continue to be weak along with deteriorating employment and income conditions and the more cautious consumer sentiment. government spending is basically projected to follow a downward trend while domestic private demand generally weakens on top of the uncertainty about exporting conditions. consequently, it may take quite a while for economic activity as a whole to stop declining, even though the decrease in industrial production may moderate somewhat in line with the progress in inventory adjustments such as of it - related goods. overall, japan ’ s economy will inevitably continue to deteriorate for a while. in this situation, continuous attention should be paid to the risk of a negative impact on the economy induced by developments in foreign and domestic financial markets. with regard to prices, import prices continue to decline reflecting the softening of international commodity prices. domestic wholesale prices are declining

you because the subject is too complex to cover in the short time i have available, and besides, we at the reserve bank are hosting a conference on the subject in about a week ’ s time. instead, i want to follow a different path and ask are there factors that contribute to asset price booms, that can be identified and eliminated or, at least, reduced? i have in mind various incentives, informational deficiencies and dubious practices which occur during the boom, but which we always seem to discover well after the bust has occurred. we realise then that these practices allowed distorted views of the profitability of businesses and investment strategies to remain in place long after they should have been corrected. each boom is different and the lessons we learn after the bust has occurred are also different. for example, after the asset price booms of the late 1980s collapsed, we learned that a lot of the problem was due to very poor banking practices - connected lending, concentrated risks, weak credit committees, forbearance whereby new loans were made to service existing debt, etc. in response to this, there have been enormous improvements in banks ’ risk management, accounting practices and bank supervision. partly as a result, or partly due to good luck, banks do not figure prominently in the wash - up of the latest boom - the us equity boom. instead, we discovered a new set of dubious or unsavoury practices. · first, were features of the system that gave a very strong incentive for the major players to push up asset prices. the use of equity - based remuneration, particularly options, gave management a huge incentive to concentrate on short - term increases in share prices, particularly as they knew that the investment community demanded it. · second, there were many means available to make profits look larger than they really were. the non - expensing of options being the most obvious, but others would include the use of special purpose vehicles and other off - balance sheet entities, the non - recognition of deficiencies in company - sponsored defined - benefit pension funds and the bringing forward of revenue recognition. in this country, we saw some very creative things being done with financial re - insurance, which basically had the aim of inflating recorded profits. · thirdly, there was a failure of the counterweights in the system to limit the excesses. in particular, the conflicts of interest in the auditing profession and the lack of independence or forcefulness of boards of directors meant that excess