bank of japan ’ s september report of recent economic and financial developments1 bank of japan, communication, 13 september 1999. * * * the bank ’ s view2 japan ’ s economy has stopped deteriorating, and there are some activities improving such as exports and production. however, clear signs of a self - sustained recovery in private demand have not yet been observed. with regard to final demand, business fixed investment has been on a downward trend. recovery in private consumption continues to be weak on the whole. housing investment, which had been recovering, has recently peaked out. meanwhile, public works have been rising, and net exports ( exports minus imports ) have started growing due to an increase in exports. reflecting such developments in final demand and continued progress in inventory adjustment, industrial production is turning to an increase. against this background, corporate and consumer sentiment has seen an improvement. the improvement in corporate sentiment, however, has not necessarily stimulated business activities, because firms strongly feel that they have excess capacity and employees and their profits remain weak. meanwhile, the improvement in consumer sentiment is underpinning household expenditure even under the worsening employment and income conditions, but is not strong enough to push up overall private consumption. as for the outlook, improvements in the overall financial environment partly due to the monetary easing by the bank, along with a series of economic measures taken by the government, are expected to continue underpinning the economy. moreover, the positive impact on domestic production of the recovery of overseas economies, especially of asian economies, is likely to continue for some time. by contrast, leading indicators suggest a high probability of a moderate decrease in housing investment from this autumn. in addition, under cautious sales plans, firms are implementing further restructuring to improve their profitability. although such corporate restructuring is expected to improve productivity, it is likely, in the short run, to reduce fixed investment and discourage household expenditure through the resulting deterioration in employment and income conditions. moreover, it seems that the recent appreciation of the yen will have an adverse effect on corporate profits in the near term. under such circumstances, it is still difficult to expect an immediate self - sustained recovery in private demand. overall economic developments require careful monitoring in consideration of the above points. it is also important to promote structural reform in order to assure the economy ’ s sustained growth in the medium term. with regard to prices, import prices have recently fallen slightly due to the appreciation of the yen, despite the rise in international commodity prices such as crude oil prices. domestic

the economy, it is indispensable to realize a situation in which japan ’ s financial system performs the credit intermediary function fully. discussion on putting the financial system on a sounder basis often focuses attention on the disposal of npls. although this issue is very important, the disposal of npls is just one of the prerequisites for achieving the much broader task of reviving the financial system. the most vital necessity in the medium to long term is to construct a new financial infrastructure, which can play a key role in the economy in the 21st century. after world war ii, japanese financial institutions raised their profitability by maintaining a certain asset size, supported by high economic growth and private savings. in undertaking risk management, a basic function of commercial banks, most of the work associated with assessing the profitability and risk of each individual project was often substituted by monitoring the price of real estate that had been pledged as collateral. this system was based on the condition that real estate prices continued to rise. market participants are now keenly watching whether japanese financial institutions can generate a new business model and establish a sufficient foundation for profitability in the future, now that the external environment that supported their profitability in the postwar era has drastically changed. the value - added and the profit of financial institutions are ultimately generated from their activities of taking and controlling various risks such as credit risk, interest rate risk, and liquidity risk. for the japanese financial system and economy to revive, it is extremely important that japanese financial institutions create a new business model that ensures a foundation for profitability while supporting the japanese economy in the 21st century. i think it is essential for financial institutions to make further efforts in this respect. the bank of japan will make its best effort on various fronts, such as enhancing the transmission mechanism of monetary easing, promoting the permeation of the easing effects through the economy, as well as ensuring financial market stability. as other developed countries are keenly watching our monetary policy conduct, it is my sincere hope that japan realizes sustainable economic growth accompanying price stability, and succeeds in recording a victory over deflation.