have risen has been outweighing that for which prices have declined by an increasing margin ( chart 8 ). monthly data for the cpi are susceptible to various factors, such as developments in import prices that reflect changes in energy prices and fluctuations in foreign exchange rates. on the other hand, the underlying trend in inflation is determined mainly by the output gap and medium - to long - term inflation expectations. from this perspective, significant changes that have not been seen in recent years are taking place. i will elaborate on these two aspects as follows. developments in the output gap the output gap indicates the supply and demand balance of japan ’ s economy as a whole ; that is, the extent to which capital and labor are utilized. although capacity utilization has continued its increasing trend as the economy continues to recover moderately, the effects of the flattening of exports, reflecting the slowdown in emerging economies, have been observed recently ( chart 9 ). meanwhile, labor market conditions have continued to tighten. this is partly because, reflecting firmness in domestic demand, the current economic recovery has been largely attributable to the nonmanufacturing sector, which is more laborintensive than the manufacturing sector. therefore, the output gap has steadily followed its improving trend, mainly on the labor side ( chart 10 ). looking ahead, with the economy expected to continue growing at a pace above its potential, capital and labor utilization is likely to rise further and thereby the output gap is expected to continue improving further. thus, upward pressure on prices stemming from the output gap is likely to increase steadily. bis central bankers ’ speeches developments in medium - to long - term inflation expectations let me move on to inflation expectations. medium - to long - term inflation expectations appear to have been rising on the whole from a somewhat long - term perspective. inflation expectations can be assessed from various market indicators and survey results. although there are some indicators or results showing that inflation expectations have been somewhat weak, they have been flat on the whole recently, despite the significant decline in crude oil prices ( chart 11 ). in addition, it is important to analyze firms ’ and households ’ views on prices upon which they engage in economic activities. since the turn of the fiscal year, firms ’ price - hiking behavior has been increasingly conspicuous. at the same time, households have come to accept price increases as well, against the backdrop of actual and prospective increases in their income. the increases reflect rises in wages, including base pay, which took place at

in china, the relative weight of nonmanufacturing has been on the rise, and even within the manufacturing sector, domestic production of manufactured parts and products with high value - added, which were mostly imported previously, has been increasing. against this background, the effects of the economic growth in china stimulating exports of other countries in east asia via a trade channel have been getting smaller. taking this into account, there remains uncertainty about the impact of the positive spillover from the recovery of the chinese economy on other economies in east asia. as i described earlier, the slowdown in emerging economies already has been exerting downward pressure on japan ’ s exports and production, which already is incorporated in the baseline scenario. if the slowdown in emerging economies is within the range of our assumption, notwithstanding its negative impact, japan ’ s economy is expected to continue to grow, reflecting the steady increase in domestic demand and the positive impact of the decline in energy prices on real income. however, if the slowdown in emerging economies becomes much deeper than expected or prolonged, the negative impact on japan ’ s economy accordingly will be larger. what matters most is the impact on the business confidence of japanese firms. if firms start to downsize their fixed investment plans or wage increases against the backdrop of increasing concerns over the developments in emerging economies, this will have a negative impact on the steady increase in domestic demand. although this is currently one of the risk factors rather than a probable scenario, we are mindful of it. when it comes to the impact on prices, the focal point is the developments in wage increases toward next fiscal year. as i described earlier, the rates of increase in wages and in prices move almost in parallel in the long run, and the underlying trend in inflation already has shown a clear improving trend. in order to maintain the real wages and income of households, it is important for the underlying trend in inflation to be reflected in wage increases, notwithstanding the recent seeming decline in the rate of change in inflation. in the baseline scenario, wage increases that are consistent with the trend inflation are expected. we are mindful of a downside risk, however, of firms becoming more cautious with regard to wage increases against the backdrop of uncertainties regarding developments in overseas economies, particularly emerging economies. there is also a downside risk that, in bis central bankers ’ speeches the case of insufficient wage increases, consumers will become more resistant to price increases on goods and services, pushing down the pace of inflation. iv