toshihiko fukui : developments in japana€™s economy in 2006 and the outlook for 2007 summary of a speech by mr toshihiko fukui, governor of the bank of japan, to the board of councillors of nippon keidanren ( japan business federation ), tokyo, 25 december 2006. * * * introduction there is now less than a week until the end of 2006. the year has been marked by the sustained recovery of japan's economy, which began in january 2002, exceeding the record of the izanagi boom, the longest postwar economic expansion ( 57 months during 1965 - 70 ). the bank of japan terminated the quantitative easing policy in march and in july returned to pursuing a monetary policy in which it controls interest rates. although japan's economy still faces further structural changes going forward, the year 2006 can be regarded as a year of steady progress toward normalization after the long adjustment phase since the bursting of the bubble. today i will review this year's developments in the economy and prices as well as the conduct of monetary policy, and talk about the outlook for 2007. i. developments in overseas economies one of the factors behind the sustained recovery of japan's economy is the continued strong growth of overseas economies. according to the international monetary fund ( imf ), the global economy is likely to register growth of around 5 percent in 2006 for the third consecutive year. it is a generally accepted view that the global economy will continue to expand in 2007, at around the same pace as in 2006, across a broader range of regions. as a risk factor to this outlook, developments in the u. s. economy should be mentioned. the pace of growth in the u. s. economy has been slowing recently reflecting decreases in housing investment, while private consumption has so far been firm with a limited slowdown in the pace of growth. since the adjustment in the housing market seems to be continuing, attention should be paid to future developments in that market and the possible negative effects on private consumption and production. as for prices, the rate of increase in the core consumer price index is still relatively high, despite a moderate decline in crude oil prices. we basically think that inflation pressures are likely to ease gradually in line with the deceleration of economic expansion and the u. s. economy is likely to realize a soft landing and move toward sustainable growth, but both upside and downside risks should be borne in mind. with regard to developments in other regions, china

resource utilization has been rising. wages are increasing, albeit moderately, particularly in special and overtime payments, and downward pressure on prices stemming from declining unit labor costs has been abating. furthermore, inflation forecasts of households and firms are being revised upward. for instance, in the december tankan, the share of firms that replied their sales prices had risen compared to three months earlier increased to levels not seen since the early 1990s. with such changes in the environment surrounding prices, year - on - year changes in domestic corporate goods prices rose to around 3. 5 percent in mid - 2006, reflecting increases in prices of international commodities such as crude oil. although the pace of increase has recently been slowing somewhat due to a softening of crude oil prices, it is expected to continue its uptrend if there were no large fluctuations caused by commodity prices and foreign exchange rates. on the other hand, although the year - on - year rate of change in the consumer price index ( cpi ) has been on a positive trend, the rate of increase remains very low relative to the improvement in the economic situation. it is possible that the sensitivity of prices to changes in economic activity has been decreasing compared to the past. this tendency has been observed in recent years in economies overseas as well. it is thought that economic globalization as well as deregulation and advances in information and communication technology are behind this phenomenon. if competition with products imported from newly industrialized countries heightens, inflationary pressure is likely to be contained. likewise, if firms, faced with intensified global competition, become more cautious in raising wages, price developments will be influenced. in the case of japan, where year - on - year changes in the cpi have been in the process of improving from negative territory, the rate of increase in the cpi tends to be low compared with other major economies. we project that the rate of increase in the cpi will gradually rise as the economy continues its long expansion. however, the pace at which it rises should continue to be watched carefully. v. conduct of monetary policy in 2006 looking back on the conduct of monetary policy this year, the bank terminated the quantitative easing policy in march, and in july it raised the operating target of money market operations ( the uncollateralized overnight call rate ) from " effectively zero percent " to " around 0. 25 percent, " bringing the zero interest rate environment to an end after five years. an underlying factor that enabled us to make this decision was the fact that structural adjustment