toshihiko fukui : 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, nagoya, 3 december 2007. * * * introduction today, i would like to explain the bank of japan's view regarding developments in economic activity and prices and the basic thinking behind its conduct of monetary policy. in addition, i would like to touch upon the issues currently facing japan's financial system. i. the current situation and the outlook for economic activity and prices i would first like to talk about the current situation and the outlook for economic activity and prices. japan's economy as a whole has continued to expand moderately, although the pace of improvement in the household sector has remained slow relative to the strength in the corporate sector. at the end of october, we released the outlook for economic activity and prices ( hereafter the outlook report ), and presented the projection through fiscal 2008. the gist of the outlook report is that although there are uncertainties regarding overseas economies and global financial markets, japan's economy is likely to continue its sustained expansion under price stability. in terms of the rate of real gdp growth, we projected that this is likely to register around 2 percent on average, somewhat higher than the potential growth rate. i would now like to elaborate on the mechanisms that form the basis for the outlook as well as some associated risk factors. within the corporate sector, exports have remained on the increase, reflecting the widening base of continuing world economic growth. business fixed investment is likely to keep rising steadily, supported by high corporate profits. the rate of growth is, however, likely to be lower than it was up until fiscal 2006, since capital investment has continued to increase at a rapid pace for the last several years. the positive influence of the strength in the corporate sector has been feeding through into the household sector slowly but steadily. with the number of employees rising, employee income has been increasing moderately, and growth in household income has continued to be further supported via various other channels, for example, increased dividends. meanwhile, wages have been somewhat weak recently, reflecting labor cost restraint by firms in the face of greater exposure to global competition and capital market discipline, and increased materials prices. the change in the composition of the workforce due to the retirement of the high - salaried baby - boomer generation and increases in

account of fruits, vegetables, mineral oils, fuels, and cotton textiles. two important international factors have contributed to more than the unanticipated upward pressure on prices. first, international oil prices have remained firm. the average price of opec basket had reached us $ 29. 5 a barrel at the end of 2003, while us prices are hovering around us $ 32 a barrel. the global oil prices today are thus about 10 per cent higher than they were at the time of the mid - term policy statement. the outlook for oil prices in the near term appear highly uncertain. secondly, world primary commodity prices have also increased in 2003. these trends, along with revival of growth and falling excess capacities in several advanced economies have brought about a noticeable shift in the outlook for prices. the fear of deflation in advanced economies has been replaced by a possible upward pressure, led by increases in commodity prices. no doubt, these international developments enhance the probability of international transmission of inflation. at the same time, there are three favourable factors to counter these recent adverse global developments. first, in the normal course, it is expected that the inflation rate would fall in the period mid - january to march 2004. secondly, there are cushions in terms of food stocks and ample forex reserves. thirdly, our economy has, in recent years, shown remarkable resilience in absorbing shocks including on the oil front. in view of all these factors, it is possible that the downward bias may not be attainable but it appears that the range of 4. 0 per cent to 4. 5 per cent for inflation indicated in the mid - term review continues to be relevant for policy purposes unless there are unanticipated severe shocks. it may be noticed that the policy assumption in april 2003 was 5. 0 - 5. 5 per cent and the latest assessment placing it in the range of 4. 0 - 4. 5 per cent demonstrates that, overall, inflationary situation continues to be benign for 2003 - 04. there has been a marginal improvement in central government finances since the mid - term policy statement. the gross fiscal deficit of the central government as at the time of mid - term review which was higher by 40. 3 per cent ( based on fiscal data available up to september 2003 ) is now higher by 12. 3 per cent ( based on fiscal data available up to november 2003 ) over the corresponding periods of last year. similar improvement is also seen on the revenue account, which was higher by 37