the real interest rate neutral to economic activity, declined. standard economic theory implies that the degree of monetary accommodation is determined by to what extent real interest rates are lower than the natural rate of interest. in japan, real interest rates remained high due to deflation expectations while the natural rate of interest declined due to a decline in the potential growth rate. as a result, despite the low nominal interest rates, monetary accommodation remained insufficient and could not sufficiently stimulate the economy. firms ’ unwillingness to invest despite low interest rates represented such a bis central bankers ’ speeches situation. the breakthrough to that is either decreasing real interest rates by increasing inflation expectations or raising firms ’ expected returns and the natural rate of interest by enhancing the growth potential. japan is now tackling both of them. the former corresponds to the qqe that the bank has been pursuing and the latter corresponds to what firms have been tackling under the government ’ s growth strategy. ii. achieving the price stability target of 2 percent and transforming japan ’ s economy next, let me talk about the qqe. the mechanism of the qqe starts from showing the bank ’ s strong and clear commitment to achieve the price stability target of 2 percent at the earliest possible time, and converting people ’ s deflationary mindset. concurrently, the bank has put downward pressure on the entire yield curve including longer - ends through its massive purchases of japanese government bonds ( jgbs ) and has lowered nominal interest rates further. as a result, real interest rates have declined, which has generated a situation in which you must come to recognize that financial conditions are accommodative in not only nominal terms but also real terms. in such financial conditions, coupled with the effects of other policies, private demand has increased, the output gap has improved, and actual prices have increased. if firms and households experience actual price increases, they will come to realize that prices will increase and thus inflation expectations are expected to increase further. in the economy, in which the price stability target of 2 percent is achieved by pursuing this mechanism, the rational behavior of firms and households should not be to hoard cash and deposits, but to invest and consume. in a situation in which prices rise moderately, the real return on cash hoardings is negative. if firms accumulate retained earnings gained by cost reductions and hold them simply in cash and deposits, the value of those firms is impaired. it is imperative for firms to undertake strategic initiatives such as improving their production system, carrying

hearing that “ those who are benefitting from the qqe seem to be only large firms and wealthy households that hold financial assets, thus the benefits do not seem to be spreading through the whole economy ” and “ even if deflation is overcome, making a living might actually become difficult unless wages rise in accordance with a price increase. ” japan ’ s economy is currently in the process of transition from a shrinking equilibrium under deflation to an expanding equilibrium under the 2 percent inflation. in the process in which such a major change occurs at a relatively high speed, it is inevitable that its effects arise differently depending on the sector, the firm size, and the income bracket. even so, it is without question that japan ’ s economy is heading for the better. i believe that none of those unsatisfied with the current economic situation thinks that the situation during the deflationary period was better. today, i will elaborate as clearly as possible on what the economic state the bank of japan aims at would be like in comparison with the deflationary state. on that basis, i will explain how far we have proceeded and what challenges are left to be dealt with, going forward. i should say that overcoming deflation and achieving the price stability target of 2 percent will benefit not only some firms and financial asset holders, but also a wide range of sectors and a variety of people. bis central bankers ’ speeches i. what does the deflationary economy look like? in japan, deflation – a situation in which prices keep declining – continued for 15 years since the latter half of the 1990s. in that situation, firms and households behave on the assumption that prices will not increase, or that prices will fall moderately. as a result, their spending behavior has become passive. since firms could not expect an increase in sales, the top priority of management was to ensure profits and stabilize firms ’ financial conditions by cost reduction – such as reducing the number of employees, wages, or expenses for materials – and by compressing business fixed investment as much as possible. however, cost reduction or investment reduction was nothing but equivalent to a decline in demand for goods and services of other firms, and as a result, the corporate sector as a whole could not increase profits. firms ’ cost reduction resulted in a decline in wages for households. households were able to avert facing a surge in unemployment against the background of a tradition in japan that people prioritize job security, but had to change their employment status from regular