mr hayami reports on recent monetary and economic conditions in japan and elucidates progress toward the reconstruction of japan ’ s financial system speech by the governor of the bank of japan, mr masaru hayami, at the research institute of japan in tokyo on 18 march 1999. i. introduction1 it is a great honor to be invited to the research institute of japan and have the opportunity to speak to you. i will begin with a brief outline of recent monetary policy management and then give my thoughts on today ’ s topic, the progress toward the revitalization of japan ’ s financial system. ii. recent monetary policy management monetary easing in february 1999 on february 12, the bank of japan decided to conduct a further monetary easing. the new guideline for the bank ’ s money market operations is to “ encourage the uncollateralized overnight call rate to move as low as possible ” while giving due consideration to avoiding excessive volatility in the markets. let me review the economic situation at the time of the decision. the pace of economic deterioration had been moderating since last autumn, supported by the increase in public investment. however, economic activities in the private sector remained sluggish, and business and consumer sentiment was persistently weak. moreover, the rise in long - term interest rates and the appreciation of the yen against the u. s. dollar since the end of last year had added to the downside risk to the economy. there was concern that, if these trends continued, the economic deterioration would not come to a halt, possibly accelerating once again in the future. in light of these developments, the bank judged that it would be appropriate to give maximum support to economic activity through monetary policy. there have been some changes in the financial market since the monetary easing. the overnight call rate has fallen, recently to close to zero percent, reflecting the bank ’ s provision of ample funds to the market. money market interest rates on instruments with relatively long maturities, such as one month and three months, have also declined considerably. in addition, long - term interest rates have marked a clear decline, although the monetary easing was probably not the only factor involved. the yen has generally followed a downward trend. stock prices, as measured by the nikkei 225 stock average, have recovered to around \ 16, 000. we believe that, if these trends in the financial markets continue, they will influence the economy positively through an improvement in returns on investment, a further alleviation of the

##ent borrowing conditions. in mid - march, a major investment bank, the bear stearns companies, inc., was pushed to the brink of failure after suddenly losing access to short - term financing markets. the federal reserve judged that a disorderly failure of bear stearns would pose a serious threat to overall financial stability and would most likely have significant adverse implications for the u. s. economy. after discussions with the securities and exchange commission and in consultation with the treasury, we invoked emergency authorities to provide special financing to facilitate the acquisition of bear stearns by jpmorgan chase & co. in addition, the federal reserve used emergency authorities to establish two new facilities to provide backstop liquidity to primary dealers, with the goals of stabilizing financial conditions and increasing the availability of credit to the broader economy. 1 we have also taken additional primary dealers are financial institutions that trade in u. s. government securities with the federal reserve bank of new york. on behalf of the federal reserve system, the new york fed's open market desk engages in the trades to implement monetary policy. steps to address liquidity pressures in the banking system, including a further easing of the terms for bank borrowing at the discount window and increases in the amount of credit made available to banks through the term auction facility. the fomc also authorized expansions of its currency swap arrangements with the european central bank and the swiss national bank to facilitate increased dollar lending by those institutions to banks in their jurisdictions. these steps to address liquidity pressures coupled with monetary easing seem to have been helpful in mitigating some market strains. during the second quarter, credit spreads generally narrowed, liquidity pressures ebbed, and a number of financial institutions raised new capital. however, as events in recent weeks have demonstrated, many financial markets and institutions remain under considerable stress, in part because the outlook for the economy, and thus for credit quality, remains uncertain. in recent days, investors became particularly concerned about the financial condition of the government - sponsored enterprises ( gses ), fannie mae and freddie mac. in view of this development, and given the importance of these firms to the mortgage market, the treasury announced a legislative proposal to bolster their capital, access to liquidity, and regulatory oversight. as a supplement to the treasury's existing authority to lend to the gses and as a bridge to the time when the congress decides how to proceed on these matters, the board of governors authorized the federal reserve bank of new york to