masaaki shirakawa : bubbles, demographic change and natural disasters opening speech mr masaaki shirakawa, governor of the bank of japan, at the 2011 annual international conference hosted by the institute for monetary and economic studies, bank of japan, tokyo, 1 june 2011. * i. * * introduction good morning. i am very pleased to address the bank of japan annual international conference. on behalf of my colleagues at the bank of japan, i welcome all the participants from central banks, international organizations, and academia. japan was hit by an unprecedented earthquake and tsunami on march 11th, the day that was etched into our memory. the scars are yet to heal in the quake - stricken regions. in the aftermath of the disaster, however, we japanese were not in a hopeless situation. we have received lots of support and numerous warm messages from our friends abroad. i express my sincere gratitude to those whose hearts and thoughts have been with us since the day. the title of this year ’ s conference is “ real and financial linkage and monetary policy. ” conventional macroeconomics has analyzed macroeconomic dynamics through the two lenses, trend growth and business cycles. while the two lenses remain important, over the past quarter century, the need to incorporate a third lens, rare but large events including financial crises, was increasingly recognized, by policy makers and academics alike. i myself already addressed the issue of bubbles and financial crises in the opening remark at the previous year ’ s conference. 1 this year, through this third lens, i find myself left with no choice but to refer to the repercussions of a natural disaster. at the other extreme compared with sharp, unanticipated shocks like financial crises and natural disasters, i also recognize the fully anticipated development, a demographic change, which japanese economy is undergoing, as the paramount issue. today, i will pick three issues, bubbles and resulting financial crises, demographic changes and natural disasters as the factors driving economic dynamics and call for further research on them. ii. a retrospective view of the japanese economy in the past quarter century and research agenda going forward the day after the great east japan earthquake before we move on, i will brief you on how matters stand in the japanese economy. in the aftermath of the earthquake, production has declined very sharply due to supply constraints caused primarily by the destruction of capital stock, disruptions in supply chains and a shortage of electric power ( slide 1 ). as a result, exports have decreased substantially, and domestic

while domestic demand is likely to maintain firmness as external demand is expected to increase, albeit moderately, the virtuous cycle among production, income, and spending is likely to be maintained. in terms of the real gdp projections in the outlook report released last week, that for fiscal 2013 is somewhat high, at 2. 7 percent, partly reflecting a front - loaded increase in demand prior to the consumption tax hike. thereafter, real gdp is expected to decline in fiscal 2014 to 1. 5 percent, partly reflecting a drop following the tax hike, and should be 1. 5 percent in fiscal 2015 ( chart 1 ). therefore, while the economy will be affected by a swing of the front - loaded increase and subsequent decline in demand prior to and after the two scheduled consumption tax hikes, it is likely to continue growing at a pace above its potential, which is estimated to be around 0. 5 percent, as a trend. bis central bankers ’ speeches two points that deserve particular attention in looking to the future of japan ’ s economy are the sustainability of firm domestic demand and the outlook for overseas economies. sustainability of firmness in domestic demand first is the sustainability of domestic demand. the major feature of the recovery this time is that, starting with domestic demand such as private consumption and public investment, the nonmanufacturing sector has been leading the recovery. this differs from typical patterns of postwar recovery in japan, in which the recovery started with an increase in exports and production and was led mainly by the manufacturing sector. in fact, while production in the manufacturing sector has remained at about 80 percent of its peak prior to the lehman shock, the indices of teritiary industry activity, which show developments in the nonmanufacturing sector, have recovered to a level close to that seen prior to the lehman shock. looking at the diffusion index ( di ) for business conditions in the tankan survey, the di for the nonmanufacturing sector has been better than that for the manufacturing sector in this recovery phase ( chart 2 ). of this firm domestic demand, private consumption had been supported by an improvement in consumer confidence and wealth effects from the rise in stock prices since the turn of the year, while buoyant consumption by the elderly, notably baby boomers, had been serving as an underlying factor ( chart 3 ). recently, it also has begun to be backed by improvement in the employment and income situation. namely, the employment situation continues to improve moderately but steadily, with both