s balance sheet the failure of some financial institutions in autumn 1997 was followed by increased anxiety about the stability of the financial system, which has had a dampening influence on economic activity. the bank has responded to this situation by implementing a variety of monetary policy measures, including an additional lowering of the target call rate on september 9, 1998 and continued provision of ample liquidity under the relaxed policy stance. – 2 – the bank has also taken the following measures in its money market operations. first, the bank has injected large amounts of longer - term funds to ease the upward pressure on market interest rates maturing beyond the end of the semiannual accounting term in september and the end of the calendar year in 1998. this has caused the bank ’ s balance sheet to expand by about 40 percent over the year. second, the bank has adopted some new measures to facilitate corporate financing, such as increasing commercial paper ( cp ) repo operations and introducing a temporary lending facility in november 1998. as a result, there has been a continuing rise in the proportion of private - sector debt to the asset account on the bank ’ s balance sheet. third, as part of its efforts to maintain financial stability, the bank has expanded special lending since 1997 under article 38 of the bank of japan law of 1997. the function of these loans, which is to provide emergency liquidity to ensure financial system stability, has recently been taken over by loans to the deposit insurance corporation ( dic ). the bank ’ s balance sheet has thus changed dramatically over the past year. the change is a reflection of the bank ’ s constant efforts to combat the economic downturn and the increasing uncertainty about financial stability. however, the expansion of the balance sheet has also given rise to a significant number of questions and criticisms focusing on a perceived threat to the financial soundness of the bank. i would therefore like to devote the rest of my speech to a fairly detailed examination of the bank ’ s role and its approach to provision of credit, in light of the changes in the bank ’ s balance sheet. iii. extension of credit by the bank of japan a. the role of a central bank and its balance sheet before explaining why the soundness of the bank ’ s balance sheet has become an issue, i need to refer to the mission of a central bank. in brief, the mission of the bank of japan, the central bank of japan, is to issue banknotes, ensure the functions of the currency, and contribute to the sound development

##ilient demand has significantly contributed to the recent rise in underlying inflation in the euro area ( slide 2 ). the second channel relevant for monetary policy is the cost - push channel. wages are an important element in firms ’ cost structure. in the services industry, for example, wages account for around 40 % of firms ’ total cost of production. [ 3 ] thus, changes in wage dynamics are typically significant enough to affect firms ’ future pricing decisions. an example of this cost - push view of inflation is the increase in the minimum wage in germany, which takes effect tomorrow. [ 4 ] according to a survey, around 60 % of affected firms said that they intend to raise prices in response to the increase in the minimum wage. central banks have different ways to analyse and evaluate the relevance and strength of these two channels for the inflation outlook. despite its pitfalls, a prime tool for making such an assessment is the new keynesian phillips curve. under this framework, firms set prices as a mark - up over marginal costs. because firms are forwardlooking and change prices only infrequently, profit maximisation implies that consumer price inflation fundamentally depends on current and future expected real marginal costs. real marginal costs, in turn, can empirically be related to average cost measures, such as real unit labour costs, which are defined as the ratio of real wages to labour productivity. using real unit labour costs as an indicator yields two important insights. one is that rising real wages resulting from stronger productivity growth will leave unit labour costs unchanged and will not put pressure on firms ’ profits. it should, therefore, not lead to firms raising prices. the cost - push channel thus critically depends on future productivity developments. the second insight is that, from an accounting perspective, real unit labour costs are identical to the labour share of income. that is, for the aggregate demand channel to be consistent with higher inflation, the labour share of income should go up. a declining labour share will weigh on aggregate demand the link between the labour share and inflation is not just a conceptual idea. new research by economists at the federal reserve board suggests that the sharp decline in inflation in the united states and the united kingdom in the 1980s may have been driven to a significant extent by the marked decline in the labour share. the study suggests that the secular erosion of workers ’ bargaining power is an important factor explaining the joint dynamics of inflation and the labour share. the same mechanism has likely been at work in the euro area.