activity in various ways. in contrast, price hikes due to a rise in the consumption tax rate are equivalent to a once only rewriting of all the old price tags on april 1. there are no relevant changes in economic activity, such as a tightening of supply and demand conditions, an increase in wages, or excessive money supply. therefore, it would not be appropriate to formulate monetary policy against such superficial changes in prices. although this represents the fundamental thinking of the bank, it does not mean that the central bank is indifferent to the rise in the consumption tax rate. if the rise triggers price hikes taking advantage of the tax rate rise, or if overall inflationary expectations are heightened, then the risk of a genuine inflation will arise. in particular, this risk cannot be disregarded when the supply and demand conditions for products are fairly tight. therefore, it is necessary to pay attention to the inflationary expectations and possible over - reactions caused by the rise in the consumption tax rate rather than paying attention to the previously - mentioned superficial hikes in prices. in summary, in order to promote a smooth structural adjustment, to bring about a strengthening of the economic recovery, and to encourage the renewed development of the japanese economy, the implementation of a drastic structural reform, including effective deregulation, is indispensable. in this respect, i hope that the government will continue to exercise strong leadership and earnest efforts will continue to be made by various parties. v. financial system reform and revision of the bank of japan law a. financial system reform i would like to use the remaining time to discuss financial system reform and the revision of the bank of japan law. the important challenge for japan today is to vigorously promote structural reform as discussed above, and this also applies to the reform of the financial markets and of the financial system. financial markets worldwide have experienced significant changes in recent years amid rapid financial and economic globalization and technological innovation. new financial instruments such as derivatives and securitized products have been developed in succession to provide firms and households with diverse means of risk - hedging, investment, and financing. at the same time, profit opportunities for financial institutions have expanded in various fields. it seems that it is now time for the market participants to select the market, rather than the markets selecting the participants. countries are vying with each other to reform their financial markets, based on a growing worldwide perception that the financial services sector will show rapid growth and create numerous employment opportunities into the twenty - first

mr matsushita comments on recent monetary and economic conditions in japan speech given by the governor of the bank of japan, mr yasuo matsushita, at the keizai club in tokio on 4 / 2 / 97. i. introduction i truly appreciate this opportunity to address this distinguished audience at the invitation of the keizai club. over the past several years, the japanese economy has had to overcome the aftereffects of the bursting of the economic “ bubble ” while facing the weighty challenge of establishing an economic structure suitable for the new era. although there were concerns about a deflationary spiral at one time, the economy has been recovering moderately since the beginning of 1996 partly due to strong monetary and fiscal support. recently, this economic recovery has gradually firmed, offering signs that progress has been made toward establishing this suitable economic structure. however, since the beginning of the year, stock prices have fallen significantly, suggesting that market participants remain cautious about the economic outlook. with this in mind, i would like to discuss the bank of japan ’ s thinking on the recent economic developments and monetary policy management, together with the bank ’ s views on the uncertain factors regarding the economic outlook. ii. domestic economic condition with regard to the domestic economic condition, the bank of japan ’ s judgment is that a moderate economic recovery continues, and that the economic recovery is gradually becoming firmer. when considering the strength of an economic recovery, the bank pays attention to the positive interactions between production and private demand. specifically, attention is given to whether the increase in production is leading to an expansion of business fixed investment through improved corporate profits, and whether this increased production is followed by a recovery in personal consumption through increased income. looking back on the economic developments in japan over the past year from a viewpoint of determining the strength of the recovery, the growth of aggregate demand, including public and housing investments, accelerated in the first half of 1996, and accordingly, market expectations of an economic recovery strengthened and long - term interest rates showed a temporary rise. however, no significant improvement was seen in production, as the increase in final demand was partly offset by inventory adjustment and by an increase in imports. as a result, a virtuous circle of demand, production, and income was not confirmed. this situation, however, appears to have changed somewhat in the latter half of 1996. firstly, the decline in external demand, which had been a constraining factor of the economic recovery, halted in autumn 1996