pressure on the manufacturing sectors of commodity exporters coming from the strength in their exchange rates, again in the absence of traditional demand from the g - 3. adjustment is inevitable – and it will be substantial. in general, such changes should not be frustrated, but rather facilitated by policies that enhance economic flexibility. second, all countries need to maintain price stability in an environment where g - 3 monetary policy cannot be expected to lead the global cycle. as i will discuss in a moment, a key mistake would be to let fears of capital inflows and exchange rate pressures dominate the imperative of domestic price stability. it is paramount that monetary policy everywhere acts to ensure that inflation expectations remain in line with medium - term policy objectives. everything else being equal, higher commodity prices usually necessitate higher policy interest rates. the degree of the policy response depends on many factors, including the reasons behind the price increases, the expected persistence of the shock, and whether a country is a net exporter. policy - makers also need to weigh the importance of commodities in the consumption basket ( chart 7 ), the historic experience with price pass - through, and how well anchored are inflation expectations. it bears consideration that the terms - of - trade shock could be even more disruptive. most of us have become heavily reliant on manufactured goods and components from china ( table 2 ). for example, in canada, partly as a consequence of chinese trade, goods price inflation has run about 1 per cent for the past decade. however, with commodity prices rising sharply in china, second - round effects on manufactured goods pricing are possible, due to rising wages and input costs and, potentially, exchange rate appreciation. finally, it has to be considered that the process of globalization, with its large - scale displacement, may actually reduce potential growth in advanced economies during the adjustment phase. 6 canada has learned through long experience that the role of the exchange rate is crucial. for commodity exporters, improvements in the terms of trade tend to put upward pressure on the exchange rate. when such movements in the nominal exchange rate are limited, wages and a range of other prices respond. this is a more disruptive form of adjustment that can have profound implications for employment, financial stability and competitiveness – the very objectives exchange rate management seeks to protect. recent experience suggests that many emerging economies are taking the real adjustment through higher domestic inflation ( chart 8 ), in part because of concerns over capital inflows. to the extent that the nominal exchange

hirohide yamaguchi : path toward overcoming deflation and pursuit of monetary easing speech by mr hirohide yamaguchi, deputy governor of the bank of japan, at a meeting with business leaders, hiroshima, 25 july 2012. * * * introduction thank you for giving me an opportunity to exchange views with administrative and business leaders in hiroshima. and i express my gratitude to everyone for your cooperation in various business operations of the bank of japan ’ s hiroshima branch. today, before exchanging views with you, i will first talk about the developments in overseas economies, including the european debt problem, followed by a short - term outlook and medium - to long - term challenges japan ’ s economy is faced with, while focusing on the recent developments in domestic demand. finally, i will talk about the recent monetary policy conduct of the bank of japan. i. developments in overseas economies : future recovery that stands back to back with a big risk let me start with the developments in overseas economies. while the economies were recovering after around mid - 2009 from the lehman shock in autumn 2008, the pace of recovery has somewhat slowed after the second half of 2011 and they still have not gotten out of a deceleration phase. by region, the u. s. economy has been moderately recovering, partly supported by accommodative financial conditions. while there are cautious views in the market on the outlook for the u. s. economy as the growth in the number of workers has been slowing since early spring, private consumption has been increasing moderately and home sales, which remained low for a long time, have been showing signs of a pick - up. that suggests that the household sector ’ s debt burden, which weighed on the economy after the lehman shock, has been gradually easing. it is also expected that a decline in gasoline prices since early spring will increase households ’ real purchasing power and underpin an increase in private consumption. therefore, while the pace of growth might not accelerate markedly, it is likely that a moderate recovery will basically continue without interruption. the european economy as a whole has been stagnant, due partly to the european debt problem, which i will talk about later, and will continue to be in a severe situation for the time being. in the meantime, in china, the economic slowdown has been still continuing. the year - on - year growth rate of real gdp was on a downtrend after it peaked at the beginning of 2010 at 12 percent, and fell below 8 percent in