whether this performance is sustained will be importantly determined by whether growth is supported by increases in the economy's potential. i am hopeful that potential growth, and particularly productivity, could accelerate from its relatively anemic pace of late, sustaining growth without overheating the economy. the more the economy's potential growth increases, the more gradual we can be in our removal of monetary policy accommodation. thus, an assessment of the pace of potential growth will be an important 2 / 5 bis central bankers'speeches input into what i view as the appropriate path of policy to achieve our objectives of maximum sustainable employment and price stability. the difficulty in identifying potential the tricky thing, as i pointed out earlier, is that potential output is unobserved and can only be inferred from the behavior of other measured economic indicators. traditionally, as taught in econ 101, inflation provides a signal on whether the economy is operating above or below its potential level. if inflation moves up in a sustained manner, not just because of temporary shocks, then the economy is likely operating above its productive capacity, as firms have the leeway to raise prices given the strength of demand. likewise, if inflation moves down persistently, then the economy is likely operating with some slack, as firms restrain prices to sell their products in the face of weak demand. if inflation is the primary indicator of the economy's position relative to potential, how confident can we be in the quality of the signal? it has been noted - - quite frequently, i might add - - that the relationship between inflation and the tightness of the economy has gotten weaker, which is to say that inflation appears to be less affected by movements in economic slack or tightness, traditionally measured by the unemployment rate, than in the past. as the role of slack in explaining inflation has diminished, inflation expectations have assumed greater importance. however, it is reasonable to ask, if inflation is, in fact, now largely a reflection of inflation expectations, is inflation still a good indicator of the cyclical state of the economy? or, more directly, can we count on inflation to warn us in time if the economy is overheating? to be a little controversial, perhaps what we are witnessing with inflation is an application of what has been called goodhart's law, named after charles goodhart, the distinguished scholar of central banking at the london school of economics. 4 the law can be summarized as the idea that if an indicator becomes a target of policy, that

oil prices. domestic wholesale prices are levelling off due to the progress in inventory adjustment as well as an increase in prices of some products closely related to international commodities, such as those of petroleum products. consumer prices continue to be unchanged. corporate service prices are still falling, although the pace of the decline is slowing. as regards the movements of overall prices in the future, they are likely to be flat, this report was written based on data and information available when the bank of japan monetary policy meeting was held on 13 october 1999. the bank ’ s view on recent economic and financial developments, determined by the policy board at the monetary policy meeting held on 13 october as the basis of monetary policy decisions. as the rise in crude oil prices to date will continue to be passed on to prices of other products for a while. however, substantial narrowing in the output gap led by a recovery in private demand is unlikely for the time being, and wages continue to decline. thus, downward pressure on prices is expected to remain. in the financial market, the overnight call rate has stayed at nearly zero, and financial institutions have been confident about the availability of overnight funds. as for interest rates on term instruments, short - term rates maturing before the year - end have been moving at a historically low level. meanwhile, rates maturing beyond the year - end are relatively high due to market participants ’ concern over the year 2000 problem. the japan premium has continued to be nearly zero for short - term transactions, but a small premium has been observed for transactions maturing beyond the year - end. yields on long - term government bonds declined from late august to the level of around 1. 6 percent. they rose somewhat thereafter and have recently been moving between 1. 7 and 1. 8 percent. the yield spread between government bonds and private bonds ( bank debentures and corporate bonds ) has been stable and noticeably smaller than before. stock prices fell below the 17, 000 yen level in late september against the background of the weak tone in u. s. stock prices and the rapid appreciation of the yen, but subsequently rebounded reacting to the recovery in u. s. stock prices and the restoration of stability in the foreign exchange market. the prices are presently moving around 18, 000 yen. in the foreign exchange market, the yen surged against the u. s. dollar and reached the 103 – 104 yen level in the middle of and late september, but then declined to the current level of 106 — 108 yen to