nominal rates are those that can be seen, real rates represent the extent to which money – i. e., purchasing power – will increase in reality, taking account of price changes. if people expect that inflation is on the horizon, the expected purchasing power of those assets, such as cash – which does not yield any returns – as well as deposits and bonds – which have fixed returns – will go down. suppose the nominal rate of jgbs is 0. 5 percent and the inflation expectation for the next 12 months is 1. 0 percent. the real rate will then become minus 0. 5 percent by subtracting the inflation expectation of 1. 0 percent from the nominal rate of 0. 5 percent. this example suggests that, even if the nominal rate is 0. 5 percent, as long as the inflation rate remains at 1. 0 percent, the purchasing power of jgb holdings after a year will go down by minus 0. 5 percent. likewise for cash, given that its nominal rate is 0 percent, the purchasing power bis central bankers ’ speeches of cash holdings after a year will decline by 1. 0 percent if the inflation rate is 1. 0 percent. indeed, the real rates derived from the jgb yields have been declining moderately as a trend since end - 2012 ( chart 2 ). as i explained, if people expect prices to go up down the road, the real rates of return from cash as well as deposits and bonds – for which interest rates are fixed – will decline. holding those assets will become less attractive than in the past. in light of such developments, market participants with rising inflation expectations will shift part of their portfolios from cash, deposits, and bonds including jgbs to equities ( including equity trust funds ), real estate and homes ( including real estate investment trusts such as j - reits ) or, alternatively, foreign - denominated assets for which returns are higher than those derived from yen - denominated assets. as a result of this, expectations would be for stock prices to rise, the yen to depreciate, and foreign currencies to appreciate ( chart 3 ). increase in consumption and exports both rising stock prices and the yen ’ s depreciation will lead to an increase in the value of household assets that are held in the form of either equities or foreign - denominated assets. according to recent statistics, the financial assets of households at end - june 2013 increased by 5 percent on

kikuo iwata : purpose and mechanism of quantitative and qualitative monetary easing special lecture by mr kikuo iwata, deputy governor of the bank of japan, commemorating the 50th anniversary of the institute of economic research, chuo university, chuo, 18 october 2013. * * * introduction it is a great honor for me to give a special lecture to commemorate the 50th anniversary of the foundation of the institute of economic research, chuo university. i wish to extend my great respect to those who were involved in its foundation and activities, and thank you for inviting me to speak on such a distinguished occasion. on april 4, the bank of japan introduced a new policy framework, called quantitative and qualitative monetary easing ( qqe ). it decided that it would continue with the qqe, aiming to achieve the price stability target of 2 percent in terms of the year - on - year rate of change in the consumer price index ( cpi ), as long as it is necessary for maintaining that target in a stable manner. in my lecture today, i would like to answer the following three questions. first, why does the bank aim to achieve and maintain the price stability target of 2 percent? second, what is the transmission mechanism through which the qqe achieves and maintains its purpose? lastly, is japan ’ s economy moving along the path that the bank has anticipated? i. reason behind the price stability target of 2 percent let me start with the first question – namely, why does the bank aim to achieve and maintain the price stability target of 2 percent? the first answer is that deflation must be avoided once and for all. it squeezes corporate profits through price declines of goods and services. for this reason, unless companies manage to sell more goods and services, they will be put in a situation where they cannot pay their debts. put differently, the real value of debts will increase as deflation continues. in light of an increasing real value of debts, firms become cautious in terms of their attitude toward business investment that requires fund - raising. as a result, production and labor demands of the economy as a whole will decline, leading to a rise in the unemployment rate and a decline in wages ; hence, people ’ s living standards will go down as well. on top of this, an inflation rate of about 1 percent is not necessarily enough as a buffer against the slightest risk of deflation. the second answer to the question is the upward bias