. stage 1 is where firms reflect higher import prices in their selling prices. stage 2 is where they reflect the increase in general price levels in wages they pay. stage 3 is where they reflect higher labor costs in their selling prices. stage 4 is where firms'pricing policies become more diverse, facilitating firms'exploration of strategies of selling more attractive products and services at commensurate prices in addition to those of selling good products and services at low prices. this stage may provide firms with broader options for attaining higher productivity. some might argue that firms have always endeavored to develop products and services that are attractive to customers and to set prices at levels commensurate with the value, and that this has been the case regardless of whether firms have entered stages 1 to 3. while i believe this to be true, let me examine if there could be a development which could facilitate and encourage a broader range of firms to make further efforts. in recent months, the import price index has declined more than 10 percent compared to a year ago, and thus if the firms just stop at stage 1 - - a pass - through of higher import prices - - the japanese economy may revert to the former deflationary state. on the other hand, if a virtuous cycle begins in which both stage 2 - - wage hikes - - and stage 3 - - a pass - through of higher labor costs to selling prices - - progress, moderate inflation may be sustainable. however, if wages increase just as much as prices rise, this will not make people better off in real terms. living standards would rise if the wage - price cycle ushers in stage 4 - - firms diversifying pricing strategies and pursuing broader options in adding higher value to their products and services as well as in enhancing productivity - - and if the gains from the enhanced productivity are shared with stakeholders. stage 1 corresponds to imported inflation, or what we call " the first force, " and stages 2 and 3 correspond to homemade inflation, or what we call " the second force. " 1 stage 4 does not necessarily correspond to inflation if firms'pricing is commensurate with the increased value added to their products. judging from what we have heard from firms, progress seems to be mixed in each of the four stages at present. regarding stage 1, a survey of small and medium - sized firms showed that many firms could pass on only a portion of higher import prices. there was similar feedback from a large japanese firm in the basic materials

in market operations and other bank transactions should be made open to non - bank entities. if we look at examples overseas, it appears that the ecb will carry out its market operations only with banks. in the united states, however, the federal reserve conducts market operations with so - called primary securities dealers, many of which are securities companies that do not have accounts at federal reserve – 6 – banks. a key point in considering this counterparty issue is whether the emphasis is on interbank transactions or open market transactions. if a central bank primarily conducts interbank transactions, the counterparty will naturally be the banking sector. yet it seems that the global trend is a growing preference by central banks for open market transactions. in japan, the bank selects counterparties according to its own eligibility criteria from among banks, securities companies, tanshi companies ( money market broker - cum - dealers ), and other institutions that have accounts with the bank. in the final analysis, i think that the rational solution to this issue is not to restrict counterparties to banks, but choose them from a wider range of entities in order to achieve swift and certain permeation of policy effects and adequate control of counterparty risk, while taking into account such factors as changes in the financial structure. it is certainly essential that the money market, where the central bank makes transactions, be sufficiently developed in both qualitative and quantitative terms. in this regard, japan will soon have a fully fledged fb market with the introduction of a public auction system for fb issues. as such open market transactions expand, leading to diversification of financial services providers, the bank will review its selection of counterparties in the bank ’ s market operations. c. corporate bonds and equities the third question is whether the bank should purchase corporate bonds and equities in view of the critical state of the japanese economy. this argument is based on the fact that the stock market was at one time supported by the public sector ’ s purchase of equities. it is also the view of the advocates of such intervention that, if the bank is concerned about risks, it can ask for government guarantees. first of all, i would like to emphasize that a central bank can create liquidity but not capital. there is intrinsically a definite limit to the extent to which a central bank can take on private - sector risk. assuming such risk and compromising the quality of its assets might impair the bank ’ s credibility, which is needed to fulf