bank of japan ’ s january report of recent economic and financial developments1 bank of japan, communication, 19 january 2000. * * * the bank ’ s view2 japan ’ s economy, which had stopped deteriorating, has recently started to improve, with exports and production increasing. the economic environment surrounding private demand is gradually improving, as seen in the continuing increase in corporate profits. however, clear signs of a selfsustained recovery in private demand have not been observed yet. with regard to final demand, housing investment has recently peaked out, and public investment seems to have stopped rising. recovery in private consumption continues to be weak through lack of notable improvements in employment and income conditions. business fixed investment, which had been on a downward trend, shows signs of leveling off. meanwhile, net exports ( real exports minus real imports ) continue to follow an upward trend, despite monthly fluctuations, due to an upturn in overseas economies. reflecting such developments in final demand and progress in inventory adjustment, industrial production continues to rise and an increase in corporate profits is becoming distinct. in this situation, corporate sentiment continues to improve. regarding the employment condition, there are some indicators that suggest a slowdown of decrease in the number of employees. the positive developments in corporate profits and sentiment, however, have not necessarily stimulated business activities, because firms still strongly feel that they have excess capacity and employees and that they should reduce their debts to restore financial soundness. in addition, efforts by firms to reduce personnel expenses have prolonged the severity of households ’ income conditions. as for the outlook, improvements in the overall financial environment partly due to the monetary easing by the bank, along with a series of economic measures taken by the government, are expected to continue underpinning the economy. moreover, the positive impact on domestic production of the recovery of overseas economies, especially of asian economies, is likely to continue for some time and have favorable effects on corporate profits and then on household income. by contrast, it is highly probable that housing investment will remain flat for the time being. in addition, firms are expected to maintain a cautious stance toward business fixed investment based on their modest prospects for sales, although corporate restructuring is improving profitability to some extent. moreover, it seems that the appreciation of the yen since the summer of 1999 will have an adverse effect on corporate profits in the near term. in these circumstances, future economic developments still require careful monitoring in spite of the gradual recovery in the environment for private demand. furthermore, it is important to

will argue, is justified by both theory and empirical evidence, and which has served us very well in the conduct of our policy since the establishment of the ecb. on this last point, we have no doubt. in fact, we have organised this conference because we are interested in promoting scholarly debate on these important issues in an open and transparent manner. we believe that we can all benefit by sharing our experiences and learning from each other. in my remarks, i would like to share with you some thoughts on four issues pertaining to the role of money in the design and implementation of monetary policy. these issues relate to the theoretical arguments, the empirical evidence, the uncertainty and practical considerations facing policy - makers that have a bearing on the role of money in the conduct of monetary policy. in addition, i will briefly address the role of money in performing the central banking task of safeguarding financial stability. ii. theoretical arguments what are the basic principles and theoretical arguments supporting the view that money is the fundamental determinant of the price level over the medium and long term, and that money and its counterparts – notably credit – play a key role in the transmission of the effects of monetary policy to the economy? the essential role of money as the fundamental determinant of the price level can be established – and has been established – in the context of a microeconomic general marketequilibrium framework and a stylised consensus macroeconomic model. at a microeconomic level, and under certain plausible and rational assumptions concerning agents ’ preferences and optimising behaviour, the conditions for equilibrium in the product, services, labour and asset markets determine the relative prices of goods and services, the real wage ( in terms of a general price index ), and the spectrum of the relative real rates of return on all assets, including the associated risk premia. the determination of the general price level, and its rate of change, requires control of the nominal quantity of base money or of some other monetary aggregate that can be effectively controlled by the central bank. this result reflects the role of money both as a medium of exchange and as a unit of account. under price and wage flexibility, and in the absence of any nominal rigidities, the price level will promptly and fully respond to a change in the money stock. more generally, the determination of the price level by the nominal quantity of money will be established in the long - run equilibrium. at an aggregate, macroeconomic level, the fundamental proposition concerning the link between the supply