liquidity, and the quality of loans continues to deteriorate because of the adverse feedback loop between the financial system and the real economy. a “ mirage ” phenomenon is taking place in that, despite public capital injection, concern over additional losses on the assets mounts over time and such concern in turn will heighten concern for a capital shortage of financial institutions. under those circumstances, it is of vital importance to remove uncertainty. there are two options to remove uncertainty stemming from financial institutions ’ nonperforming assets ; the government purchases those assets or provides a loss guarantee to those assets. nevertheless, even in both cases, uncertainty might not be removed for the assets not covered by the purchases or the guarantees, and investors thus would continue to ask the institutions for high risk premiums. consequently, the institutions might not be able to fully restore confidence in the market. in addition, there are also other difficulties ; how to set the selling price of the nonperforming assets in the case of asset purchase scheme and how to set the fee in the case of guarantee scheme. what japan faced in the past and what the u. s. is facing now is arguably those difficulties. however, even with such difficulties, it is an indispensable process to promptly identify the amount of losses and to carry out recapitalization to secure financial system stability, if necessary. it should be noted that new issues have emerged in the global financial system as public capital injection prevails. one of them is a gap between the level of capital recorded on the balance sheet and market participants ’ perception of franchise value of financial institutions. the level of capital presumably should reflect market expectations about earning growth potential of a firm. on one hand, recapitalization by the government serves as a buffer for future losses, in the same way with privately raised capital. on the other hand, it comes from different incentives from private capital, in which investors shoulder the risk with an expectation to recoup their investments by the future growth of the firm. in addition, if people increasingly tend to judge the soundness of a financial institution simply by looking at the level of capital on the balance sheet – in other words, looking at the capacity to absorb future losses rather than the earning growth potential –, a financial institution could face a paradoxical situation. a financial institution which does not accept public capital because of its financial soundness might suffer a competitive disadvantage against another institution which accepts public capital, because the sound institution has a lower capital

to undertake a range of projects, in response to the surge in energy and materials prices and growing interest in environmental issues. these include the reduction in use of structural steel and facilitation of the reuse of scrap, the use of alternative energy, and the introduction of energy - saving equipment. in these areas, large firms in particular have been increasing capital spending to improve efficiency. with regard to development of new products, automakers, for example, have been working to develop energy - saving products such as hybrid cars and electric cars, and sales of hybrid cars are growing steadily. some electric manufacturers are increasing production of products related to alternative energy, such as solar batteries. v. the outlook for japan's economy and the conduct of monetary policy in view of the issues i have discussed, i would now like to talk about the outlook for japan's economy and the bank's conduct of monetary policy. the bank's main scenario is that growth will likely remain sluggish for the time being against the backdrop of high energy and materials prices and weaker growth in exports due to a slowdown in overseas economies. the sluggishness in japan's economy has arisen against the background of the broad adjustments in the world economy that i mentioned earlier. in this situation, the point that should be examined is whether or not japan's economy will experience a deep adjustment phase. i believe that the possibility of this occurring is small. let me explain the thinking behind this projection. first, as a result of firms'restructuring efforts, which continued in the 1990s up until recently, the " three excesses " – namely, in production capacity, employment, and debt – have been eliminated, and japan's economy has become more resilient to shocks that weaken economic growth. second, losses incurred by japanese financial institutions due to the subprime mortgage problem are limited compared to those of u. s. and european financial institutions and japanese financial markets continue to be stable, which suggests that the functioning of the financial system remains intact. and third, japan's financial conditions have been accommodative. although it is a cause for concern that financing conditions of firms in construction and real estate industries and small firms in general are becoming increasingly severe, financial conditions taken as a whole have been accommodative. the short - term real interest rate calculated by subtracting the cpi inflation rate from the call rate has been negative, as the policy interest rate – the un