bank of japan ’ s monthly report of recent economic and financial developments bank of japan, communication, 21 / 1 / 99. the bank ’ s view the economic deterioration in japan is easing gradually mainly due to the increase in public investment. with respect to final demand, business fixed investment has been declining significantly, and housing investment continues to be sluggish. private consumption, as a whole, remains stagnant. meanwhile, net exports ( exports minus imports ) are basically increasing at a moderate pace, and public investment has turned to follow a distinct upward trend. reflecting this development of final demand and the progress in inventory adjustments, the decline in production is slowing. corporate profits continue to worsen. employment and household income conditions have deteriorated as the unemployment rate has reached a new historical high, the ratio of job offers to applications remains at its lowest ever level, and winter bonuses have decreased significantly. financial conditions are improving with the effects of the policy measures taken by the government and the bank. nonetheless, firms apparently cannot eliminate their anxiety about the availability of funds toward the end of fiscal 1998. consequently, corporate and household sentiment remains cautious, and a recovery has not yet been observed in private demand. as for future developments, the increase in public investment is likely to underpin the economy toward the first half of fiscal 1999 with the implementation of the government ’ s economic measures. furthermore, the bank ’ s monetary and financial measures and the government ’ s measures to alleviate the credit crunch will remain in effect. nevertheless, an immediate selfsustained recovery in private demand is hardly expected since corporate profits and household income are deteriorating and the constraints from corporate finance are likely to persist for some time due to the cautious lending attitudes of private banks. moreover, attention should be paid to the effects of the continued appreciation of the yen since autumn 1998, and to the uncertainty in financial and economic developments abroad. to lead japan ’ s economy into a steady recovery, it is important to prepare an environment where firms and households can regain confidence in japan ’ s economic future by, for instance, promptly restoring the stability of the financial system. with regard to prices, reflecting the large output gap, domestic wholesale prices are on a downtrend, and corporate service prices are weakening. consumer prices have increased above the previous year ’ s level due to the rise in prices of perishables. excluding this effect, however, consumer prices basically continue to be weak. as for the outlook, the economic deterioration is likely to continue easing mainly due to

the usa, this “ originate - to - distribute ” model was partly responsible for too many excessively risky loans being granted. only now is it gradually becoming clear in what portfolios these risks ultimately end up. these structural developments took place in a setting of abundant monetary liquidity and increasing financial globalisation. ii ongoing uncertainty we have given a detailed account of the tense situation in the financial markets in our stability review. today ’ s press conference gives me the opportunity to look at the situation somewhat more from the current juncture. in doing so, i would like to highlight the following three points. my first point goes somewhat beyond the current juncture, in fact, because it relates to the macroeconomic projections. what is crucial is that at least some potential developments already incorporated in the risk scenario have now become a reality and are therefore of greater relevance to the baseline scenario. that applies especially to the exchange rate and the massive increase in the price of oil. the resulting dampening effects for germany will lead to a flattening but not a cessation of growth. the degree of flattening is likely to depend, not least, on the future development of global growth. the direct impact of the financial market disruptions on growth in germany will, in our view, be limited. in making my second point, having discussed the macroeconomic risks, i am directly revisiting the financial markets. the last few days, in particular, have made it clear to us here that we are essentially dealing with two overlapping developments. one of these developments is characterised by the fact that the problems emerging in the third quarter are still having an impact. an end to the necessary adjustments in the us real estate market is still not in sight, for example. if anything, the incidence of defaults on variable - interest mortgage loans is likely to grow further. an extended period of adjustment has to be expected in the market for credit risk transfers, too. an additional development consists essentially in the fact that other financial market segments are being affected by adverse factors. the government - sponsored freddie mac and fannie mae mortgage associations are but one example. my third point, finally, is that the recent problems in the financial system were, over time, heading more and more in the direction of the banks. first, risk premiums rose and the securitisation markets faltered. then, however, financial institutions found themselves in a situation where they were forced into an unplanned and unwanted expansion of their balance sheets