foreign exchange – such as the technological catch - up of emerging economies and the increase in free trade agreements concluded abroad – some of which i will discuss later. in addition, issues that directly affect the competitiveness of japanese firms, such as various environmental constraints, the tax burden, and labor laws and regulations, still give cause for concern. thus, attention should be paid to the growing possibility that the japanese economy and japanese firms will not be able to benefit from global demand to the extent commonly expected. as for the price outlook, the year - on - year pace of decline in the cpi excluding fresh food is expected to continue slowing as the aggregate supply and demand balance is projected to continue improving gradually in a situation where medium - to long - term inflation expectations are assumed to remain stable. in the outlook report, the bank projected that the timing of the year - on - year rate of change in the cpi entering positive territory would likely be sometime in fiscal 2011, and that thereafter the rate of increase would start rising through fiscal 2012. however, i have a more cautious view of future developments in prices. let me explain why this is the case. 2. views on the expected rate of inflation when examining the outlook for price developments, key aspects to be considered are the size of the output gap, the expected rate of inflation, and import prices. in addition, empirical studies show that the current rate of inflation is also affected by past inflation. thus, empirical analyses of inflation dynamics often use the following type of specification : inflation rate for the current term = γ × ( the expected rate of inflation for the next term ) + ( 1 – γ ) × ( the inflation rate for the previous term ) + β × ( the output gap for the current term ) + α × the rate of change in import prices, where α, β, and γ are parameters. a frequent criticism of this type of specification is that the inclusion of the inflation rate in the previous term lacks microfoundations and its role is therefore difficult to interpret. however, one possible interpretation is that the rate of inflation not only is determined by medium - to bis central bankers ’ speeches long - term inflation expectations but also may be affected by short - to medium - term inflation expectations that are influenced by actual inflation in the past. according to this interpretation, the key question for japan at the moment is which of the two influences is stronger – positive medium - to long - term inflation expectations or negative inflation rates in the past. 3 it goes

##itical events, changes in the outlook on global economies, and policy changes in major economies. we also regularly check, in the financial system report, a “ heat map ” of financial activity indexes that helps us to gauge the macro conditions of bis central bankers ’ speeches financial activity by combining a host of indicators in both the financial and non - financial sectors ( chart 2 ). the indexes, with few parts in red, suggest that currently no signs of financial imbalances are observed. having said this, we will of course continue looking carefully for any signs of overheating in the financial markets. negative interest rates another development attracting attention in japan ’ s financial markets is seen in the negative interest rates of some financial products. the rates for treasury discount bills ( t - bills ) declined to negative territory in september and remained there for most of the time since then ( chart 3 ). the payment of negative interest on securities sounds counter - intuitive and thus may prompt concern that japan ’ s financial markets are suffering a serious malfunction. if we look into the details of each transaction, however, we can see plausible reasons why investors have accepted negative interest rates. let me briefly mention a few cases where investors would buy t - bills at negative interest rates. commercial banks have an incentive to hold a certain amount of liquid short - term assets for the purpose of liquidity and duration risk management. among various types of these assets, investors often prefer t - bills because they are not only eligible collateral for borrowing from the bank of japan but also most suitable as collateral pledged against other money market and derivative transactions. under the qqe, yields of liquid short - term assets have already approached zero across the board, and therefore even a small premium added to t - bills could easily push their rates below zero. foreign investors have also played an important role in driving yen rates into negative territory. since the summer of 2014, u. s. dollar funding rates implied in foreign exchange swaps have risen, as the net demand for dollars in the foreign exchange swap market has increased ( chart 3 ). this means that foreign investors with dollar cash liquidity can convert dollars into yen via a foreign exchange swap contract and borrow yen at a much cheaper rate. since yen money market rates are already at almost zero, the yen funding cost for these investors would most likely turn negative. they can take advantage of the negative funding cost by investing in t - bills even with negative rates. this investment strategy can still capture a reasonable