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Recent Economic and Financial Developments in Japan
Summary of a speech given by Toshikatsu Fukuma, Member of the Policy Board, at a meeting with business leaders in Yamanashi on February 24, 2005
March 29, 2005
Bank of Japan
Contents
- I. Overseas and Domestic Economic and Financial Developments
- II. Monetary Policy of the Bank of Japan
- III. Concluding Remarks: Tasks to be Addressed for the Japanese Economy
I. Overseas and Domestic Economic and Financial Developments
A. Overseas Economic Developments
1. The economic trend
I will first talk about developments in overseas economies. I would summarize the situation as follows: the general trend of economic expansion continues, albeit at a decelerated pace, and consumer prices are generally stable.
Looking at the current situation, it is noticeable that the growth rates of the NIEs, ASEAN, and BRIC1 economies are faster than those of industrialized nations. Their combined GDP, according to IMF statistics, has grown to account for more than 30 percent of the world's GDP, and naturally, they have come to exert a larger impact on the economies, prices, and corporate behavior within Japan, the United States and Europe. The rapid economic development of BRIC has been the main factor behind the surge in the prices of natural resources, such as crude oil, and shipping freight for transporting them. The sharp rise has benefited countries producing natural resources, OPEC nations in particular, that have long been beleaguered by the "north-south" problem. The budgetary condition of OPEC countries has improved, thanks to the sharp increase in export income from oil, enabling them to increase expenditures on domestic oil development, facilities for oil and petrochemical products, as well as improving basic infrastructure. These developments have, in turn, led to increased exports of capital goods from industrialized countries to oil producing countries, helping boost the global economy as a whole. Given that the population of BRIC is more than double that of developed nations, the impact of their rise on the global market economy may be compared, without exaggeration, to an emergence of another globe.
- Brazil, Russia, India and China.
2. The trend in prices
Despite the global economic expansion and the resultant sharp increase in the prices of natural resources, consumer prices have remained generally stable in recent years. To be more specific, inflation rates within Europe and the United States have stabilized at around 2 percent since 2000, after an average of 8-10 percent in the first half of the 1980s. The inflation rate in Brazil has eased to only 7 percent, as compared with the staggering hyperinflation of 6,000 percent in the early 1990s. Changes in the price environment have been rapid indeed.
The current phenomenon, where consumer prices remain stable despite the economic expansion, has been in place on a global basis and over a long period of time. Here again, BRIC and NIEs have had a part to play. Newly industrializing countries, led by China, have become mass exporters of high-quality, low-priced consumer goods, such as electrical appliances, information and telecommunications equipment, and apparel, thanks to their abundant workforce and direct investment from overseas. This has led to downward pressure on the prices of these products. Furthermore, trade liberalization led by the WTO and the spread of deregulation in each country have provided further momentum. Newly industrializing countries, particularly BRIC, are adding upward pressure on prices upstream, while putting downward pressure on prices downstream. Meanwhile, the widespread use of the Internet has made it easier for consumers to compare prices and purchase products at reasonable prices, making it difficult for firms to pass on higher costs on to end-product prices.
In this environment where product prices are under structural downward pressure, firms need to make constant efforts to contain and reduce their unit labor cost by increasing productivity through the use of information technology (IT) or by restraining wages. The foregoing initiatives are underlined by data, and the stable consumer prices, despite the higher costs of natural resources, are, indeed, the result of such efforts. At present, monetary policy in many countries is being conducted accommodatively, providing a factor to buoy the global economy. Accommodative monetary policy has been possible because of the continued price stability worldwide and low inflation expectations. The stability in prices, especially under the accommodative monetary policy, is further adding weight to subdued inflation expectations. Regarding inflation expectations, however, it is necessary to be vigilant for signs of change, as crude oil prices have once again become volatile and the pace of decline in unit labor costs in Japan and the United States appears to be slowing.
B. Developments in the Japanese Economy
1. The current economic situation
Turning to Japan, the growth in the economy overall appears to be at a temporary pause. Divergence between regions, industries, and firms remain. On the one hand, for example, firms in heavy industry - producers of raw materials such as steel, automobiles, ships, and other machinery - are operating at full capacity, thanks to strong demand from both home and abroad against a global shortage in supply capacity and also to the high quality of their products. On the other hand, production of electronic parts, such as semiconductor memories and liquid crystal displays, continue to decline because of inventory adjustments. Production by some automakers has also declined, due to a shortage in steel materials and a fire accident at a plant last year. Thus, taken as a whole, production is neither increasing nor decreasing markedly. The overall picture, therefore, deviates somewhat below the forecast we made in October 2004.
2. Progress in structural reforms at the microeconomic level
a. Disappearance of the three excesses
Regarding the outlook for the Japanese economy, it is important to bear in mind that the so-called three excesses, namely, excess workforce, production capacity, and debt, have by now been mostly eradicated. In other words, firms have made great progress in structural reforms at the microeconomic level and are in a much improved position in terms of their earning power.
It is shown in data that firms of all sizes perceive the excess in their workforce and production capacity to have been almost resolved. The ratio of outstanding debt to sales has also declined sharply among firms of all sizes regardless of the sector, indicating that the problem of excess debt has been resolved to a large extent.
Regarding production capacity, the introduction of impairment accounting from the next fiscal year beginning in April 2005 has encouraged firms to sell or dispose of low-yielding fixed assets, including land, whose market values diverged greatly from book values. This has contributed to the reduction in excess production capacity, and improved balance sheets, while laying the basis for increased business fixed investment, reutilization of land, and real estate financing. As for the workforce, it is noticeable that, while the number of workers in the manufacturing industry has declined, the number in the service industry has been increasing. This fact indicates that the workforce has been shifting from the manufacturing to the service sector for reasons, including regulatory reforms that provide greater opportunities for employment in the service industry. The employment environment has improved greatly with signs of a recovery in new graduate recruitment recently. Also, the unemployment rate has marked the lowest level since December 1998.
b. Improved profitability
While dealing with the negative legacy as explained above, firms are also working to improve their profitability. Profits are defined as the difference between price and cost. Firms are making efforts to maintain and increase prices by differentiating the quality of their products and technologies through superior research and development and protecting their new proprietary technologies from competitors. Firms are also making efforts to reduce costs in the following manner. Productivity is enhanced by the use of IT. The cost of wages is cut by increased reliance on non-regular employees and outsourcing of production. Furthermore, globalization of management has made it possible to make use of production elements overseas that are of both high quality and yet low cost.
Japan's unit labor cost has consistently been on a downward trend since around 1993. This is a result of Japanese firms operating in a region with the fiercest price competition in the world, comprising highly competitive countries, such as China, South Korea, and Taiwan. Also, firms have made unceasing and sincere efforts to achieve sustainable profit growth through creative technological development, while the increased awareness and enhanced corporate governance in recent years have prompted cost-cutting through higher productivity based on IT.
c. Results of structural reforms at the microeconomic level
Along with the elimination of the "three excesses" and increased profitability, the increases in dividend income from overseas and domestic subsidiaries, which I will talk about later, have lowered the break-even point for firms, in particular, a substantial reduction for major manufacturers. Structural reforms at the microeconomic level have been the driving force for the current economic recovery, having engineered the improvement in corporate profitability. These microeconomic structural reforms, in turn, have been underpinned by regulatory reforms and "zero" interest rates.
Microeconomic structural reforms have been a great success. Return on assets (ROA) has returned to the levels posted at the peak of the asset bubble period, while return on equity (ROE) has recovered to the levels seen in the early 1990s. Corporate profitability has thus returned to levels comparable to the bubble period, but a marked difference is that firms are now much more financially sound. It is now possible to say that a new Japan has come into being. Borrowing the words of Minister Heizo Takenaka, in charge of economic and fiscal policy, and postal privatization, "We are not in the post-bubble period any more, it is behind us." In other words, the nation has entered a new stage. Other supportive data indicate a substantial decline in the number of corporate failures. They show that failures due to lax management have decreased, indicating that firms have been determined to achieve autonomous growth through microeconomic structural reforms and enhanced corporate governance.
3. Economic outlook
It is unlikely that the positive cyclical momentum will easily run out of steam, given that progress is being made in microeconomic structural reforms and that banks, as well as firms, are switching to an aggressive management stance. I will talk about banks later on. It is likely that Japanese firms will continue to endeavor to differentiate themselves and cut costs, spurred by competition from Chinese, South Korean, and Taiwanese firms. As I have said earlier, the break-even point for firms has fallen substantially. This may be interpreted that the levels during the 1990s had probably been a little too high2.
The inventory adjustments of electronic parts are already in the final stage and perhaps will be completed by the end of spring this year, because manufacturers, having learned from the experience of the bursting of the IT bubble, were quick to begin inventory adjustments, and also because of continuing growth in worldwide demand for digital appliances and automobiles, which nowadays incorporate many electronic parts. In fact, the outlook for orders for electronics and telecommunications equipment during the January to March 2005 quarter was up by 7 percent from the same period a year earlier, after a negative growth outlook for the previous quarter. There have also been reports from some manufacturers of a completion in inventory adjustments. After release of their business performance for the October-December quarter of 2004, manufacturers of digital appliances have realigned their product lines on the basis of "selection and concentration." Such speedy reshaping of the industry augurs well for the supply-and-demand equilibrium to come.
Taking a look at demand components, business fixed investment is likely to remain firm and this will spread to a larger number of firms as: (1) heavy industry, including affiliates and subcontractors, is already operating at full capacity and is increasingly aware of the shortage in production capacity, and (2) the lending stance of banks is becoming more accommodative, stimulating business fixed investment by small and medium-sized firms in this sector. Firms' attitude toward business fixed investment, however, is restrained relative to the size of the increase in their cash flows. This indicates that their investments are based on a careful monitoring of trends in demand. Such a cautious attitude toward investment underlines the expectations for a continued expansion in business fixed investment.
As for private consumption, typhoons, earthquakes, and a warmer-than-usual winter temporarily dampened consumption during the October-December quarter of 2004. However, it is likely to maintain a steady upward trend as the recovery in corporate profits and the improvement in the employment situation, that I mentioned earlier, begin to affect salaries under a merit-based pay system. The effect of remuneration on a merit-basis is evident in the household income data for November and December 2004. The possible negative effect on consumption of various policy measures - a series of tax reforms, including the phasing out of across-the-board income tax cuts, and social security reforms, notably pensions and health insurance - needs to be carefully monitored. Fiscal consolidation, however, has an aspect to help ease consumers' uncertainty about the future, since a growing number within the population is now aware of the necessity to reform.
Exports are likely to be steady in a wide range of sectors including materials, general machinery, shipping, automobiles, and electronic parts, helped by an expansion in the overseas economies, and the growing ties of interdependence particularly with East Asian economies. Exports to East Asia account for half of total exports, while about 40 percent of imports are from the same region. Other than trade, Japanese direct investment in the region is bringing in an increasing amount of dividend income. The closer ties with East Asia are a valuable driving force in revitalizing the Japanese economy.
- 2For more information on Japan's employment and income situation, please refer to Koyo Shotokujosei ni Miru Nippon Keizai no Genjo, published in the January 2005 issue of Nippon Ginko Chousa Kiho (Bank of Japan Research Bulletin). Currently available only in Japanese.
4. Corporate performance and management
a. Trend in profitability
For fiscal 2004, current profits of firms of all sizes and sectors are expected to grow for the third consecutive term. Particularly, the manufacturing sector, led by heavy industry, which encompasses a great number of related industries, is expected to show a sharp increase in profits of 20 percent from the previous year.
b. Globalization of management
The background to this expansion in corporate profits is the globalization of management. For example, take a look at automobile production by Japanese manufacturers. Since 2002 overseas production has increased sharply. In 2004, overseas output appears to have accounted for about half of the total production. Among them, Toyota Motor Corporation, including exports, earned 70 percent of its operating profit from North America in fiscal 2003. A similar profit structure can be seen at Canon Inc., Honda Motor Co. Ltd., and Yamaha Motor Co. Ltd., to name just a few.
It is noteworthy that while Japanese firms operating overseas are reliant on the local workforce and local production facilities, many of them are sticking to the Japanese management systems that value feedback from each workplace, and cooperation between management and labor, making use of cellular work units, "just-in-time" production processes, and quality and process control called kaizen, or improvement. While many firms from around the world are trying to expand overseas, a greater success achieved by Japanese firms is attributable to the fact that these superior management methods are supported by, and firmly rooted in, the local workforce. The current system, in which Japan exports management know-how to apply to local resources and markets in pursuit of global profit growth, is indicative of the new Japan emerging. As was the case in the past, exports of only or mainly manufactured goods tended to create trade friction.
c. Centralized control of cash flows at headquarters: centripetal and centrifugal focus
Fast growth in business of consolidated overseas subsidiaries is likely to result in further centralization of the group cash flows in the hands of the parent companies. The reason for this is to respond to the request from shareholders for a higher net worth and a higher share price. At present, dividend payout as well as dividend yields of Japanese companies on a consolidated basis is low in comparison with both Western and Asian standards. The revised U.S.-Japan tax treaty that took effect in July 2004, reduced withholding taxes on dividends from a U.S. subsidiary and a parent company in Japan, and similar agreements with other countries are expected to be made. Such developments would provide a further stimulus for concentration of cash flows at headquarters.
The cash flows pooled at the headquarters are appropriated for repayment of bank loans to improve the financial standing as well as for dividend payout. They are also being used for business fixed investment, the launch of new projects overseas, and mergers and acquisitions, all aimed at increasing profits. From the viewpoint of corporate management, the parent companies take charge of cash flows of their consolidated entities, appointment of executives, and the planning of group strategies, while leaving the autonomy of day-to-day business in the hands of each subsidiary. To put it another way, there is a quest for optimization for both the whole and the parts, or a balance between centripetal and centrifugal forces, which has become a fundamental condition for consolidated management.
d. Selection and concentration
As mentioned above, Japanese firms are, in general, continuing to display a good performance. The disparity, however, between the good and poor performers is widening. This trend may reflect the differences in IT productivity, capabilities in R & D, branding power, rationalization efforts, or the ability to make inroads into overseas markets. From a wider perspective, additionally, a firm's ability to review its business lineup flexibly and to keep up with the changing environment greatly affects its performance. After the oil crises, for instance, the business buzzword was "light, thin, short, and small" and there were moves away from heavy industry. Nowadays, however, with the booming BRIC economies, heavy industry has once again become a growing area. Also, the domestic market for white goods, such as refrigerators and washing machines, which had long been believed to be in a state of saturation, is currently enjoying buoyant sales from appliances that meet the needs of the times and consumers. They include environment-friendly refrigerators and washing machines that incorporate a dryer function. In this age of low growth, it is crucial that firms continuously "select and concentrate" to achieve a sustained expansion in profits. To be more specific, firms must foresee the demand and needs of the market, and proceed with mergers and acquisitions, strategic alliances, and divestiture, as and when occasions arise. Furthermore, there may be a case for reincorporation or insourcing of divested, but currently booming, businesses - currently, heavy industry is a case in point. "Select and concentrate" is the term to express such a flexible organization and reorganization of operations, as well as the reallocation of management resources to expand the cash flows for the group as a whole.
5. Risk factors in the short term
Quite a few business leaders are cautious about the outlook for corporate profits for fiscal 2005, warning of the risks arising from a strong yen, high oil and raw materials prices. In fact, some sectors, such as the materials, machinery, and shipbuilding industries, have forecast declines in their profits, as a result of the negative effect of these three factors. Given that the strength in corporate profits has been the driving force of the present economic recovery, the macroeconomic outlook is likely to be affected by these three risk factors.
6. Price trends
a. Domestic corporate goods prices
With regard to prices, domestic and overseas commodity prices and shipping freight rates have hit the ceiling for the present. Prices of high-grade steel for automobiles, shipbuilding, and digital appliances, and special steel for plants and generators continue to be firm, reflecting a worldwide supply shortage. In contrast, the prices of steel construction materials are tending to ease, due to an increase in China's production capacity. Consequently, the pace of rise in domestic corporate goods prices has slowed since December 2004. All in all, domestic corporate goods prices are very likely to remain on the weak side, although the volatility of crude oil prices may well undermine such a forecast. This, in any case, is more or less in line with our forecast made in October 2004.
b. Consumer prices
Core consumer prices remain on a slight downward trend. With the cuts in fixed telephone and electricity charges as a result of competition and deregulation, it is uncertain whether the Bank will be able to conclude that the year-on-year rate of increase in the core consumer prices registers stably above zero percent through the next fiscal year. If, however, factors that temporarily dent prices are excluded, the rate of decline in consumer prices has gradually been shrinking. This trend can be attributed to the fact that upward pressure on prices, due to the shrinkage of the output gap along with economic recovery, outweighs slightly the downward pressure caused by the decline in unit labor costs. According to the preliminary estimate of GDP for the October-December quarter of 2004 announced recently, the deflator for domestic demand, which correlates closely with the output gap, increased for the first time in seven years, albeit with some temporary factors. I believe that it is necessary to monitor such developments closely, while maintaining the framework of the Bank's quantitative easing policy.
7. Financial developments
The overall financial environment remains extremely accommodative. The lending attitude of banks has become more active regardless of the size of the borrowing firm. It is my impression that the situation is somewhat similar to the latter half of the 1980s when banks competed to lend. It appears that banks' risk-taking ability has increased with the substantial progress in nonperforming-loan (NPL) disposals, having improved their financial health, and the recent upgrade in the credit ratings of Japanese banks, which I will discuss later. It is true that, on the borrowing side, major firms with high credit ratings in particular, are shifting to direct financing from indirect financing after the experience of the financial crisis of 1997-98. Furthermore, they are continuing to repay their bank loans using their abundant cash flows generated from their strong business performance. Consequently, although lending by regional banks, whose loans to large firms are relatively small, is increasing from the previous year, lending by other banks has not increased as much as expected. Loans, however, to small firms, real estate businesses, and foreign firms are on the increase. Since the mainstay of fund raising for small firms is indirect financing, the increased bank loans are a factor to encourage their business fixed investment.
II. Monetary Policy of the Bank of Japan
Next, I will turn to the Bank's current monetary policy, namely the quantitative easing policy.
A. The History of Quantitative Easing Policy
1. The framework of quantitative easing policy
Let me begin with an explanation of the framework for the quantitative easing policy. The aims of the quantitative easing policy are described as follows in the public statements released on March 19, 2001, when the policy was first introduced. First, the Bank aimed to provide ample liquidity to the money markets by changing the main operating target for money market operations from the uncollateralized overnight call rate to the outstanding balance of the current accounts at the Bank. Second, the Bank intended to steadily provide ample liquidity to the markets until the year-on-year rate of change in core consumer prices registered zero percent or higher on a sustainable basis, thereby inducing a decline in short-term interest rates, including those on instruments with relatively long maturities with the effects from the Bank's new commitment in terms of policy duration. And third, the Bank abolished the restriction on the use of the Complementary Lending Facility (Lombard-type lending facility), so that the official discount rate, which is currently 0.10 percent, would be the ceiling, beyond which the call rate would not rise. It was expected that deflation would be overcome by ensuring that the quantitative easing effects of the zero interest rate policy further permeate the economy.
2. Raising the target balance of current accounts held at the Bank
The Bank has been raising the target balance of current accounts held at the Bank successively since the quantitative easing policy was introduced back in March 2001. The primary reason given by the Bank for raising the target had been to maintain the stability of financial markets, reflecting, as you are all aware, increased concerns about the financial system and increased liquidity risk. I will explain this point in detail.
In Japan, as I have explained earlier, due to the bursting of the asset bubble in the 1990s, firms faced the problems of the "three excesses," namely, the number of employees, production capacity, and debt; and, banks faced the emergence of large amounts of NPLs, which led to the financial crisis in 1997 and deflation thereafter. Moreover, due to the subsequent stagnation that lasted for a long time, firms' and banks' balance sheets were seriously impaired, causing their business performance to deteriorate. The economy was almost experiencing a deflationary spiral from 2001 to the first half of 2003, as there was strong uncertainty about the economic outlook, as seen for example, in the fact that yields on ten-year Japanese government bonds (JGBs) marked a record low of 0.43 percent and the Nikkei 225 Stock Average reached 7,607 yen, a post-bubble low. Reflecting such a situation, credit ratings of an increasing number of Japanese firms and banks had been downgraded after 2001.
As a result, the amount of inter-company credit decreased to a level of about 70 percent in the first quarter of 2003 compared to the peak, and credit spreads, which show the difference in the creditworthiness of firms, widened significantly through the first half of 2002. In addition, concerns about the financial system heightened due to increased uncertainty about the NPL problem, reflecting a series of events, in addition to the increasing number of downgrades in banks' credit ratings, such as, the terrorist attacks in the United States in September 2001, partial removal of the government's blanket deposit insurance and a system failure of a major bank group in April 2002, and moreover, the release of the "Program for Financial Revival" by the Financial Services Agency (FSA). This was why the amount outstanding in the call market, in which banks adjust their daily surplus/shortage of funds, decreased substantially, particularly for term instruments. On the other hand, banks started to have a strong anxiety about the availability of funds because of the decrease in bank deposits after the partial removal of blanket deposit insurance in April 2002. The significant increase in the outstanding balance of banknotes issued at around the same time symbolizes people's strong anxiety about the outlook for the financial system, and each individual bank at that time: banks were regarded unsound to the extent that it was said to be better to rent a safe and keep money there than to hold bank deposits.
Reflecting such a critical situation, the Bank decided to deal with the banks' anxiety about the availability of funds and the related precautionary demand for large current account balances at the Bank, by providing more ample funds to the market as part of the crisis management for maintaining financial market stability. This action was taken because the Bank had a strong sense of crisis that, given the extremely severe economic and financial situation at that time, it was necessary, by all means, to avoid a situation as at the time of the financial crisis in 1997-98, where the economy faced a further deflationary impact, due to the 'credit crunch' and banks' aggressive collection of loans from firms that had been triggered by banks' anxiety about the availability of funds. Together with raising the target for current accounts at the Bank, the Bank provided funds to the market through its money market operations to deal with the situation, where it was becoming difficult for banks to conduct transactions in term instruments in the call market. Specifically, the Bank absorbed funds from the market through market operations using instruments with shorter maturities of one to two weeks, and provided funds to the market through operations using instruments with maturities of three to six months or longer. As a result, the Bank played the "role of broker" in the market, giving consideration to the banks' asset-liability management (ALM).
Moreover, in October 2002, when the financial environment was in the most critical situation and when the FSA released the "Program for Financial Revival," the Bank made the utmost effort to address the banks' liquidity risk and concerns about the financial system. For example, the Bank strengthened its capacity to provide liquidity to the market by extending maturities for bills purchased in bill purchasing operations from six months or less to a year or less, and also decided to increase its outright purchase of JGBs and purchase stocks held by banks. The purchase of stocks was aimed at contributing to the sound management of banks, thereby maintaining the stability of the financial system, by further promoting the banks' efforts to reduce their exposure to the risk of stock price fluctuations. There was such a strong anxiety about the financial system and, moreover, about liquidity risk in Japan at that time, as to urge the Bank to decide on such an unprecedented measure as the purchase of stocks held by banks.
As part of crisis management, similarly, the Federal Reserve made efforts to minimize the impact of anxiety about the availability of funds and the related credit contraction on the economy and financial markets, by providing massive funds to the market or individual financial institutions on each of the following financial crises: Black Monday in 1987, the crises of U.S. money center banks in the early 1990s, the Long-Term Capital Management (LTCM) crisis in 1998, and the terrorist attacks in 2001. It is a cardinal rule in any country to take such action in case of financial system instability, and from this viewpoint, I think it was appropriate as a means of crisis management that the Bank has been providing an unprecedented massive amount of funds to the market.
B. The Bank's Current Monetary Policy Stance
The Bank has been conducting market operations, aiming for an outstanding balance of current accounts held at the Bank at "around 30 to 35 trillion yen" since January 2004. The amount is six- or seven-times as large as the original target, and as a result, the total assets on the Bank's balance sheets increased significantly, and the monetary base, which is the source of money in circulation, or the central bank's provision of funds to banks, has been at an unprecedented high level relative to the size of economic activity.
However, compared with the time when the Bank had successively raised the target for the outstanding balance of current accounts at the Bank, the financial environment has been improving on the whole recently. Concerns about financial system stability are being dispelled, as an increasing number of firms' and banks' credit ratings have been upgraded, reflecting the following factors, in addition to the utmost efforts made by firms to adjust their balance sheets and by banks to dispose of their NPLs. First, the injection of public funds into Resona Bank was decided in May 2003. Second, a safety net was established after the enactment of the Financial Function Strengthening Law in August 2004. And third, moreover, it turned out at the semiannual book closings of large banks at the end of September 2004 that it would be possible to achieve the target to reduce the NPL ratio by half. As for banks, several credit rating agencies have successively raised the credit ratings of large banks since November 2004. Credit ratings by Moody's, for example, are recovering on the whole to the level seen in 1992. As a result, it is becoming clear recently that the amount of inter-company credit has stopped declining and credit spreads have started to decline sharply. The amount outstanding in the call market has started to show an increasing trend since 2003, and the proportion of transactions in term instruments has stopped declining, having recently started to show signs of an increase. The availability of foreign-currency funds is increasing, as seen in the fact that the "Japan premium" has become almost at zero percent and foreign banks are expanding credit lines to Japanese banks. Thus, the environment is improving to enable market participants to engage in funds transactions by themselves.
Along with such an improvement in the Japanese financial environment, bid-to-cover ratios in the Bank's funds-supplying operations are declining, as seen in the frequent undersubscriptions in the Bank's funds-supplying operations recently. This is mainly because banks' precautionary demand for maintaining large current account balances at the Bank has been decreasing in a situation, where it is becoming easy for them to conduct call transactions due to a decline in their liquidity risk and anxiety about financial system stability, and because banks have started to reduce their total assets, so that their ROA, as well as ROE, will improve and their credit ratings will be upgraded further. I think it is necessary to conduct monetary policy giving due consideration to such developments in the market.
In a situation where an undersubscription is frequently observed in its market operations, the Bank has been making efforts to provide funds to maintain the outstanding balance of current accounts at the Bank within the current target range by devising ways to enhance its money market operations, such as providing funds using instruments with longer maturities. Such market operations have been criticized recently that they are not consistent with the changes in economic activity and financial markets and that the Bank has been providing funds solely to achieve its objective to maintain the target balance. Nevertheless, given that the Bank had been raising the target, paying due consideration to financial system stability, I think it is appropriate to continue to provide funds to maintain the current target range of "around 30 to 35 trillion yen" for the outstanding balance of current accounts at the Bank, until at least anxiety about financial system stability has been dispelled. As I have reiterated on occasions like today, I think the full removal of the government's blanket deposit insurance in April 2005 will provide a point at which the Bank should examine the stability of the financial system.
C. Positive and Negative Effects of the Quantitative Easing Policy
The provision of ample liquidity and the resultant zero interest rate under the quantitative easing policy have contributed to revitalizing entities' economic activities by supporting firms' restructuring efforts and banks' disposal of NPLs. They have consequently contributed to lowering the rate of decline in the core CPI through the narrowing of the output gap.
Let us see by how much firms could reduce their interest burden on loans as a result of lowered interest rates. There is an estimate obtained by calculating the difference between the cumulative amount firms actually paid as loan interest from 1990 to 2002 and the cumulative amount they would have paid, if interest rates on those loans had been fixed at the 1990 level during the same period. According to the estimate, firms could reduce their cost of paying loan interest by about 250 trillion yen in total, over the period from 1990 to 2002. Although this result might be slightly overestimated, it implies that low interest rates maintained over the long term, particularly the zero interest rate, had significant positive effects on the adjustment of firms' balance sheets, including the psychological aspects. Meanwhile, the year-on-year growth rate of the monetary base has dropped markedly, reflecting the unchanged operating target for the quantitative easing policy. That is, the target range for the outstanding balance of current accounts at the Bank has been fixed since January 2004. On the other hand, that of the money stock (M2+CDs) has continued to be on a modest recovery trend and the money multiplier, which shows the capability of banks to create credit, has stopped declining over the same period. This seems to be another item of evidence for the fact that structural reforms at the microeconomic level have further progressed and the behavior of firms and banks is becoming more forward-looking under the zero interest rate policy.
On the other hand, some people insist that the quantitative easing policy has some negative effects. Their claims are as follows: the policy undermines the market mechanism; it increases future inflation expectations beyond a controllable level; and it prevents fair competition among firms, delaying the progress in structural reforms within the economy. With regard to the market mechanism, however, as I mentioned earlier, banks' demand for current account deposits at the Bank has been declining and more transactions are made easily in the call market, indicating that the market mechanism has started to function again. As for inflation expectations, it is difficult for firms to raise the prices of their products without careful consideration, considering the fierce international competition among firms. On land prices, not only firms, but also individuals, have begun to use the income approach to value, having learned lessons from the bursting of the asset bubble or having introduced mark-to-market accounting. As for the claim that the quantitative easing policy delays the progress in structural reforms, the following are main factors encouraging reforms by firms, as you all know: heightened consciousness of corporate social responsibility; a series of reforms in the Commercial Law that is intended to enhance corporate governance; the progress toward convergence with the international standards in accounting rules; and market discipline achieved through disclosure of information. Governor Kohn of the Board of Governors of the Federal Reserve System noted in his speech in early January 20053 that crisis management by means of providing ample liquidity to the market and individual financial institutions could increase inflation risk excessively and could create moral hazard if it went too far. I think his remarks imply that, once crises are overcome, crisis management should be accordingly shifted to ordinary risk management, and I myself will always keep this in mind.
Taking into account the above-mentioned positive and negative effects overall, the Bank will firmly maintain the quantitative easing policy framework while ensuring the easing effects of the zero interest rate policy further permeate the economy, in order to support restructuring efforts by firms and banks, thereby leading to further revitalization of the economy and overcoming deflation. I hope this will, in turn, contribute to closing the gap between different regions, industries, and firms.
- 3For details, please refer to: Kohn, D. (2005), "Crisis Management: The Known, the Unknown, and the Unknowable."
III. Concluding Remarks: Tasks to be Addressed for the Japanese Economy
In concluding my speech, I would like to talk about some tasks to be addressed for the Japanese economy.
A. Fiscal Consolidation and the Maintenance of the "NICE" Economic Condition
First of all, fiscal consolidation must be achieved. As you know, the Council on Economic and Fiscal Policy has been vigorously discussing this matter. In order to place Japan's economy on a truly sustainable growth path, it is critical to reconstruct public finance which is loaded with a huge amount of debt exceeding 700 trillion yen, following structural reforms in the private sector. The fiscal consolidation is also one of the tasks to be addressed, in order to eliminate the nation's concern over the future economy and boost sluggish private consumption over the medium to long term. Particularly, in Japan, where a further increase in social security costs will be inevitable due to the declining birthrate and aging population, it is impossible for the central and local governments to appropriate a budget for all the necessary policies, as they did in the past period of high economic growth. The governments are therefore required to continue making choices in appropriating budget to policies with a clear priority. In order to deal with this difficult situation, it is necessary to achieve a sustainable economic growth by carrying out reforms in regulations and the tax system, leading to an increase in tax revenue, while thoroughly streamlining expenditure by raising the productivity of the public sector through the digitalization of administrative services and the introduction of competitive bidding for the right to supply public services. Meanwhile, it is required that interest rates are stable at the lowest level possible to minimize the costs of reconstructing the public finance - price stability is its prerequisite.
Governor King of the Bank of England used the term "non-inflationary, consistently expansionary (NICE)" to describe a desirable economic condition where the balance between the following two is kept, as seen in the United Kingdom in the 1990s, namely: a sustained economic growth that causes a continuous increase in revenue; and price stability as a prerequisite for the stability of interest rates at low levels. To pursue this "NICE" economic condition, which is critical for reconstructing public finance, is almost the same in nature with the Bank's philosophy, namely - through the pursuit of price stability, the Bank aims to contribute to the sound development of the national economy. I think therefore the pursuit of this "NICE" economy should be a pillar of macroeconomic policy for the new Japan. Considering the above, there seems to be no difference between the directions pursued by the government and the central bank. The Bank should make every effort to maintain its accommodative monetary policy if a "NICE" economy is to be realized. On the other hand, policies that might work against it, namely, policies that weaken fiscal discipline and enhance inflation expectations in the markets should be strictly avoided. The Bank should have the wisdom and courage for following such a narrow path in the conduct of monetary policy.
B. Fostering Human Resources
In addition to fiscal consolidation, one of the important tasks facing the Japanese economy is the fostering of skilled human resources. As I have already mentioned, firms have increased the number and ratio of non-regular employees as a means of cutting wages. In some aspects, they seem to have gone too far. As a byproduct, it has become harder to hand down and improve the skills in a manufacturing work setting, leading to problems related to product quality and safety management. Therefore, an increasing number of firms are planning to increase the number of young regular employees. In fact, the number of engineers with special skills is in short supply, and the number of contracted workers dispatched from human resource agencies is also falling short of demand. Accordingly, some large automobile firms have started to rehire employees, who had once worked for them.
When I said the number of engineers is in short supply, it does not mean the total number of those available is scarce. The problem is that young people, who are qualified in terms of knowledge and motivation, are scarce. There is a mismatch in the qualifications held by labor. This phenomenon emerged against the backdrop of the increasing number of young people, who are part-time workers, or who are not in employment, education or training (NEET). It is essential, therefore, that both the private and public sectors take initiatives to re-establish the framework of education and vocational training. At the same time, it should be an important point as to further utilize the ability of young people in a broader arena apart from the traditional categorization of industries. It was reported that Mr. Hayao Miyazaki, director of an animation movie titled Howl's Moving Castle, would receive a Golden Lion Award for Career Achievement (Leone d'oro alla carriera), a prize given to movie people who have produced many remarkable movies, in the upcoming movie festival in Venice Film Festival in August. Thus, the Japanese popular cultural industries, such as animation, cartoons, and game software, are globally accepted. It is expected that the market value of the animation industry will be over 10 trillion yen. It is the sensibility and zeal of young Japanese, who will follow Mr. Miyazaki, that are supporting these industries.
C. Conclusion
The Industrial Revitalization Corporation of Japan will stop purchasing debt by the end of March 2005, and the full removal of the government's blanket deposit insurance is scheduled in April. Integrated revitalization of both industrial and financial sectors has been successful to some extent through cooperative efforts by both the private and public sectors. Reflecting these developments, the financial system is steadily stabilizing as evidenced by the shift of emphasis in financial administration from "financial system stability" to "financial system vitality" by replacing its policy guideline of the "Program for Financial Revival" with the "Program for Further Financial Reform." I believe that the program for further financial reform came in at the right time and was appropriate from the viewpoint of changing the financial environment. It is urgently hoped that the financial infrastructure, such as, the payment and settlement system, tax system, financial information technology, and rules and practices, be reorganized and redesigned in accordance with the "Program for Further Financial Reform." The deflationary spiral in terms of prices of goods and assets, which has been a concern up to now, is subsiding. The negative cycle is being replaced by a forward-looking cycle with the mindset of "We are not in the post bubble period any more, it is behind us," partly characterized by the phrase "from defensive management to an aggressive one."
In doing so, a firm cannot make sufficient profit without being a front runner in the current environment of fierce global competition as symbolized by the IT industry. If a firm is in the third or fourth place, it cannot make sufficient profit and merely contributes to increasing the size of the market. Firms should promptly foster the ability of comprehending changes in the environment of the market and move with the times, and take a stance of proceeding with "selection and concentration" in a timely manner by reforming swiftly their own management style in response to the changes. And then only those who achieve these goals will win in the game of "Winner takes all." The phrase "Time is money" was once often quoted, but it is now time for a new phrase "Speed is money." Furthermore, there will be a new phrase "Acceleration is money" to describe the present age, in which firms can hardly survive if they do not accelerate their management reform through IT innovation. It should not be forgotten that, partly helped by the withdrawal of American and European firms, there are not only large steel and chemical firms, but also many small and medium-sized firms in heavy industries, such as a medium-sized firm in the machinery industry, which became the leader or number two in the industry and are enjoying the remaining pie of profit, as a result of over ten years of strenuous efforts of cost cutting and creative technological innovation.