Home > About the Bank > Speeches and Statements > Speeches 1996–2010 > Speeches 2007 > Summary of a Speech Given by Hidetoshi Kamezaki, Member of the Policy Board, at a Meeting with Business Leaders in Kanagawa on December 26, 2007 (Recent Economic and Financial Developments in Japan)
Recent Economic and Financial Developments in Japan
Summary of a Speech Given by Hidetoshi Kamezaki, Member of the Policy Board, at a Meeting with Business Leaders in Kanagawa on December 26, 2007
February 22, 2008
Bank of Japan
Contents
- Introduction
- I. Economic and Financial Developments
- II. Achieving Sustainable Growth of Japan's Economy
- III. The Bank's Conduct of Monetary Policy
- Conclusion
Introduction
For 41 years before joining the Bank of Japan in April 2007, I worked for a general trading company that has more than 200 offices abroad, and was mainly in charge of coordinating management of these offices and planning business strategies tailored to different countries. This is the first time for me to attend a meeting such as this one, where the members of the Policy Board -- that is, the Governor, the two Deputy Governors, and the six other members -- exchange views on economic and financial developments with business leaders from various regions in Japan, and it is a great honor for me to have this opportunity.
I. Economic and Financial Developments
First, I would like to discuss recent economic and financial developments and the outlook for them.
A. Developments Overseas
For most of the three decades since the early 1970s, the global economy has grown at an average annual rate of around 3 to 4 percent. In the past few years, however, the growth rate has risen to around 5 percent, supported by favorable conditions in the major economies and robust growth in emerging economies. However, more recently, uncertainty regarding developments in overseas economies, especially the U.S. economy, has been growing.
In the United States, housing investment had been strong for several years due to a favorable financial environment and increased reallocation and diversification of mortgage loan-related credit risks through securitization. In parallel with the spread of securitization of mortgage loans, financial institutions loosened their standards for mortgage loans and increased the extension of loans, including subprime mortgage loans for individuals with low creditworthiness. This, coupled with the correction in the housing market, has caused the problem of nonperforming subprime mortgage loans. Since the summer, increased concerns about credit risks on securitized products backed by mortgage loans have impaired the functioning of credit markets. Furthermore, there has been a shortage of liquidity in the money market, in which financial institutions conduct their day-to-day short-term borrowing and lending. The disturbance in these markets has not entirely subsided yet. Faced with this situation, financial institutions have tightened their standards for providing mortgage loans, resulting in a drop in home sales, a prolongation of adjustments in housing inventory, and a fall in housing prices. Firms' financing has also been negatively affected, as seen in the decrease in the issuance of corporate bonds. Against this background, the deceleration in car sales and the rise in materials prices have restrained corporate profits, which had been growing fast supported by the global economic expansion, and the improvement in business sentiment has slowed.
Employment conditions have nevertheless remained firm. However, due to the drop in housing prices, large swings in stock prices, the tightening of lending standards by financial institutions, and the surge in gasoline prices, the consumer confidence index has declined to the lowest level since October 2005, when it dropped significantly reflecting the adverse effects of Hurricane Katrina. Indicators relating to private consumption have recently been somewhat weak, and several other related indicators have also shown developments that warrant attention. For example, the year-on-year rate of increase in sales tax revenues for all 50 states released by the Department of Commerce, which largely reflects developments in private consumption, had exceeded 5 percent since 2004, but fell below 5 percent in the October-December quarter of 2006 and has continued to decrease (Chart 1-1). Looking at developments by state, sales tax revenues have tended to drop significantly in states where housing prices have declined considerably -- such as California, Florida, Illinois, Maine, and Nevada (Chart 1-2). This suggests that the adjustment in the housing market is starting to affect private consumption. Since U.S. private consumption accounts for about 70 percent of domestic GDP and around 20 percent of global GDP, these trends warrant careful monitoring.
On the price front, although the slowdown in the U.S. economy is expected to ease core inflation pressure in the future, upside risks remain, partly due to high unit labor costs as well as recent high materials prices and the depreciation of the U.S. dollar. Therefore, in monitoring developments in the U.S. economy, it is especially important at present to pay careful attention both to downside risks to the economy and upside risks to prices.
European economies are likely to stay on a sustainable growth path, as high corporate profits and record-low unemployment rates suggest strong economic fundamentals. Nevertheless, business and consumer sentiment has begun to deteriorate due to the turbulence in global financial markets. It is highly uncertain when global financial markets will stabilize, and thus developments in global financial markets, as well as the effects of high materials prices, warrant attention.
Meanwhile, economies of countries in Asia -- such as China, India, the NIEs, and the ASEAN countries -- as well as those of the Middle East and Russia have so far remained firm. The Chinese economy has been particularly strong and has been growing at rates of more than 10 percent for some years now against the background of robust exports and fixed asset investment. Although some overheating has been observed and there are some concerns about a possible future slowdown in reaction to the current high growth, for the time being the economy is expected to continue to register high growth, as demand for infrastructure, such as roads and railroads, remains strong and the government continues to promote growth with the aim of maintaining social stability. India's economy also continues to be firm, led mainly by domestic demand. The Chinese and Indian economies are likely to continue to enjoy high growth, given that both have populations of over 1 billion and are increasingly turning into consumer societies with a growing middle class. However, careful attention should be paid to developments in economies that rely heavily on exports to the United States, such as the NIEs, as they are likely to be affected by the slowdown in the U.S. economy.
B. Developments in Japan's Economy
Japan's economy has continued to be on a trend of moderate but long-lasting expansion. This expansion, however, has been led by exports and export-related business fixed investment, which have had relatively limited positive influences on private consumption. Against this background, a slowdown in the economy has recently become evident partly due to a significant drop in housing investment, which I will discuss later. Therefore, it is necessary to monitor developments in the economy carefully, taking into account the effects of the rise in prices of materials such as crude oil, the appreciation of the yen, and the fall in stock prices.
1. Developments in the corporate sector
According to the December Tankan (Short-Term Economic Survey of Enterprises in Japan), business sentiment has become somewhat cautious. The performance of small firms has recently been relatively poor, partly because slow growth in demand has made it difficult for them to pass on higher materials prices to sales prices. The October issue of the Bank's quarterly Regional Economic Report shows that, although most regions remain on an expansion or recovery trend, the degree differs among regions.
Let me now look at the corporate sector in detail.
Exports as a whole have been solid, reflecting the strength in exports to, for example, Europe, Asia, the Middle East, and Russia, while those to the United States have remained relatively weak since the end of 2006.
In this situation, production has continued to be at high levels but warrants attention. Housing investment has dropped sharply, affected by the revised Building Standard Law coming into force last June. This has led to a reduction by some manufacturers in the production of construction goods, such as structural steel and cement, as well as to a decline in prices of materials and machinery equipment. Although housing investment itself only accounts for slightly more than 3 percent of GDP, it has ripple effects on production in housing-related industries and the drop may start to negatively affect industries making products used at a later stage of the construction process, such as industries producing window frames and glass. As for electronic parts and devices, prices of semiconductors, such as those of dynamic random access memories (DRAMs), have been declining. Although global demand for electronic parts and devices is likely to remain steady reflecting the diversification of IT-related products, there is a risk of supply becoming somewhat excessive.
Business fixed investment has also continued to be at high levels against the background of generally high corporate profits. In industrialized countries, including Japan, investment for replacement and rationalization of obsolete fixed capital assets has been at high levels, while in emerging economies demand for capital equipment and construction machinery for the building of infrastructure and factories has continued to be strong. Firms' efforts to meet such strong demand by reinforcing their capacity to supply goods and services have led to active business fixed investment in Japan. Firmness in fixed investment has also been observed in the nonmanufacturing sector such as in the electricity and transportation industries. However, firms, which conducted a high level of fixed investment in recent years, now seem to be generally paying added attention to investment efficiency in conducting new investment projects.
2. Developments in the household sector
As for the employment and income situation, firms have continued to feel a shortage of labor. Growth in nominal wages per worker, however, continues to be somewhat weak due to the following factors. First, firms have been exposed to increased global competition. With the former planned economies such as China, the former Soviet Union, and Eastern Europe becoming market economies following the fall of the Berlin Wall in 1989, the population living in market economies has jumped from 0.8 billion to 2.8 billion, and is likely to increase further. As low-priced goods made by cheap labor in these economies have been flooding into the global market, Japanese firms continue to restrain wages to maintain global competitiveness. And second, small firms, which tend to benefit less from economic globalization than large ones, are facing difficult business conditions due to higher materials prices, and this forced them to restrain labor costs. Given that small firms account for a large share in the total number of employees, the effects of developments in small firms should be watched closely.
Let me note, however, that, with the number of employees increasing, employee income as a whole has been rising, albeit moderately. The positive influence of the strength in the corporate sector has continued to gradually feed through into the household sector via various channels other than the rising employee income, such as increased dividends. The weakness in wages per worker may be reflecting not only the fact that the pace of economic expansion has been moderate, but also the fact that there have been structural changes in the labor market, reflecting, for example, changes in people's lifestyles. Part-time workers now account for a significant 26 percent of the total number of employees, and this percentage is still on an increasing trend, depressing the average wage per worker. These trends reflect the fact that it has recently become easier for housewives to join the workforce, and working conditions have changed to give workers greater latitude in their working hours. Moreover, retired baby boomers not only have their pension benefits as well as retirement benefits, but they now have the choice of returning to the workforce, although at lower wages. As a result of these changes, the increase in the number of employees has exerted downward pressure on the average wage per worker, even though the year-on-year rate of change in hourly wages for part-time workers has become positive. The changes in lifestyles are expected to continue for the time being, and this will restrain the increase in the average wage per worker in the statistics. Therefore, it is necessary to carefully watch developments in wages, together with the effects of the changes in lifestyles.
In this situation, indicators relating to private consumption have been firm on the whole, but the consumer confidence index has recently been deteriorating due to concerns about the Japanese pension system and higher gasoline prices. Looking at consumers abroad, in the United Kingdom, demand for housing, food, and clothing has been strong, reflecting a significant increase in immigrants -- the government has recently made a significant upward revision to the number of immigrants since 1997 from 0.8 million to 1.1 million -- a large part of which comprises young people from emerging economies. The United States also owes much of its economic dynamism to the inflow of immigrants. In contrast, in Japan the number of immigrants has been small and its population has been decreasing and aging. Japan now has a mature economy, and unlike during the era of rapid growth people already have most daily necessities. These circumstances seem to be one of the factors preventing private consumption in Japan from gaining strength.
3. Price developments
Developments in the consumer price index (CPI) have been affected by the economic situation described earlier. The year-on-year rate of increase in the CPI was 0.6 percent on average for the past 20 years and has recently been around 0 percent despite the ongoing economic expansion (Chart 2). While these developments in the CPI, as well as developments in wages, have been partly affected by intensified global competition, the underlying trend has recently been steady and such stability is the key to achieving sustainable economic growth. However, it should be noted that, since the absolute value of the rate of change is very small, developments in the CPI are currently prone to changes in the prices of a limited number of items, such as petroleum products, cellular phone charges, and digital appliances. In this situation, I believe that, in order to fully understand the underlying trend of the CPI, it is important to carefully examine the details of the CPI, not merely to look at the headline index excluding fresh food. Looking at the movements in the 523 items in the basket of the CPI (excluding fresh food), the number of items showing a price rise has been exceeding that showing a decline for 15 consecutive months since August 2006. Prices of many daily necessities have been rising noticeably, especially since April 2007, and it is important to note that this has been changing the public's price expectations.
With regard to developments in prices of international commodities, crude oil prices are rising at the fastest pace since the oil crisis in the 1970s, reflecting factors such as strong global demand, geopolitical risks, and a speculative inflow of funds. Gold prices have been surging partly because of a speculative inflow of funds amid the depreciation of the U.S. dollar. Prices of nonferrous metals and rare metals have also been rising due mainly to increased demand from emerging economies reflecting further industrialization. Moreover, prices of major crops such as wheat, corn, and soybeans have been rising and are about to exceed the upper limit of their price ranges of the past 30 years due to heightened demand arising from the increasing world population and rising incomes in emerging economies, and from the growing demand for bioethanol as an alternative to oil, prices of which have surged. Meanwhile, the domestic corporate goods price index (CGPI), which represents upstream prices, has remained positive on a year-on-year basis, and this hinted at the possibility of a rise in the CPI, that is, downstream prices, in due course. Therefore, developments in the CGPI continued to warrant attention.
II. Achieving Sustainable Growth of Japan's Economy
I would now like to talk about factors that will be crucial in the medium to long term for Japan's economy to continue to follow a path of sustainable growth.
A. Measures to Deal with an Aging Society
In order to maintain and enhance the growth capacity of Japan's economy with an aging population, it is essential to increase labor productivity. To this end, it is necessary that firms proceed with capital investment to rationalize production, save labor, and increase capacity, as well as with investment in research and development. It is also vital to ensure that the skills and expertise of firms in the manufacturing sector are steadily passed on to the next generation. Furthermore, as the expansion of the domestic market is expected to slow, the way firms are managed and tools such as mergers and acquisitions involving both domestic and foreign firms will take on even greater importance.
It is undeniable that the aging of the society is likely to restrain economic growth, but at the same time it is also likely to expand opportunities not only for firms that provide medical and nursing care, but also for those offering cultural and educational services. Since the bulk of financial assets in Japan is held by the elderly, who generally have a strong interest in culture and education, this potential should not be overlooked. While Japan leads other countries in terms of the pace at which its population is aging, Europe, the United States, and other Asian countries will follow suit sooner or later. Japanese firms in the services sector will then have the opportunity to expand their business globally if they are successful in raising their productivity ahead of firms in other countries.
Meanwhile, one of the driving forces behind the 15 years of sustainable growth in the United Kingdom and the 10 years in the United States has been the dynamism brought about by the stream of immigrants, which I mentioned earlier. Whether immigration can play a role also in Japan may be worth examining in finding ways to ensure the sustained growth of Japan's economy, although there may be some difficult issues to be resolved, such as the impact of immigration on society overall.
B. The Global Expansion of Japanese Firms
As a result of the global expansion of Japanese firms, Japan has enjoyed not only a surplus in the trade account of the balance of payments, but also a surplus in the income balance that exceeds the trade surplus, and this has been the source of further economic growth in Japan. While such global expansion entails risks, it is reassuring to find that Japanese firms are reducing such risks by tying up not only with experienced Japanese firms, but also with prominent local firms. In addition to these private initiatives, it is also important that the government provide the necessary policy support by promoting further economic partnership agreements and free trade agreements.
There were concerns that the increase in overseas operations of Japanese firms would lead to a hollowing out of the domestic industry. Lately, however, some Japanese firms have devised a pattern of international division of labor along the following lines: while transferring production overseas, they retain core technologies in the "mother factory" in Japan, in which they develop unique production methods and know-how through research and development as well as capital investment and concentrate on high-value-added production processes. Thanks to this accumulation of knowledge and capital investment, the domestic industry has not experienced a hollowing out and will be able to continue to benefit from the high growth of overseas economies.
C. Globalization of Japanese Financial Markets
Relying solely on the global expansion of the manufacturing industry, however, will not bring about the strength required to achieve sustainable growth. Therefore, it is useful to look at the United Kingdom and the United States, where the financial industry plays a more dominant role. The financial industry is an information-intensive industry, and the fact that financial markets in London and New York attract talent and amass information from around the world raises the value added of the financial industry there and contributes to the dynamism of the real economy in these countries as well. Furthermore, financial institutions based in the United Kingdom and the United States help to raise the value added of financial markets in these countries by establishing global networks and enhancing their innovative capabilities and risk management through gathering reliable, high-quality information.
Since the Japanese "Big Bang" financial deregulation launched after the mid-1990s, a variety of financial products has become available, and rules and systems for transaction practices, accounting, and settlement have been reformed. However, there remains ample room for attracting investors, domestic and foreign ones, to Japanese financial markets, given that Japan is the world's second largest economy with household financial assets amounting to 1,500 trillion yen. For a long time, Japanese financial institutions have been giving top priority to coping with the financial crisis and the nonperforming-loan problem. As a result, they seem to be lagging behind the manufacturing industry in expanding their overseas business. While financial institutions of course should each follow their own business strategies, I believe that there is further scope for the financial sector as a whole to expand its global networks and, as an information-intensive industry, further increase its value added.
D. Issues Relating to Natural Resources and the Environment
Strong global economic growth can give rise to various problems that may eventually undermine sustainable growth unless they are brought under control in time. From this viewpoint, issues relating to natural resources and the environment are currently of utmost concern.
As I have mentioned earlier, prices of natural resources are soaring in tandem with those of agricultural products. Given the expectation that the global population will continue to increase and that emerging economies will further industrialize, difficulties might arise in the near future in securing sufficient amounts of natural resources and food supplies to support global economic growth. Thus, it is vital that efforts are directed toward the conservation of energy and natural resources, the development of alternative energy, and increases in food production. The supply-demand conditions for food have tightened recently, partly due to sluggish production in Australia, the United States, and other major producers reflecting droughts.
The environment is now being threatened by global warming, which has led, for example, to droughts caused by environmental destruction, and constraining global warming has become a major political issue. Parties to the 1997 Kyoto Protocol are required to reduce greenhouse gas emissions to a certain level during the period of 2008 to 2012. An agreement to succeed this protocol, which expires in 2012, is expected to be put in place by the end of 2009, with the United States and China, which are not bound by the Kyoto Protocol, taking part in discussions. A worldwide framework is also starting to be established to limit the use of certain chemical substances. In order for Japan to continue to benefit from global economic growth, it needs to cooperate with other countries and take action to preserve the environment.
From a short-term perspective, the problems regarding natural resources and the environment should be considered as factors likely to restrain Japan's economic growth. However, the experience of the first oil shock in 1973 led Japan to look for alternative fuels and enhance its fuel efficiency, and as a result, the level of Japan's crude oil imports today is lower than at the time of the oil crisis. The appreciation of the yen has also helped to increase the resilience of Japanese firms in the face of higher crude oil prices. Increased overseas demand for Japan's environmentally friendly technology, which supports efficient use of energy and natural resources, and expertise in building and renovating oil refining plants are expected to prompt further innovation and open up new business opportunities for Japanese firms.
III. The Bank's Conduct of Monetary Policy
Lastly, I will explain the Bank's conduct of monetary policy. The Bank releases the "understanding of medium- to long-term price stability," the level of inflation that each member of the Policy Board understands, when conducting monetary policy, as being consistent with price stability over the medium to long term, which I will refer to hereafter as "understanding." The "understanding" reviewed in April 2007, expressed in terms of the year-on-year rate of change in the CPI, takes the form of a range approximately between 0 and 2 percent. The Bank also assesses the economic and price situation from two perspectives and then outlines its thinking on the future conduct of monetary policy, taking account of the "understanding."
A. Assessing the Economic and Price Situation from Two Perspectives
The first perspective involves assessing the most likely outlook for economic activity and prices in the next two fiscal years: the Bank assesses whether Japan's economy is likely to realize sustainable growth under price stability. As I mentioned earlier, although downside risks to the U.S. economy are increasing, Japan's economy is likely to continue to show moderate but long-lasting growth, supported by the firmness of overseas economies. The year-on-year rate of change in the CPI is also likely to remain stable for the time being, as it has been for many years.
The second perspective extends the time horizon and assesses the risks considered most relevant to the conduct of monetary policy, taking account of the cost incurred should risks materialize, even though the probability of such materialization may be low. With uncertainties regarding overseas economies and global financial markets, a significant change in their situation may adversely affect Japan's economy. Meanwhile, it is also necessary to consider the risk that maintaining low interest rates that are inconsistent with economic and price developments may cause large swings in the future.
B. Upside and Downside Risks to Economic and Financial Activities
It seems that, in recent years, the frequency of large swings in economic and financial activities stemming from turbulence in financial markets has increased worldwide. For example, in 1997 there was the Asian currency crisis, in 1998 the Russian crisis and the crisis triggered by the failure of Long-Term Capital Management (LTCM), a U.S. hedge fund, and in 2000-2001 the bursting of the global IT bubble. And since last summer, there has been the prolonged turbulence in global financial markets triggered by the U.S. subprime mortgage problem, increasing downside risks to the U.S. and U.K. economies, which have both enjoyed sustained growth for many years. These swings in global financial markets can be seen as examples of situations in which the risk assessment by market participants became slack amid long-lasting, favorable economic and financial conditions and a correction in the markets followed. I believe that this teaches us how important it is to minimize swings in economic and financial activities in order to achieve sustainable growth. Large swings in economic and financial activities have occurred from time to time. It is frequently pointed out that, historically, the economic and price situation often seemed generally favorable before large swings occurred, but at the same time economic and financial excesses that were not recognized as such built up. Furthermore, the nature of these excesses differs every time, and this calls for extra care.
Once large swings in financial markets occur and uncertainty about future developments in an economy increases as with the present situation in the U.S. and European economies, it is necessary to grasp economic and financial developments in detail and address them carefully. European Central Bank (ECB) President Jean-Claude Trichet said that the ECB would "monitor very closely all developments." And Federal Reserve Chairman Ben S. Bernanke said that the Fed would "have to remain exceptionally alert and flexible." These statements indicated that central banks in Europe and the United States are addressing the turbulence in financial markets and are paying close attention to both upside and downside risks in the economic and financial situation.
C. The Future Conduct of Monetary Policy
With regard to the future conduct of monetary policy, I believe that the Bank should continue to gather as much information as possible, including information on U.S. and European economies and global financial markets, and, based on this, have a clear view of what may occur, but at the same time examine economic and price developments without having any predetermined view. The Bank will continue to make policy decisions appropriately from a comprehensive viewpoint, while communicating well with the market.
Conclusion
Yokohama, the capital of Kanagawa Prefecture and home of the university I attended more than 40 years ago, arouses many fond memories. The streets and flow of people have changed greatly over the years, but I am very pleased to find that the city remains an attractive port town with a distinct character of openness and a welcoming atmosphere. At the university here, a professor I respect dearly taught me the dictum of a great British economist Alfred Marshall on the need for "cool heads but warm hearts," which I have always kept at heart. These words have become all the more important to me since I started to be involved in the decisionmaking on monetary policy this spring. I am determined to strive even harder to act in accordance with these words.