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Semiannual Report on Currency and Monetary Control (Summary)
Second Half of Fiscal 2001

The semiannual report, which included this summary, was submitted to the Diet in June 2002.

July 2002
Bank of Japan

The Economy

1. Japan's economy deteriorated broadly in the second half of fiscal 2001, as adjustments in the corporate sector spread to private consumption through the worsening of employment and income conditions. The deterioration, however, slowed somewhat toward the end of fiscal 2001, reflecting a recovery in overseas economies and progress in inventory adjustment.

Overseas economies, which further deteriorated simultaneously in early autumn of 2001, moved toward improvement after the turn of 2002. The U.S. economy decelerated further immediately after the terrorist attacks, but it turned around thereafter. Against this background, East Asian economies displayed signs of recovery, and there were signs that deceleration of economies in the euro area was coming to a halt.

2. Regarding price developments, demand-side factors tended to exert downward pressure on prices as the economy deteriorated broadly. In addition, supply-side factors, such as deregulation, streamlining of distribution channels, and technological innovation, continued to exert downward pressure. As a result, prices stayed on a gradual declining trend. The year-on-year decline in domestic wholesale prices, however, stopped expanding toward the end of fiscal 2001 in March 2002 due to an increase in import prices and progress in inventory adjustment.

As for land prices, both commercial and residential land prices continued to decline.

Financial Developments

3. In the money market, the uncollateralized overnight call rate was stable at extremely low levels. This was because the Bank of Japan successively increased the outstanding balance of current accounts at the Bank, against the background of the increase in demand for liquidity as financial institutions and investors became more cautious. Short-term interest rates on instruments with maturities longer than overnight were generally unchanged until the middle of December 2001, and they declined thereafter in response to the Bank's additional monetary easing measures decided at the Monetary Policy Meeting (MPM) on December 19. The rates rose slightly after mid-February 2002 due to increasing eagerness of market participants to raise funds maturing beyond the fiscal year-end, but the uptrend came to a halt in response to the Bank's additional measures taken on February 28.

Long-term interest rates generally stayed in the range of around 1.3-1.5 percent. Stock prices were hovering at their lowest levels since the bursting of the economic bubble until the end of 2001. They then fell substantially in early February 2002, recording a new post-bubble low. However, they recovered rapidly thereafter, partly due to the introduction of tighter regulations on short selling of stocks.

In the foreign exchange market, the yen depreciated against the U.S. dollar and the euro.

4. The year-on-year decline in lending by private banks expanded gradually. Private banks maintained their stance of increasing lending to firms with good performance, while their lending attitude toward firms with low creditworthiness became more cautious. Banks' lending attitude as perceived by small firms gradually became more severe. Firms' demand for funds remained on a downtrend as firms continued to (1) reduce borrowing as part of their efforts to improve their financial position and (2) decrease business fixed investment.

5. The year-on-year growth rate of the money stock (M2+CDs) continued to increase moderately. This was mainly due to the continuing shift of funds from postal savings. In the private sector, however, borrowing from banks continued to decrease and the growth rate of funding in the capital markets through such instruments as corporate bonds and CP slowed. These developments had greater negative effects on the growth of the money stock than before.

The year-on-year growth rate of the monetary base (currency in circulation plus current account balances at the Bank) rose significantly. This was due to an increase in the outstanding balance of current accounts at the Bank associated with the monetary easing measures and the higher growth rate of banknotes in circulation reflecting the extremely low interest rates.

Monetary Policy Meetings

6. Nine MPMs were held in the second half of fiscal 2001. At MPMs during October and November 2001, members of the Policy Board revised their assessment of the economy slightly downward for two consecutive months. This was because they generally shared the view that adjustments in economic activity were becoming more severe, as the substantial decline in production was beginning to have an adverse effect on private consumption through the deterioration in employment and income conditions. Regarding the conduct of monetary policy, members decided to provide ample liquidity to the money market in a timely manner, given that demand for liquidity in financial markets remained unstable. Specifically, members decided to maintain the guideline for money market operations adopted at the MPM in September 2001, aiming at an outstanding balance of current accounts at the Bank of above 6 trillion yen with no upper limit.

7. At the MPM on December 18 and 19, 2001, members generally held the view that the economy was deteriorating broadly as the weakness in private consumption was becoming pronounced, and decided to make a further downward revision of their assessment of the economy. Most members agreed that downside risks stemming from the financial side, such as risks related to the financial system and corporate financing, required particular attention.

Given these developments, members decided to take an additional monetary easing measure to raise the outstanding balance of current accounts held at the Bank to around 10 to 15 trillion yen, with a view to underpinning economic activity and reducing the risk that financial developments might adversely affect the economy. In line with this decision, the Bank's outright purchase of long-term government bonds was increased from 600 billion yen to 800 billion yen per month from the viewpoint of providing liquidity smoothly. In addition, members decided to immediately examine operational issues to broaden the range of (1) eligible CP for CP operations and collateral uses to include asset-backed commercial paper (ABCP) and (2) eligible asset-backed securities (ABS) as collateral.

8. At the MPMs on January 15 and 16, and on February 7 and 8, 2002, members decided to maintain the guideline with the aim of stabilizing financial markets by providing ample liquidity. Members also decided to examine how the significant increase in the outstanding balance of current accounts at the Bank would affect developments in financial institutions' behavior and financial markets.

9. At the MPM on February 28, 2002, the majority of members considered that there was a possibility that, with the end of a fiscal year approaching, liquidity demand would increase further, depending on financial market developments. Therefore, they considered it extremely important to take all possible measures to secure financial market stability in order to prevent a deflationary spiral and to pursue sustainable economic growth.

On this basis, members decided to (1) maintain the guideline aiming at an outstanding balance of current accounts at the Bank of around 10 to 15 trillion yen; (2) provide more liquidity irrespective of the above target for the current account balance until the end of the fiscal year; and (3) as a temporary measure, apply the official discount rate to the Lombard-type lending facility on any business day during the period from March 1, 2002 to April 15, 2002. In addition, the Bank's outright purchase of long-term government bonds was increased from 800 billion yen per month to 1 trillion yen per month in order to provide liquidity smoothly. It was also decided to immediately examine operational issues to broaden the range of eligible collateral to include loans to the Deposit Insurance Corporation as well as those to the Government's"Special Account for the Allotment of Local Allocation Tax and Local Transfer Tax."

10. At the MPM on March 19 and 20, 2002, most members concurred that, although Japan's economy still continued to deteriorate as a whole, it was appropriate to revise the assessment of the economy upward as the downward pressure from exports and inventories was gradually abating against the background of an improvement in overseas economies. Regarding the conduct of monetary policy, members maintained the guideline for money market operations unchanged.

The Bank's Balance Sheet

11. In the second half of fiscal 2001, the size of the Bank's balance sheet continued to exceed that of the previous year. This was due to an increase in the outstanding balance of current accounts at the Bank and in the amount of banknotes issued, as well as the establishment of a new account of payables under repurchase agreements, associated with a change in the accounting practice in relation to the Bank's transactions under repurchase/resale agreements. Total assets on the Bank's balance sheet at the end of March 2002 were 138.6 trillion yen, an increase of 20.4 percent from the previous year. The Bank continued to improve the quality of its balance sheet by enhancing both the liquidity and the soundness of its assets.