Minutes of the Monetary Policy Meeting

on December 18 and 19, 2001
(English translation prepared by the Bank's staff based on the Japanese original)

January 21, 2002
Bank of Japan

A Monetary Policy Meeting of the Bank of Japan Policy Board was held in the Head Office of the Bank of Japan in Tokyo on Tuesday, December 18, 2001, from 2:00 p.m. to 3:21 p.m., and on Wednesday, December 19, from 9:01 a.m. to 2:54 p.m. ¹

Policy Board Members Present
Mr. M. Hayami, Chairman, Governor of the Bank of Japan
Mr. S. Fujiwara, Deputy Governor of the Bank of Japan
Mr. Y. Yamaguchi, Deputy Governor of the Bank of Japan
Mr. T. Miki
Mr. N. Nakahara
Mr. K. Ueda
Mr. T. Taya
Ms. M. Suda
Mr. S. Nakahara

Government Representatives Present
Mr. S. Murakami, Senior Vice Minister of Finance, Ministry of Finance ²
Mr. H. Fujii, Deputy Vice Minister for Policy Planning and Coordination, Ministry of Finance ³
Mr. H. Takenaka, Minister of State for Economic and Fiscal Policy, Cabinet Office ⁴
Mr. K. Iwata, Director General for Economic Assessment and Policy Analysis, Cabinet Office ⁵
Mr. Y. Kobayashi, Director General for Economic and Fiscal Management, Cabinet Office ⁶

Reporting Staff
Mr. M. Matsushima, Executive Director
Mr. M. Masubuchi, Executive Director
Mr. S. Nagata, Executive Director
Mr. M. Shirakawa, Advisor to the Governor, Policy Planning Office
Mr. T. Wada, Associate Director, Policy Planning Office
Mr. M. Amamiya, Associate Director, Policy Planning Office
Mr. I. Yamashita, Director, Financial Markets Department
Mr. H. Hayakawa, Director, Research and Statistics Department
Mr. T. Yoshida, Senior Manager, Research and Statistics Department
Mr. E. Hirano, Director, International Department

Secretariat of the Monetary Policy Meeting
Mr. I. Yokota, Director, Secretariat of the Policy Board
Mr. Y. Nakayama, Advisor to the Governor, Secretariat of the Policy Board
Mr. H. Onobuchi, Manager, Secretariat of the Policy Board
Mr. H. Yamaoka, Senior Economist, Policy Planning Office
Mr. S. Shimizu, Senior Economist, Policy Planning Office

1. The minutes of this meeting were approved by the Policy Board at the Monetary Policy Meeting held on January 15 and 16, 2002 as "a document which contains an outline of the discussion at the meeting" stipulated in Article 20, Paragraph 1 of the Bank of Japan Law of 1997. Those present are referred to by their titles at the time of the meeting.
2. Mr. Murakami was present on December 19.
3. Mr. Fujii was present on December 18.
4. Mr. Takenaka was present on December 19 from 9:01 a.m. to 11:20 a.m.
5. Mr. Iwata was present on December 18.
6. Mr. Kobayashi was present on December 19 from 11:22 a.m. to 2:54 p.m.

I. Summary of Staff Reports on Economic and Financial Developments ⁷

A. Money Market Operations in the Intermeeting Period

Market operations in the intermeeting period were conducted in accordance with the guideline determined at the previous meeting on November 29, 2001. The Bank provided ample liquidity to the money market by aiming at maintaining the outstanding balance of current accounts held at the Bank at above 6 trillion yen.

On November 30, when interest rates rose due to month-end factors and the financial difficulties of Enron, a large U.S. company, the Bank increased the outstanding balance of current accounts at the Bank to around 14 trillion yen. In December, the Bank conducted market operations so that the balance decreased to around 8 to 9 trillion yen as the market regained stability gradually. As a result of these market operations, the weighted average of the uncollateralized overnight call rate moved at 0.001-0.003 percent.

1. 7Reports were made based on information available at the time of the meeting.
2. 8The guideline was as follows:
   The Bank of Japan will provide ample liquidity to the money market by aiming at maintaining the outstanding balance of current accounts held at the Bank at above 6 trillion yen.

B. Recent Developments in Financial Markets

1. Developments in domestic financial markets

A feature of the intermeeting period was the further heightening of concern among participants in Japanese markets about credit risk reflecting the failure of some firms.

In the stock market, stocks of banks, construction companies, and real estate firms, and other stocks in the low price range had been sold further, and their prices had declined significantly. In contrast, IT-related stocks, such as those of electrical machinery manufacturers, were firm on the whole reflecting expectations for a recovery in the U.S. economy, the rise in the U.S. Nasdaq composite index, and a further depreciation of the yen.

Credit spreads, the yield differentials between corporate bonds and Japanese government bonds (JGBs) traded in the secondary market, were on a widening trend recently for some bonds issued by firms with a single A rating, in addition to those issued by firms with BBB/Baa rating, which had been widening for some time. These credit spreads, however, were smaller than those in 1997-98 when corporate financing conditions tightened in general. Long-term interest rates remained at the levels reported at the previous meeting, moving at around 1.35 percent recently.

Interest rates on term instruments remained extremely low reflecting the Bank's ample provision of funds. Interest rates on some instruments such as TBs, however, had risen slightly recently. This reflected the fact that some investment trusts sold some of their assets such as TBs for cash in preparation for possible withdrawal from money management funds (MMFs) following the failure of Enron.

2. Developments in the foreign exchange market

The yen fell to the 128-129 yen level against the U.S. dollar recently, reflecting the failure of some Japanese firms, the downgrading of JGBs, and the market's interpretation of the comments by Japanese currency authority officials as indicating that they would accept a depreciation of the yen.

C. Overseas Economic and Financial Developments

In the intermeeting period, the economic deterioration continued in various countries. By contrast, in financial markets, stock prices and long-term interest rates rose reflecting market expectations for an economic recovery in the future.

The U.S. economy was deteriorating, as evident in a rapid worsening of employment conditions reflecting continued adjustments in the corporate sector such as a decrease in production and business fixed investment. Inventory adjustments, however, were making significant progress due to the effects of production cuts. With regard to private consumption, automobile sales remained firm due to the effects of special sales promotion measures such as the zero-interest program for automobile loans offered by automakers, and Christmas sales were also fairly firm so far. These developments in private consumption were to some extent working to stop a further economic deterioration in the United States.

The Federal Open Market Committee (FOMC) lowered its target for the federal funds rate from 2.0 percent to 1.75 percent on December 11. Yields on U.S. federal funds futures factored in to some extent an additional cut of around 25 basis points in the federal funds rate by the end of February 2002. However, for the futures rates for delivery in March 2002 or after, the later the delivery dates, the higher the rates, and this indicated the market's expectations for an economic recovery in or after the middle of 2002.

Long-term interest rates and stock prices in the United States rose to levels higher than before the terrorist attacks reflecting heightened expectations for an economic recovery in the future. In particular, the U.S. Nasdaq composite index, a large proportion of which was accounted for by high-tech stocks, was rising markedly. Investors' cautiousness about taking risks, which intensified temporarily following the terrorist attacks, was subsiding gradually.

European economies continued to decelerate due to a slower growth in exports and business fixed investment, and in Germany the economy had already entered a recessionary phase. Inflation rates in European countries were on a downtrend. In the financial markets, on the other hand, long-term interest rates and stock prices were on an uptrend reflecting expectations for an economic recovery in the future.

NIEs and ASEAN economies also continued to decelerate on the whole. Exports and business fixed investment in the region continued to decrease, and the growth in private consumption was generally slowing, except in Korea. Economies that depended greatly on IT-related industries continued to show negative growth, in particular those of Taiwan, Singapore, and Malaysia.

The pace of the decline in IT-related exports from NIEs was slowing gradually, reflecting the progress in worldwide inventory adjustments of IT-related goods. In this situation, stock prices in these economies had risen markedly recently.

D. Economic and Financial Developments in Japan

1. Economic developments

Japan's economy was deteriorating broadly, as private consumption was weakening in addition to a decline in exports and business fixed investment.

With regard to final demand, exports continued to be on a downward trend, but a further decline due to the terrorist attacks, anticipated immediately after them, had not occurred so far.

In domestic demand, business fixed investment was decreasing. Housing investment remained sluggish, and public investment was on a downward trend. Moreover, indicators related to private consumption, such as passenger-car sales, outlays for travel, and sales at chain stores, were evidently weakening.

Reflecting these developments in final demand, production continued to decline considerably. Pressure for inventory adjustment remained strong on the whole, although inventory adjustments progressed considerably in electronic parts and began to make progress in materials. Business sentiment continued to deteriorate reflecting the substantial fall in corporate profits due to the production cuts. The December 2001 Tankan (Short-Term Economic Survey of Enterprises in Japan) indicated that projections for sales and corporate profits in both manufacturing and nonmanufacturing industries were revised downward, and that plans for business fixed investment for fiscal 2001 were also revised downward, particularly those of large manufacturers. Business sentiment of firms generally continued to worsen.

In this situation, employment and income conditions for households became increasingly harsh.

The outlook for Japan's economy was as follows. Exports were likely to remain on a downward trend for a while. With respect to domestic demand, it was expected that business fixed investment and public investment would continue to follow a declining trend and private consumption would also weaken further. Due to these developments in final demand as well as persisting strong pressure for inventory adjustments, production would continue to decline markedly at least until the end of March 2002.

Inventory adjustments of IT-related goods worldwide were showing progress, and this had strengthened the view that IT-related adjustments would be mostly completed by around spring 2002. This forecast suggested that Japan's exports and production of these goods would stop declining in the near future.

This scenario for Japan's economy, however, would continue to depend greatly on a recovery in the U.S. economy as well as other overseas economies. In the current situation, production of IT-related goods was unlikely to recover quickly even after the completion of inventory adjustments because final demand, especially network-related investment, remained sluggish.

With regard to prices, domestic wholesale prices were declining faster due to (1) technological innovation, (2) the fall in prices of electronic parts and of pulp and paper reflecting an easing of the supply-demand balance, and (3) the sharp drop in prices of petroleum products reflecting the softening of international crude oil prices. The consumer price index (CPI) was weakening owing mainly to the decline in prices of imported goods and domestic goods that were competing with imported goods.

As for the outlook for prices, the balance between supply and demand in the domestic market was likely to exert downward pressure on prices gradually. Factors such as technological innovation, deregulation, and the streamlining of distribution channels would continue to exert downward pressure on prices. The fall in crude oil prices would also push prices down for a while. In sum, the rate of decline in various price indexes would remain unchanged or slightly accelerate for some time.

2. Financial environment

With regard to monetary aggregates, the year-on-year growth rate of monetary base (currency in circulation plus current account balances at the Bank) was as high as 15.5 percent in November. The year-on-year growth rate of M2+CDs also rose to 3.2 percent in November, increasing from the 3.0 percent growth in the previous month, due mainly to a shift of funds from MMFs. Lending by private banks, on the other hand, remained sluggish.

Regarding developments in direct financing, the year-on-year growth of the amount outstanding of corporate bonds issued had been slowing because the issuance of corporate bonds of firms with low credit ratings remained almost zero. The year-on-year growth rate of the amount outstanding of CP issued was declining reflecting a slight deterioration of the issuing environment for firms with low credit ratings, although the amount outstanding of CP issued was at a record high.

Corporate financing conditions remained fairly easy on the whole. However, private banks were being more selective about borrowers, for example, more cautious in extending loans to firms with high credit risk, as firms' cash flow decreased. The December 2001 Tankan indicated that the diffusion indexes of small firms' "financial position" and "lending attitude of financial institutions" as perceived by small firms continued to be slightly tight and severe. However, the degree of deterioration was smaller and the levels of the diffusion indexes were considerably higher than in 1997-98 when there was a general tightening of corporate financing conditions.

The number of corporate bankruptcies in November was in the 1,800-1,900 range as in October, considerably higher than in September and before.

Overall, the financial environment remained extremely easy in terms of interest rate levels. However, fund-raising conditions for some firms were becoming severe as private banks and investors were becoming more cautious in taking risks against the background of a growing number of corporate bankruptcies. Therefore, developments in the behavior of financial institutions and corporate financing needed closer monitoring.

II. Summary of Discussions by the Policy Board on Economic and Financial Developments

A. Current Economic Situation and the Outlook

On the current state of Japan's economy, most members concurred that it was deteriorating broadly, as private consumption was weakening in addition to a decline in exports and business fixed investment. On this basis, many members expressed the view that the economy stood at the crossroads in relation to whether it would (1) start to recover led by an upturn in overseas demand, as inventory adjustments at home and abroad progressed and downward pressure on production eased; or (2) deteriorate spirally with stronger downward pressure due to weak domestic demand and financial system problems, before the momentum for economic recovery started to work.

The first topic of discussion was overseas economic developments.

Many members pointed out that (1) the economies of the United States, Europe, and Asia were slowing further recently; and (2) in contrast to this, stock prices and long-term interest rates in overseas markets were rising reflecting market expectations for an economic recovery in the future.

Regarding the U.S. economy, some members noted the following as positive factors that would support the economic recovery ahead: (1) the decline in crude oil prices, (2) progress in adjustments in IT-related industries, (3) support from fiscal policy, and (4) easy monetary policy. These members expressed the view that unless prices of assets such as stocks fell sharply, the most likely scenario for the U.S. economy would be a recovery starting around the middle of 2002.

These members also pointed out the following. First, the recent firmness in the U.S. sales statistics was partly the result of pumping up by aggressive special sales promotion measures such as the zero-interest program for automobile loans offered by automakers. And second, the extent of adjustments required in business fixed investment and private consumption in the United States remained highly uncertain.

Based on these discussions, many members shared the following view: they supported the scenario that the U.S. economy would start to recover around the middle of 2002, but considered that the economic outlook remained highly uncertain and thus future developments, including the results of Christmas sales, required close monitoring. Accordingly, it was also necessary to monitor carefully whether economies outside Japan would follow a recovery path in line with financial markets' expectations.

A different member commented that the rapid deterioration in economies worldwide--especially that of consumption in the United States--could have a significant impact on China, a large proportion of whose exports were consumer goods.

Members then discussed the current situation and the outlook for Japan's economy.

Many members said that Japan's economy, which was confronting structural and financial system problems, was in a markedly severer situation than overseas economies that were starting to show positive developments toward a recovery.

Most members pointed out that in the corporate sector, adjustments were spreading to a wider range of industries.

A few members said that the results of the December 2001 Tankan showed that the corporate sector was undergoing severe adjustments as evident in the fact that the diffusion indexes of business conditions had deteriorated and the forecasts for corporate profits had been revised downward in a wider range of industries. Some members also pointed out that there were some positive developments: (1) the pace of deterioration in various diffusion indexes and corporate profits had not accelerated recently, and (2) inventory adjustments of IT-related goods were making progress gradually.

A different member took a more cautious view than other members for the following reasons. First, the diffusion indexes of change in prices had become weaker. Second, forecasts for corporate profits for the second half of fiscal 2001 were still over-optimistic and would be revised downward. Third, the number of employed workers had hardly decreased at all, even though corporate restructuring had been strongly called for. And fourth, there would be an increasing number of economic indicators that would fall below the previous lows.

One member raised concern about the growing impact a reduction in automobile production would have on the economy. This member said that production was likely to drop to the 9,200-9,400 thousand range for fiscal 2002 from the 9,500-9,700 thousand cars of the current fiscal year. This member gave the following reasons for this forecast. First, the year-on-year growth rate of automobile sales in Japan had been negative for three consecutive months. Second, automobile sales in the United States were expected to fall in the future in reaction to the pumping up of sales due to the zero-interest program for automobile loans. And third, exports to the United States would inevitably be reduced in the future as Japanese automakers were shifting their production lines abroad. This member also expressed concern that, while construction starts (nonresidential) had finally stopped falling and started to level off, sales of condominiums had been slowing.

Regarding developments in the household sector, many members pointed out that (1) considerably faster adjustments in employment and income conditions were being observed; and (2) in this situation, weak indicators of private consumption were becoming prominent.

One member said that in the current economic phase, the pace at which adjustments were spreading from the corporate sector to employment and income conditions in the household sector seemed to be faster than in past phases of economic slowdown. The member noted that this was due to a rise in the proportion of non-regular employees such as part-time workers among total employees in a period of changes in the structure of the labor market. This member continued that the faster pace of adjustments in employment and income conditions implied that the corporate sector was able to respond more swiftly to economic fluctuations but these faster adjustments would not lead to an early recovery of the economy as a whole, unless (1) economic activity of blue-chip firms and venture firms became more active, and (2) excess production resources such as capital and labor in a particular industry were reallocated to other industries smoothly.

Against the background of the adjustments in employment and income, many members shared the view that private consumption had been weakening clearly since autumn 2001.

One of these members said that while sales of consumer durables such as automobiles and electrical appliances declined markedly, positive developments as the following underpinned private consumption: (1) firm sales of some luxury goods and goods and services whose prices had been lowered while maintaining their quality; and (2) brisk performance of businesses in food services, leisure activities, and travel. The member commented that it was firms and the Government that were experiencing severe conditions. This member continued that, given this situation, although the household sector could still afford to spend and the level of private consumption was still in a normal state, there was an increasing risk that this level of consumption might not be maintained in the future.

With regard to prices, one member pointed out that the output gap was widening recently as the economy showed a slight negative growth, and the imbalance between supply and demand in the economy continued to exert downward pressure on prices. The member went on to note that the recent expansion in the rate of decline in wholesale prices clearly reflected the deterioration in the supply-demand balance. A few other members agreed with this view.

Another member expressed the view that the rate of decline in wholesale prices would expand in the future, judging from developments in the ratio of inventories to shipments for final goods and materials and in the Nikkei commodity price index.

A different member commented that the CPI showed that the supply-demand balance of goods, in particular, was deteriorating.

Another member said that it was necessary to give priority to preventing a spiral deterioration of prices and demand during the period of intensive adjustments during which full-scale structural adjustments should be carried out.

One member expressed the view that Japan's economy was already in the early stages of a deflationary spiral.

This member said that (1) the level of stock prices could fall further in the future as Japan's economy would have to bear the pain of finally dealing with the various problems that had been left unsolved, (2) the Indexes of Business Conditions were deteriorating markedly, (3) a decline in machinery orders had spread from IT-related industries to other industries, and (4) the number of corporate bankruptcies was increasing. With regard to corporate bankruptcies, this member expressed the view that there were around 1 million firms that could potentially go bankrupt, and in the near future there might be around 100 thousand corporate bankruptcies in one year. The member added that the rebound in stock prices of IT-related firms in overseas markets was mostly a quasi-bubble brought about by ample provision of liquidity.

B. Financial Developments

Many members expressed the view that the downside risks that required the most attention for the time being stemmed mainly from the financial side.

Many members referred to risks related to the financial system. These members said that market participants' view of banks' soundness was becoming extremely severe, pointing out (1) the recent pronounced fall in the prices of bank stocks, (2) the expansion in spreads between bonds issued by banks and JGBs, and (3) the further rise in credit default swap rates. One of these members said that land prices had not stopped falling and the financial condition of life insurance companies was deteriorating.

Members next exchanged views on risks related to corporate financing.

Many members said that private banks and investors were becoming more cautious in taking risks, reflecting the decrease in banks' real capital bases due to the increase in unrealized capital losses on stocks, and a series of failures of major firms at home and abroad, against the background of the decreasing cash flow of firms. These members elaborated that (1) yield differential in CP and corporate bond markets was widening reflecting the difference in the creditworthiness of issuers, (2) the range between the highest and lowest prices in the stock market was expanding with the plunge in stocks in the low price range, and (3) various surveys showed that banks' lending stance as perceived by firms was gradually becoming more severe.

These members, however, remarked that, judging from the size of credit spreads and various diffusion indexes of "firms' financial position" and "banks' lending attitude," a general tightening of corporate financing conditions as seen in 1997-98 had not been observed to date. On this point, a few members expressed the view that, unlike the autumn of 1998 when a contraction in corporate financing had spread widely to financial markets and affected a wide range of firms, the current situation was that market participants focused only on certain firms and assessed them severely.

Some of these members said that pain arising from the banks' and investors' moves to secure profits from interest margins and to be selective about borrowers and investment was inevitable in the course of structural reforms and of restoring the soundness of the financial system. In addition, these members pointed out that such moves were basically generated by problems related to banks' nonperforming loans (NPLs) and firms' excessive debts, and it was difficult for monetary policy alone to stop such moves, and also the momentum for the restoration of a sound financial system should not be stopped.

Many members, however, noted that careful attention should be paid to the possibility that such moves might (1) go so far as to bring about instability in corporate financing conditions overall including those for viable firms, and (2) adversely affect economic activity toward the end of the calendar and the fiscal year, together with the termination of measures to fully protect bank deposits in case of bank failures. One of these members pointed out the risk that a further decline in stock prices could adversely affect not only business sentiment, but also, through impairment accounting, corporate profits, resulting in a negative impact on the economy in the future.

In relation to this, a different member remarked that the Bank was expected to take measures in collaboration with the Financial Services Agency (FSA) in a timely manner to stabilize the financial system, and this was the foremost issue for the Bank at present.

One member noted that the recent fall in prices of bank stocks was partly due to speculative investments but mainly reflected market participants' view that the disposal of NPLs was insufficient. Therefore, it would be difficult to halt the fall unless drastic measures that could be easily understood by the markets were employed. On this basis, this member said that concrete measures such as removing NPLs from banks' balance sheets and improving banks' financial strength were important, and public funds should be promptly injected if necessary. A different member also pointed out that it was important for banks to (1) advance concrete plans to dispose of NPLs at maximum possible speed by the end of the current fiscal year, and (2) ensure that market participants recognized their efforts to advance their plans.

In relation to securities regulations, a different member advocated that (1) the so-called uptick rule, which required short sales to be made only at the same or a higher price than the most recent one, should be strictly followed; (2) an article in the ministerial ordinance, which exempted various margin transactions from the uptick rule on short-selling of stock transactions, should be abolished; (3) as the number of issues which required backwardation in margin transactions had become too great, although issues with the amount outstanding of stocks issued of 20 million stocks or more were eligible under the current system, only issues with 20 million floating stocks or more should be eligible for loans for margin transactions; and (4) negotiable margin transactions should be expanded.

III. Summary of Discussions on Monetary Policy for the Immediate Future

Members discussed the monetary policy stance for the immediate future.

Most members shared the view that the economy was deteriorating broadly, as the weakness in private consumption was becoming pronounced amid a clearer deterioration in employment and income conditions. Members generally agreed that the downside risks stemming from the Japanese financial side would require particular attention for a while.

Based on this understanding, all members shared the view that the Bank should employ monetary policy measures to deal with the current economic situation, with a view to underpinning economic activity and reducing the risk that financial developments might adversely affect the economy.

Members discussed specific measures, mainly changing the target level of the outstanding balance of current accounts at the Bank and taking measures to strengthen money market operations to facilitate firms' financing activities.

A. Methods of Setting a Target for the Outstanding Balance of Current Accounts at the Bank and an Increase in the Target

Many members remarked that increasing the outstanding balance of current accounts at the Bank should be the primary response within the framework of monetary easing decided in March 2001.

Members discussed methods of setting a target for the outstanding balance of current accounts at the Bank. Most members agreed with the following basic points outlined by a few members: (1) the current target for the outstanding balance of current accounts at the Bank without an upper limit should be regarded as an emergency measure following the terrorist attacks, (2) it was desirable that the Bank should return to the previously employed measure of targeting a specific level in order to bring about a sense of stability in the markets, and (3) the members should discuss in greater depth whether the Bank should pinpoint a specific target or set a target with a range.

With regard to the specific target level, members expressed the opinion that (1) rebalancing of financial institutions' portfolios through the increase in the outstanding balance of current accounts at the Bank seemed to have been limited to date; (2) in view of this, a drastic increase in the outstanding balance would be necessary to affect the expectations of market participants; and (3) the Bank should set a target higher than the latest peak of the outstanding balance of 14 trillion yen. In the course of these discussions, many members mentioned 15 trillion yen as a specific target level or upper limit for the outstanding balance of current accounts at the Bank.

Members exchanged views on the feasibility of increasing the outstanding balance of current accounts at the Bank.

A few members remarked that (1) the outstanding balance of current accounts at the Bank could not be increased beyond actual demand without any limit, and (2) the amount of the outstanding balance of current accounts would not necessarily indicate the degree of monetary easing in the market. These members raised the question of whether, if liquidity demand decreased for some reason, the Bank could continue its provision of funds to maintain the outstanding balance of current accounts at a high level. One member said that it was undesirable to set a fairly high target level for the outstanding balance of current accounts and then lower it, because it might cause misunderstanding that the Bank was tightening monetary conditions.

One member gave a theoretical explanation in answer to the above question.

This member explained that the amount of funds provision to the outstanding balance of current accounts at the Bank and demand would eventually meet, and this would be brought about through the following mechanism: (1) the Bank would try to provide funds exceeding the demand at the time; (2) and as a result, interest rates--in other words, prices--would fall; (3) thereby increasing demand, which would then meet supply. The member concluded that it was both theoretically and practically uncertain whether such a mechanism--of demand increasing in line with supply--would work with interest rates close to zero percent.

At the request of the chairman, the staff explained the feasibility of increasing the outstanding balance of current accounts at the Bank.

The staff pointed out that the Bank's ample provision of funds in and after September 2001 was made possible by the marginal expansion of the scope for decreasing interest rates due to the change in the unit of rates for transactions to 0.001 percent from 0.01 percent in September 2001, in addition to the increase in liquidity demand following the terrorist attacks. On this basis, the staff said that given that there was only limited room for short-term interest rates to decrease, it could not be denied that, depending on liquidity demand, there was a possibility that the total amount of bids in market operations would often fall short of the amount the Bank offered, i.e., a possibility of undersubscription, if the Bank continued constant provision of funds with an extremely high level of the outstanding balance of current accounts.

Based on the above discussions, there was a convergence of opinion, with many members agreeing that the Bank should set a target of a range of around 10 to 15 trillion yen for the outstanding balance of current accounts at the Bank in view of the following: (1) the Bank should set a target greatly exceeding the actual outstanding balance of current accounts if its intention was to have some kind of positive effect by, for example, affecting market participants' expectations; and (2) the Bank should be capable of dealing with the situation where demand for funds decreased as the demand did not seem to have become stable yet.

A few of these members added in support of the above view that efforts should be made to avoid a situation where the actual outstanding balance of current accounts at the Bank stayed at the lowest level within the range of around 10 to 15 trillion yen.

Members generally shared the view that it was desirable that the Bank should include a contingency clause in the guideline for money market operations in case liquidity demand surged.

Some members said that in order to provide liquidity smoothly, the Bank should increase its outright purchase of long-term government bonds within the framework of the monetary easing decided in March 2001. There were several opinions regarding the amount by which it should be increased, and the chairman's judgment was that it would be appropriate for the Bank to increase it by 200 billion yen once in a month.

One member contended that in considering the conduct of monetary policy for the future, (1) it was necessary to clarify whether the Bank of Japan Law allowed purchases by the Bank of foreign bonds on its own decision, and (2) it was necessary for the Government to gain the market's confidence regarding fiscal discipline in order not to narrow the Bank's discretion in monetary policy.

B. Measures to Strengthen Money Market Operations

Based on the above discussion of the downside risks stemming from the financial side, members discussed measures to strengthen money market operations to ensure that the financial markets continued to work in a stable manner and to support and enhance penetration of the monetary easing effect into the economy.

Many members shared the view that (1) monetary policy alone could not completely stop market participants from becoming more selective about borrowers and investment, nor was it appropriate to do so, but (2) the Bank should take measures to reduce the risk that such a move among market participants might lead to a tightening of overall corporate financing conditions and negatively affect Japan's economy. One of these members commented that the Bank should find ways to (1) put an end to the current situation where liquidity was merely circulating between the Bank and financial institutions and (2) allow funds to flow outside the financial system.

With regard to specific measures that the Bank could take, many members raised the issue of whether the Bank could more actively purchase CP under repurchase agreements (CP operations) and include asset-backed securities (ABS), including asset-backed CP (ABCP), whose market size was expected to expand in the future, as eligible assets to be widely used in the Bank's market operations and as eligible collateral.

Some members said that the volume of issuance of ABS was currently small, but it was expected to grow in the future. On this basis, these members commented that it would be beneficial, from the standpoint of fostering intermediary channels for raising funds through markets, to include ABS as eligible assets to be widely used in the Bank's market operations and as eligible collateral for the Bank's provision of credit, given that restoration of the functioning of indirect financing was expected to take time due to the NPL problem.

One of these members gave the following as advantages of the expansion of the ABS market. First, it would cut firms' fund-raising costs and improve their return on assets. Second, banks could lend actively because the loans would be securitized. And third, if mortgage loans were approved as assets backing eligible ABS, this would not only promote the securitization of mortgage loans held by banks, but would also help the Government to advance the reform of special public corporations. This member continued that if ABS was included as eligible assets for the Bank's market operations and as eligible collateral, this would enhance the effect of the current "quantitative" easing, and in addition, it was expected that it would further reinforce the momentum for structural adjustments from the monetary side by means of "qualitative" easing, i.e., increasing the channels for funds provision.

Some members, however, commented that it was not desirable for a central bank to make outright purchases of CP or corporate bonds, and that there was no need to make such purchases at this point for the following reasons. First, outright purchase of CP and corporate bonds would mean the provision by the Bank of uncollateralized credit to firms, and this involved various problems in terms of the soundness and neutrality of central bank assets. And second, in the situation where demand for funds was weak, the Bank's provision of funds to firms through these measures would not lead to an expansion of credit creation in the overall economy because firms might use these funds to repay their loans to private banks.

Based on the above discussions, many members asked the Bank's staff to report on specific measures to strengthen money market operations, including any possible room for improvement in the conduct of money market operations, and the staff outlined the following measures.

1. Measures for making further use of CP and ABS (including ABCP) in money market operations would be as follows:

a. First, for the time being, the Bank could more actively purchase CP under repurchase agreements (CP operations). This measure was taken in autumn 1998 when corporate financing conditions had tightened and was effective to a certain extent. This measure could be brought into effect immediately by the staff.a. First, for the time being, the Bank could more actively purchase CP under repurchase agreements (CP operations). This measure was taken in autumn 1998 when corporate financing conditions had tightened and was effective to a certain extent. This measure could be brought into effect immediately by the staff.

b. Second, the Bank could immediately examine operational issues to broaden the range of eligible CP for CP operations and collateral uses to include ABCP and bring this measure into effect upon completing its examination. This measure would require approval at the Monetary Policy Meeting.

c. And third, the Bank could immediately examine operational issues to broaden the range of eligible ABS as collateral to include those backed by mortgage loans and cash flows generated by real estate and bring this measure into effect upon completing its examination. Part of this measure would require approval at the Monetary Policy Meeting.

The range of eligible ABS had so far been limited to those backed by lease receivables and credit receivables as well as by collateralized bond obligations and collateralized loan obligations. If, in addition to these, the range of eligible ABS were broadened to include those backed by mortgage loans and cash flows generated by real estate, almost all types of ABS issued in Japan would be eligible as collateral.

2. Ways to improve the conduct of money market operations would be as follows, which could be put into effect by the staff:

a. The Bank could increase the frequency of bill purchasing operations conducted at the Bank's all offices, which were currently conducted three times per month.

b. The Bank could allow all eligible counterparties to participate in the outright purchase of JGBs, JGB repo operations, CP operations, and bill selling operations. The current practice of changing participants in rotation within eligible counterparties could be abolished.

In response to the above report made by the staff, most members concurred that all of the above measures were appropriate and that the Bank should release the measures that day together with the change in the guideline for money market operations.

A different member said that the member would like to propose that the Bank should (1) introduce a price level target, (2) start purchasing foreign bonds in order to provide funds smoothly, and (3) raise the target for the outstanding balance of current accounts at the Bank to around 15 trillion yen by increasing its outright purchase of long-term government bonds by 200-400 billion yen per month. This member expressed the view that it was not desirable for the Bank to make outright purchases of CP or corporate bonds, and also the Bank should be extremely cautious about increasing the amount of CP operations and broadening the range of eligible collateral. The member gave the following reasons. First, it was not appropriate for a central bank to step into the area of corporate financing without careful consideration, or to give the markets the impression that the Bank was involved in it. And second, once the Bank had stepped into the area of corporate financing, it might lead to escalated pressure for the Bank to conduct money market operations with higher risks.

IV. Remarks by Government Representatives

The representative from the Cabinet Office made the following remarks.

(1) The economy was not experiencing a deflationary spiral as shown in the GDP data released on December 7, 2001, but the Government was aware of the risk of this happening. For this reason, the Government drew up the Immediate Action Program for Structural Reform on December 14, 2001, which it considered a significant action given the current fiscal conditions. The Government would make every effort to manage aggregate demand, and, in the medium term, would positively affect market expectations appropriately while maintaining fiscal discipline.

(2) Developments in stock prices of banks and of some firms with excessive debts were extremely weak. The Government would like the Bank to share this understanding and conduct monetary policy in line with it. The Government expected the Bank to have in-depth discussions with a view to responding to the current emergency situation.

The representative from the Ministry of Finance made the following remarks.

(1) It was generally understood that the Government and the Bank would work together to prevent a deflationary spiral, and it was necessary to intensively mobilize all possible measures at this stage. From this standpoint, the Government had recently decided to compile the second supplementary budget for fiscal 2001.

(2) The Bank had continued to provide ample funds since the previous meeting on November 29, 2001 with the result that the outstanding balance of current accounts at the Bank was generally at above 8 trillion yen. The increase in the outstanding balance of current accounts at the Bank was expected to support the economy through alleviation of the market's concerns. The Government would like to ask the Bank to continue providing ample funds, giving due consideration to economic and financial developments, since there were some opinions in the markets that liquidity concerns might arise toward the end of the calendar year.

(3) The CPI showed that prices continued to fall. The Government would like to ask the Bank to further discuss measures to prevent the economy from sliding into a deflationary spiral and conduct monetary policy in a timely manner. The Government was grateful that the Bank had discussed a wide variety of options, for example adoption of new measures for market operations, at this meeting in order to prevent the economy from falling into a deflationary spiral, given the current situation where the effects of the Bank's conventional market operations using mainly short-term financial assets were limited as short-term interest rates were virtually zero.

V. Votes

Based on the above discussions, the majority of members considered it appropriate to aim at the outstanding balance of current accounts at the Bank at around 10 to 15 trillion yen and, in view of the possibility of a surge in liquidity demand beyond that range, revive the contingency clause that was maintained from the March 19, 2001 meeting until it was dropped at the September 18, 2001 meeting: "Should there be concern for financial market instability such as a rapid surge in liquidity demand, the Bank will provide ample liquidity irrespective of the above guideline."

One member, however, proposed that the Bank should (1) introduce a price level target, (2) start purchasing foreign bonds in order to provide funds smoothly, and (3) raise the target for the outstanding balance of current accounts at the Bank to around 15 trillion yen.

This member gave the following reasons. First, the Bank should make clear to the public its strong determination to prevent price falls below the current level so that the Bank's policy would be clearly evaluated. Second, purchases of foreign bonds were expected to contribute to the Bank's diversifying its means of providing funds and improving its ability to do so, although they might not be necessary for the time being. And third, given the current deterioration of the economy, the Bank should reinstate a policy with a specific target for the outstanding balance of current accounts at the Bank, raising the target at the same time. This member commented on purchases of foreign bonds in particular that purchases by the Bank of a fixed amount of foreign bonds on a regular basis would not be in contravention of the law, presenting the following interpretation of the law: (1) Article 40, Paragraph 1 of the Bank of Japan Law stated that the Bank might, when necessary, buy and sell foreign exchange, and it was clear that the paragraph was laid down separately from Paragraph 2 of the same article, which provided that the Bank could also do so as an agent of the Government when its purpose was to stabilize the exchange rate of the national currency; and (2) the phrase "to stabilize the exchange rate of the national currency" in the paragraph referred to avoiding erratic developments in the market in the short term and controlling the pace of movement in a specific direction in the medium term.

As a result, the following proposals were submitted.

Mr. N. Nakahara proposed the following procedures for money market operations:

The Bank of Japan will conduct money market operations, aiming at maintaining the average of the CPI (excluding fresh food, on a nationwide basis) in the July-September quarter of 2003 at or raising it to or above a target of 99.2, which was that in the July-September quarter of 2001.

The proposal was defeated with one vote in favor, eight against.

This member also proposed the following procedures for money market operations:

The Bank of Japan will start to purchase foreign bonds as soon as all arrangements are made. Foreign bonds will be purchased when judged necessary to increase the outstanding balance of current accounts at the Bank smoothly.

The proposal was defeated with one vote in favor, eight against.

Further, this member proposed the following guideline for money market operations for the intermeeting period ahead:

The Bank of Japan will conduct money market operations, aiming at an outstanding balance of current accounts at the Bank of around 15 trillion yen. Should there be a risk of financial market instability, e.g., a rapid surge in liquidity demand, the Bank will provide ampler liquidity irrespective of the guideline above.

The proposal was defeated with one vote in favor, eight against.

To reflect the majority view, the chairman formulated the following proposal.

The Chairman's Policy Proposal on the Guideline for Market Operations:

1. The guideline for money market operations in the intermeeting period ahead will be as follows.

The Bank of Japan will conduct money market operations, aiming at the outstanding balance of the current accounts at the Bank at around 10 to 15 trillion yen.

Should there be a risk of financial market instability, such as a surge in liquidity demand, the Bank will provide more liquidity irrespective of the guideline above.

2. A public statement will be decided separately.

Votes for the proposal: Mr. M. Hayami, Mr. S. Fujiwara, Mr. Y. Yamaguchi, Mr. T. Miki, Mr. K. Ueda, Mr. T. Taya, Ms. M. Suda, and Mr. S. Nakahara.

Vote against the proposal: Mr. N. Nakahara.

Mr. N. Nakahara dissented for the following reasons. First, the range of 10 to 15 trillion yen gave the staff too much discretion. Second, the market might put greater emphasis on the lower end of the range, 10 trillion yen, and consider that it was not a drastic measure. Third, a policy with a target range was considered vague and inadequate given that Japan's economy was in the early stages of a deflationary spiral. And fourth, the Bank should pinpoint a specific target even when there were some uncertainties.

Among the measures to strengthen money market operations discussed at the meeting, the chairman made the following policy proposal regarding the matters to be decided at the meeting, and members put it to the vote. Regarding the public statement, members decided to include matters entrusted to the staff, such as (1) increasing outright purchases of long-term JGBs, (2) making further use of CP operations, and (3) improving the conduct of money market operations.

The Chairman's Policy Proposal on the Measures to Strengthen Money Market Operations:

From the viewpoint of strengthening money market operations, the Bank will implement the following measures.

A public statement will be decided separately.

1. The Bank will immediately examine operational issues to broaden the range of eligible CP for CP operations and collateral uses to include Asset-backed Commercial Paper (ABCP).

2. The Bank will immediately examine operational issues to broaden the range of eligible ABS as collateral.

Votes for the proposal: Mr. M. Hayami, Mr. S. Fujiwara, Mr. Y. Yamaguchi, Mr. T. Miki, Mr. K. Ueda, Mr. T. Taya, Ms. M. Suda, and Mr. S. Nakahara.

Vote against the proposal: Mr. N. Nakahara.

Mr. N. Nakahara dissented for the following reasons. First, as he had been advocating, the Bank should not, without careful consideration, step into the area of corporate financing, and monetary easing should be done with conventional measures. And second, the chairman's proposal would have only a limited effect, as the market size for ABS and other instruments concerned was small.

VI. Discussion on the Public Statement

Members discussed the draft of a public statement prepared by the staff regarding the above decision of the Board and matters entrusted to the staff, and put it to the vote. The Board approved, by majority vote, "Change in the Guideline for Money Market Operations" and decided to release it after the meeting (see Attachment 1).

Votes for the proposal: Mr. M. Hayami, Mr. S. Fujiwara, Mr. Y. Yamaguchi, Mr. T. Miki, Mr. K. Ueda, Mr. T. Taya, Ms. M. Suda, and Mr. S. Nakahara.

Vote against the proposal: Mr. N. Nakahara.

Mr. N. Nakahara dissented as he opposed the proposal regarding the guideline and the measures for money market operations.

The chairman said that he would hold a press conference after the meeting, following the established custom when a policy change was decided.

VII. Discussion on the Bank's View of Recent Economic and Financial Developments

The Policy Board discussed "The Bank's View" of recent economic and financial developments, and put it to the vote. By majority vote, the Board decided to publish "The Bank's View" on December 20, 2001 in the Monthly Report of Recent Economic and Financial Developments (consisting of "The Bank's View" and "The Background").⁹

Votes for the proposal: Mr. M. Hayami, Mr. S. Fujiwara, Mr. Y. Yamaguchi, Mr. T. Miki, Mr. K. Ueda, Mr. T. Taya, Ms. M. Suda, and Mr. S. Nakahara.

Vote against the proposal: Mr. N. Nakahara.

Mr. N. Nakahara dissented for the following reasons. First, the "Bank's View" should refer to the pace of economic adjustments, which was a feature of the current phase of the economy. Second, it should refer to corporate bankruptcies and the unemployment rate. Third, it was not consonant with his view that Japan's economy was already in the early stages of a deflationary spiral. Fourth, it should mention the fact that the significant fall in public investment was having a large effect on economies in rural areas. And fifth, the judgment that prices were expected to follow a "gradual" declining trend for the time being was not appropriate.

1. 9The original full text, in Japanese, of the Monthly Report of Recent Economic and Financial Developments was published on December 20, 2001 together with the English version of "The Bank's View." The English version of "The Background" was published on December 21, 2001.

VIII. Approval of the Minutes of the Monetary Policy Meeting

The Policy Board approved unanimously the minutes of the Monetary Policy Meeting of November 15 and 16, 2001 for release on December 25, 2001.

IX. Approval of the Scheduled Dates of the Monetary Policy Meetings in January-June 2002

At the end of the meeting, members approved the dates of Monetary Policy Meetings to be held in the period January-June 2002, for immediate release (see Attachment 4).

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Attachment 1

For immediate release

December 19, 2001
Bank of Japan

Change in the Guideline for Money Market Operations

1. At the Monetary Policy Meeting held today, the Bank of Japan decided to raise the main operating target, the outstanding balance of the current accounts at the Bank, and to take measures to strengthen money market operations (see Attachent 2).
2. Japan's economy is deteriorating broadly and likely to undergo a severe adjustment phase for the time being. Against this background, looking at the stock market as well as the markets for commercial paper and corporate bonds, price differentials are widening reflecting the credit conditions of each firm. As such, financial institutions and investors are becoming more cautious.
3. To some extent, this deterioration in the financial environment is the inevitable process associated with structural reform in the area of economy and industry as well as the restoration of a robust and sound financial system. Nevertheless, there is concern that, if the deterioration in the financial environment goes too far and adversely affects financing by firms in good condition, it could exert downward pressure on economic activity and prices.
4. With these points in mind, today's decision is intended to secure that the financial markets continue to work in a stable manner and to ensure that economic recovery will be effectively supported from the monetary side.
5. While carefully monitoring developments in economic activity as well as financial markets, the Bank will continue to make every effort as a central bank to prevent a continuous decline in prices and to establish a basis for the stable and sustainable growth of Japan's economy.

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Attachment 2

1. Change in the guideline for money market operations (see Attachent 3)

The Bank of Japan will conduct money market operations, aiming at the outstanding balance of the current accounts at the Bank at around 10 to 15 trillion yen.

Should there be a risk of financial market instability, such as a surge in liquidity demand, the Bank will provide more liquidity irrespective of the guideline above.

2. Increase in outright purchase of long-term government bonds

The Bank will increase its outright purchase of long-term government bonds from the current 600 billion yen per month or 7.2 trillion yen per year to 800 billion per month or 9.6 trillion yen per year.

3. Measures to strengthen money market operations

1. 1) Making further use of Commercial Paper (CP) and Asset-backed Securities (ABS)
   1. a. For the time being, the Bank will more actively purchase CP under repurchase agreements (CP operations).
   2. b. The Bank will immediately examine operational issues to broaden the range of eligible CP for CP operations and collateral uses to include Asset-backed Commercial Paper (ABCP). Upon completing the examination, the Bank will bring it into effect with the approval at the Monetary Policy Meeting.
   3. c. The Bank will immediately examine operational issues to broaden the range of eligible ABS as collateral. Upon completing the examination, the Bank will bring it into effect with the approval at the Monetary Policy Meeting. More specifically, the range of eligible ABS, currently limited to those backed by lease receivables and credit receivables as well as collateralized bond obligations (CBO) and collateralized loan obligations (CLO), will be broadened to include those backed by mortgage loans and cash flows generated by real estate.
2. 2) Improvement in the conduct of money market operations
   1. a. The Bank will increase the frequency of bill purchasing operations at the Bank's all offices.
   2. b. The Bank will allow all eligible counterparties to participate in the outright purchase of JGBs, JGB repo operations, CP operations, and bill selling operations. The current practice of changing participants in rotation within eligible counterparties will be abolished.

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Attachment 3

For immediate release

December 19, 2001
Bank of Japan

At the Monetary Policy Meeting held today, the Bank of Japan decided, by majority vote, to set the following guideline for money market operations for the intermeeting period:

The Bank of Japan will conduct money market operations, aiming at the outstanding balance of the current accounts at the Bank at around 10 to 15 trillion yen.

Should there be a risk of financial market instability, such as a surge in liquidity demand, the Bank will provide more liquidity irrespective of the guideline above.

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Attachment 4

For immediate release

December 19, 2001
Bank of Japan

Scheduled Dates of Monetary Policy Meetings in January-June 2002

1. Outlook and Risk Assessment of the Economy and Prices (April 2002) will be published on Tuesday, April 30, 2002.