[Speech]Recent Developments in Economic Activity, Prices, and Monetary Policy

Speech at a Meeting with Business Leaders in Gunma

Takehiro Sato
Member of the Policy Board
February 6, 2013

I. Introduction
II. Recent Conduct of Monetary Policy
III. Recent Economic Activity and Prices
IV. Concluding Remarks

I. Introduction

At the Monetary Policy Meeting (MPM) held on January 21 and 22, 2013, the Policy Board of the Bank of Japan decided to take additional steps to provide monetary accommodation decisively. Specifically, the Bank decided to introduce (1) the "price stability target" set at 2 percent in terms of the year-on-year rate of change in the consumer price index (CPI) and (2) the "open-ended asset purchasing method" (i.e., to purchase assets without setting any termination date) under the Asset Purchase Program. The Bank also decided to release a joint statement with the government (Chart 1).

As was already noted in the statement on monetary policy released on January 22, 2013, I voted against the 2 percent price stability target. However, since policy decisions are made by majority vote of the Policy Board members at the MPM, the aforementioned decisions at the January MPM were made accordingly. In my remarks today, I will reflect on the conduct of monetary policy in the future, taking note of the measures to achieve the 2 percent "price stability target" that has just been introduced.

II. Recent Conduct of Monetary Policy

A. From the "Price Stability Goal in the Medium to Long Term" to the "Price Stability Target"

The "price stability target" -- introduced by the Bank as a numerical value -- is set at 2 percent in terms of the year-on-year rate of change in the CPI. This target replaces the "price stability goal in the medium to long term" introduced by the Bank in February 2012, which the Bank had judged to be in a positive range of 2 percent or lower in terms of the year-on-year rate of change in the CPI and 1 percent for the time being.

The major changes to the expressions regarding price stability from February 2012 are as follows. First, the Bank deleted the phrase "medium to long term"; and second, the Bank changed its wording from "goal" to "target." The changes reflect a situation in which awareness of the importance of flexibility in the conduct of inflation-targeting policy has been increasing.

More specifically, even inflation-targeting countries do not change their monetary policy stance mechanically in accordance with their target inflation rates (Chart 2). This reflects lessons learned from bitter experience in the past, when many credit bubbles grew under the perception that prices had been stabilized, which created a large downswing in economic activity and prices after the bubbles burst. In addition, especially after the Lehman shock, many major countries have emphasized flexibility in the conduct of monetary policy by, for example, publicly articulating the importance of paying due attention to financial system stability (Chart 3).

Given these developments, the phrase "medium to long term" is no longer necessary and the difference between a "goal" and a "target" is no longer a substantive issue.

B. Why Has the Price Stability Target Been Set at 2 Percent?

As indicated in the statement on monetary policy released on January 22, 2013, the Bank recognizes that an inflation rate consistent with price stability on a sustainable basis will rise as efforts made by a wide range of entities toward strengthening the competitiveness and growth potential of Japan's economy make progress (Chart 4). The 2 percent target looks rather high, given the current rate of inflation/deflation. However, the Bank decided that it was appropriate to set the target before confirming the product of the efforts made by a wide range of entities to strengthen the competitiveness and growth potential of the economy. The expected inflation rate of households, firms, and financial markets has been formed based on the past inflation rate that has been consistently lower than in other countries (Chart 5). As efforts made by the government, the Bank, and the private sector toward strengthening the growth potential of the economy make progress, the inflation rate will gradually increase and the expected inflation rate of households, firms, and the markets will likely rise accordingly. Furthermore, by setting a challenging target of 2 percent, the Bank expects to influence the expectations of a broad range of economic entities and to promote efforts toward strengthening the competitiveness and growth potential of the economy, thereby influencing the expected inflation rate of households, firms, and the markets.

At the same time, should prices overshoot 2 percent, the Bank should be able to anchor the expected inflation rate by clarifying its target, and this will contribute to the achievement of price stability on a sustainable basis.

Nevertheless, it is important for the Bank to continue to ensure credibility in its conduct of monetary policy in order to anchor the year-on-year CPI inflation rate at 2 percent. As the Governor of the Bank mentioned at his regular press conference after the January MPM, I dissented from setting the 2 percent price stability target with another Policy Board member, Mr. Takahide Kiuchi, for the following reasons. First, a 2 percent CPI inflation rate far exceeds the pace of price growth that is considered to be consistent with price stability on a sustainable basis. Second, it might impair the credibility of monetary policy to set the target before the efforts made by a wide variety of entities toward strengthening the growth potential of the economy achieve progress. However, as I explained at the beginning of my remarks today, I am in a position to execute the Bank's policy decisions and responsible for their execution as a member of the Policy Board. The Policy Board members, including myself, are now facing the challenge of achieving the 2 percent price stability target as well as raising the credibility of the Bank's goal.

C. An Inflation Rate of 2 Percent Was Very High in Japan in the Past

What is the implication of the 2 percent inflation rate in Japan? Following the two oil shocks in the 1970s and 80s, an inflation rate above 2 percent in the Japanese economy was rather unusual. The times when the inflation rate exceeded 2 percent are generally regarded as periods when the Japanese economy confronted a difficult situation on the whole (Chart 6). Excluding the effect of consumption tax hike, the economy did not experience an inflation rate above 2 percent in the last quarter-century except for the period from April 1990 through December 1992 -- when Japan faced a residual effect from the asset bubble economy in the late 1980s -- and the period from July through September 2008 -- just before the Lehman shock occurred. While the former period was marked by demand-pull inflation, this was due to the residual effect of the abnormal elevation of asset prices, whose collapse had produced the financial crisis of the late 1990s. This became a major cause of the protracted stagnation of the Japanese economy. The latter period was a time of typical cost-push inflation, which resulted in an outflow of purchasing power due to deterioration in the terms of trade and lowered the national economic welfare. Therefore, defining and aiming at an inflation rate that has rarely been achieved in the past two decades as the inflation rate consistent with price stability on a sustainable basis not only forces a substantial change in the Bank's way of thinking but also imposes a challenge.

As for the numerical expression for price stability, the Bank had not specified it up until the mid-2000s. In October 2000, shortly after lifting the zero interest rate policy, the Bank released a document titled "On Price Stability," in which it concluded that "it is not deemed appropriate to define price stability by numerical values."¹ It was only in March 2006 that the Bank for the first time began employing a numerical expression for price stability: it indicated the level of inflation within the range between 0 and 2 percent as a union of ranges of inflation rates that each member of the Policy Board understood as being consistent with price stability over the medium to long term -- namely, the "understanding of medium- to long-term price stability."² It was about six years later that the Bank in February 2012 introduced "the price stability goal in the medium to long term" -- rolling out a specific numerical expression that could represent the consensus among all the Policy Board members as the inflation rate judged to be consistent with price stability sustainable over the medium to long term, instead of presenting the union of ranges of inflation rates of each Policy Board member.³

In the meantime, the Japanese economy has remained in a mild deflationary situation, although the degree has varied with time. The major reason why the Bank required time to formulate a numerical expression for price stability was due to the lack of a decisive measure to elevate the inflation rate under the constraints of the zero lower-bound on the nominal policy interest rate. While an inflation-targeting policy is generally assumed to be a framework for containing a higher inflation rate within the targeted level in overseas economies, it has long been recognized in Japan as a measure for raising the extremely low inflation rate to the targeted level. However, monetary policy conduct in a time of deflation is much more difficult than that under inflation, as expressed by the metaphor of "pushing on a string."

At a time when Japan faces rising headwinds such as population aging and population decline, setting the price stability target at 2 percent is rather challenging. A decline in the total working population at an annual rate of a little less than 1 percent is expected to continue. This implies that Japan's GDP will drop at an annual rate of a little less than 1 percent, if nothing is done to overcome the headwinds. In such circumstances, in order to raise the output gap to a level that is consistent with the 2 percent inflation rate, it is necessary to boost demand by promoting further progress to strengthen the economy's growth potential. Furthermore, we will have to face the reality of the flattening of the Phillips curve -- the slower responsiveness of prices to the improvement of the output gap -- due to globalization and the progress in IT (Chart 7). Thus, the achievement of the price stability target becomes increasingly challenging.

1 See "On Price Stability," released on October 13, 2000.
2 See "The Bank's Thinking on Price Stability," released on March 10, 2006.
3 See "The Price Stability Goal in the Medium to Long Term [PDF 10KB]," released on February 14, 2012.

D. The Need for a Recovery in Wages

And yet, why has the Japanese economy consistently failed to exit from deflation for more than a decade? During the early phase of deflation in the late 1990s, this was mainly due to the substantial fall in asset prices, the subsequent credit crunch caused by the financial crisis, and the preservation of excess supply caused by the delay of firms with poor productivity in exiting the market. However, since the Japanese economy has already overcome problems in its financial system, deflation since the mid-2000s has entered a new phase. Stagnant wages have become the main factor behind deflation.

Prices of goods and services are affected by the cost of production. Assuming that the cost of production consists of personnel expenses and material costs, many of the latter are determined through cross-border competition. Therefore, their price fluctuations -- excluding volatility due to developments in the foreign exchange markets -- should equally affect the entire global economy, and thus material costs cannot be the main reason why Japan is the only advanced economy suffering from deflation. The real cause is another factor affecting the cost of production, namely, wages.

In fact, consumer prices and wages are closely correlated (Chart 8). About half of the components of the CPI are services in terms of weight, and prices of services are generally synchronized with wages in the services industry (Chart 8). This industry is labor intensive, and prices of services are easily affected by developments in wages. Accordingly, in aiming at the 2 percent price stability target in terms of the year-on-year rate of change in the CPI, it is vital, above all, to seek a recovery in wages. However, the level of annual nominal compensation of employees in the "National Accounts" dropped by more than 10 trillion yen after the Lehman shock and has shown virtually no sign of recovery (Chart 9). In order for a recovery in wages to occur, it is important that firms maintain their labor share of income distribution when they achieve an increase in their corporate profits, the source of wages. In fact, there was an opportunity in Japan for wages to recover in the mid-2000s. This occurred when the global economy overheated -- triggered by growing demand in emerging economies and supported partly by the credit bubble. At this time, many firms, especially those in manufacturing, posted record highs in their corporate profits and were expected to increase their distribution of corporate profits to employees. However, they placed a higher priority during this period on accumulating internal reserves, and thus the labor share of income distribution fell (Chart 9). As major labor unions did not strongly oppose this distribution policy, wages scarcely improved. Currently, given the situation in which firms face what have been called the "six headwinds,"⁴ the profits enabling firms to boost distribution are unlikely to rise, even if management wishes to increase the distribution to employees. This is due partly to the significant decline in the competitiveness of some sectors of manufacturing and the resultant halt in improvement in corporate profits, the source of wages.

4 The headwinds in Japan are generally characterized as (1) yen appreciation; (2) comparatively high corporate taxes; (3) delay in the creation of free trade agreements (FTAs); (4) tight labor regulations such as limitations on the employment of dispatched workers; (5) tighter environmental regulations; and (6) power shortages.

E. Differences in Employment Adjustment between the United States and Japan

The difference in employment adjustment between the United States and Japan has some effect on developments in wages. In the United States, when firms decide to adjust their employment policy, they aggressively reduce the number of employees instead of wages, which often results in a rapid retreat from unprofitable businesses. As a result, nominal wages continue to grow at a rate of about 2-4 percent irrespective of the phase of the economic cycle, and the U.S. economy is unlikely to fall into deflation since excess supply is unlikely to continue. If we consider the Phillips curve -- with the unemployment rate on the x-axis and the rate of wage inflation on the y-axis -- we reach a similar conclusion (Chart 10). On the other hand, under the employment practice in Japan it is difficult to aggressively reduce the number of employees while maintaining the nominal wage growth in an economic recession. On the other hand, Japan's unemployment rate is comparatively stable partly due to the difference in labor regulations between the two countries, but the sensitivity of wage inflation to the unemployment rate is rather high. This makes employment adjustment through dismissal relatively limited even during a recession in Japan, and such employment adjustment, if any, tends to be executed mostly through wage reduction. Consequently, in Japan consolidation and reorganization of unprofitable businesses tend to take longer and the share of labor in income distribution tends to remain at a high level, and this slows the economy's metabolism and allows excess supply to be preserved easily. In Japan the cost of employment adjustment is shared widely among workers, and this type of employment practice may be one of the main factors making it difficult for the economy to exit from deflation.

Going forward, if we see supply-demand conditions tighten in the labor market with economic expansion in Japan, can we expect wages to rise in line with the correlation I have mentioned? It might sound pessimistic, but such may not be the case, as some firms in Japan have recently begun to lose their competitive edge and profit-making ability. This might reflect a gradualist approach to the streamlining of industries and unprofitable businesses, whose expected growth rates have worsened. The current situation in Japan -- where the pricing power of firms has weakened and firms cannot pass on the rise in purchase prices to selling prices -- clearly reflects this decline in Japanese firms' competitiveness (Chart 11).

At any rate, as the Bank aims at the 2 percent price stability target, greater fundamental strength of the economy is needed to generate a wage increase of approximately 4 percent. To this end, a wide range of entities is expected to redouble efforts to strengthen the competitiveness and growth potential of the economy.

F. What the Central Bank Can Do

What kind of contribution can the Bank make from the monetary policy side, in order to achieve the 2 percent price stability target? A well-balanced price hike should materialize in a situation where general prices rise in tandem with wages, as the result of a rising level of total economic activity and subsequent improvement in the output gap. Furthermore, such a price hike must be sustainable. Although the Bank has announced that price stability can be achieved through the efforts by a wide range of entities to strengthen the competitiveness and growth potential of the economy, both the government and the Bank have also been working to address the issue. At the same time, it is difficult to think that the 2 percent price stability target will be achieved merely by enhancing ongoing policy initiatives, and therefore both the government and the Bank must tackle this issue with much greater vigor.

Generally speaking, when an economy faces a deflation trap with the constraints of the zero lower-bound on the nominal policy interest rate, the plausible channels for economic stimulation and achieving a price recovery are (1) the channel through foreign exchange rates and (2) the channel through asset prices.

In terms of the former, the Bank decided at the December MPM to increase the purchases of treasury discount bills (T-Bills) and Japanese government bonds (JGBs). The Bank considers that a stronger indirect influence on foreign exchange rates will be achieved from a further decline in interest rates -- narrowing or reversing the interest rate differentials between Japan and other countries -- while continuing with the payment of interest on excess reserve balances at 0.10 percent. The Bank's decision at the January MPM to take additional steps to provide monetary accommodation by introducing the open-ended purchasing scheme will further strengthen this influence.

Regarding this latter policy initiative, the Bank formally launched the Loan Support Program at the December MPM to vigorously support the increase in private bank lending in terms of fund provisioning. This policy initiative relies on the efforts of private banks to boost lending, and what the Bank can do is to support these efforts by the private sector. In a situation where demand for funds has been weak for a long period of time and there is no bottleneck in the availability of funds at private banks, it has been widely observed that the effects of such a policy will be limited. Nevertheless, if such an increase in bank lending promotes real economic activity and transactions in the asset markets, some positive impact can be expected on general prices through an increase in asset prices. In particular, once upward momentum starts accumulating in the economy, the effects of the policy initiative are likely to be more pronounced. In addition, if private-sector lending promotes cross-border capital expenditures or mergers and acquisitions by firms and banks, this will indirectly induce depreciation of the yen. At any rate, I would like to emphasize the importance of exerting indirect influence on the foreign exchange markets and asset markets mainly by facilitating a further decline in interest rates.

G. Policy Measures Indirectly Influencing Foreign Exchange Rates under the Zero Interest Rate

During the quantitative easing period from March 2001 through March 2006, the effects of monetary easing were likely to appear through depreciation of the yen, since Japan was the only country that had adopted a zero interest rate policy (Chart 12). From the time of the Lehman shock up to the present, however, the Bank's efforts have had limited effectiveness, given that interest rate differentials between Japan and other advanced countries have narrowed in a situation where central banks in these countries have started to adopt the zero interest rate policy as well. Nevertheless, I believe that the interest rate channel might work in this situation, albeit to a limited extent. For example, the 3-month T-Bill rate, which had been consistently higher than that in the United States, marked a recent low of 0.093 percent, edging close to the rate in the United States, reflecting the Bank's large-scale purchasing of T-Bills as part of the Asset Purchase Program even though the Bank maintained the interest on excess reserves at 0.10 percent. A favorable tailwind is also apparent in signs of change in U.S. monetary policy. For example, in December 2012 the Federal Open Market Committee (FOMC) discussed decreasing the size of its asset purchase or suspending it in the course of 2013. Against the background of such developments, the Bank is closely monitoring the extent to which both short and long-term interest rates may decline further while continuing to employ the Asset Purchase Program.

Meanwhile, steadily increasing the amount outstanding of the Asset Purchase Program is no easy task. If the asset purchases under the Asset Purchase Program are conducted smoothly as planned, the amount outstanding of the program is expected to surpass 100 trillion yen from the current 65 trillion yen by the end of 2013 (charts 13 and 14). The provision of such a large amount of funds is unprecedented for the Bank, and there is a risk that it will be unable to increase the amount outstanding of the Asset Purchase Program smoothly if private banks grow reluctant to boost excess reserves at the Bank to avoid balance-sheet expansion due to their financial strategy or other reasons such as corporate governance. It is probably the case that, in increasing the amount outstanding of the Asset Purchase Program, whether private banks submit bids for the Bank's asset purchases depends greatly on interest rate levels. Some events might be beyond the scope of expectations in an unprecedented situation, but the Bank aims to steadily increase the amount outstanding of the Asset Purchase Program by adjusting the program in a flexible manner.

H. Is a Substantial Increase in Risky Asset Purchases a Viable Option?

On the other hand, it has been argued that the Bank should substantially increase its purchase of risky assets. In line with its comprehensive monetary easing in October 2010, the Bank has been purchasing risky assets such as corporate bonds and CP and -- with government approval -- exchange-traded funds (ETFs) and Japan real estate investment trusts (J-REITs). Among major central banks, the Bank is the only central bank that purchases such risky assets for its own account. However, the Bank's intention in this operation is not to employ large-scale intervention in the asset markets but to work as a catalyst for the financial markets. Some argue that it is a viable option for the Bank to increase such purchases substantially by intervening in the markets on a large scale.

I consider the efficacy of this sort of policy initiative to be doubtful, as it contains the risk of eroding the Bank's capital base. If the prices of risky assets held by the Bank declined and the Bank incurred a loss, this would result in a reduction in its payments to the national treasury. If the size of the risky assets was sufficiently large compared with the size of the Bank's net capital, the Bank might fall into capital deficiency. The first outcome, reduction of payments to the national treasury, would be equivalent to an increase in fiscal spending, and because of this risk the Bank must obtain authorization from the government based on Article 43 of the Bank of Japan Act in order to purchase ETFs and J-REITs. The second outcome, capital deficiency, could lead to a larger issue, affecting the credibility of the Bank and the yen as well as the autonomy of monetary policy, if the Bank asked the government for recapitalization or compensation for its loss. Given these issues, whether the Bank should substantially increase risky asset purchase from the current limit is a matter that involves not only the Bank but also the government. It might therefore be effective to set ex ante policy rules for loss sharing, in order to prevent purchases of risky assets from influencing the autonomy of the Bank's monetary policy.

I. Are Foreign Bond Purchases a Viable Option?

At a press conference in July 2012 after becoming a Policy Board member, I remarked that foreign bond purchases might be an option for the Bank but a number of conditions must be met. For example, the Bank of Japan Act stipulates that the Bank may buy or sell foreign exchange solely as an agent of the government (Article 40); therefore, the Bank cannot make any subjective policy decisions to secure the stability of the yen (Chart 15). Can the Bank then purchase foreign bonds if it receives government authorization pursuant to Article 43 of the Bank of Japan Act -- as in cases of ETF and J-REIT purchases? As stipulated in Article 40 of the Bank of Japan Act, the Bank is not allowed to buy or sell foreign exchange for the purpose of intervening in the yen market. Therefore, regardless of Article 43, it is natural to consider that the Bank cannot purchase foreign bonds for such a purpose. In that case, what about purchases by the Bank of a fixed amount of foreign bonds on a regular basis as part of money market operations? This too risks contravening Article 40, if the purpose of such purchases is considered to manipulate the foreign exchange markets.

Because of the legal restriction I have mentioned, the Liberal Democratic Party (LDP) made an election pledge in December 2012 that it would establish a joint fund by the public and private sectors to purchase foreign bonds. The net impact on the economy would be basically the same whether the government or the Bank bought foreign bonds, and therefore I think that the Bank itself need not assume the dominant role in conducting such purchases. However, it might pose a problem in terms of currency diplomacy; therefore, close coordination with foreign currency authorities is indispensable in order to achieve consensus.

J. Economic Welfare Would Not Improve If a Price Hike Is Simply Driven by the Yen's Depreciation

Even if the yen depreciates against the U.S. dollar by 10 percent, I estimate that the rise in Japan's CPI would be far short of 1 percent, even if the accumulation of its effect for several years is taken into account. Therefore, if the core CPI -- now around 0 percent -- is to be raised to 2 percent solely through depreciation of the yen, a substantial depreciation is needed, and this does not seem practical. Many uncertainties remain if such a substantial depreciation of the yen is to take place through the conduct of interest rate policy. Even if it were possible, it might raise a number of issues in terms of currency diplomacy. Furthermore, a hike in import prices and deterioration in the terms of trade would cause an outflow of purchasing power. Thus, even if the inflation rate rose, it would be largely superficial and gross domestic income (GDI) as well as gross national income (GNI) would decrease; as a result, people would not feel that the economy had overcome deflation (Chart 16). In sum, although the impact of developments in exchange rates on prices is substantial, pursuing a high price stability target of 2 percent solely through the exchange rate channel is not a balanced option. What should be aimed for is a rise in prices that accompanies an increase in income.

However, it should be noted as well that underestimating the economic-stimulus effects of the ongoing depreciation of the yen on the asset markets is to take an unbalanced view. The asset markets, especially domestic stock markets, have underperformed compared to overseas markets due to the effects of the overappreciation of the yen, which has appreciated by about 40 percent in terms of the nominal effective exchange rate since the Lehman shock. Recently, however, in the process of correction of the yen's overappreciation, the valuation of domestic stock prices has been revised, and the asset markets have become buoyant after a long period of inactivity. As I mentioned earlier, the recovery in asset prices could lead to an improvement in the output gap and in turn a rise in prices, by strengthening the risk tolerance of firms and households and then raising the level of total economic activity. Therefore, I would like to continue to draw attention to the channel in which monetary policy indirectly exerts influence on foreign exchange rates.

III. Recent Economic Activity and Prices

A. Outlook for the Global Economy

According to the latest global economic outlook released by the International Monetary Fund (IMF) in January 2013, the global economy is expected to grow moderately at 3.5 percent and 4.1 percent in 2013 and 2014, respectively, and these growth rates are almost the same as or slightly above the average of the past three decades of 3.4 percent (Chart 17). In the recent past, this outlook had been revised downward mainly due to the worsening of the European debt problem and the deceleration of the Chinese economy. However, the global economy has not become subject to a considerable downward revision since summer 2012, because (1) the U.S. economy remained comparatively albeit modestly firm, (2) the tail risk receded substantially in Europe thanks to a variety of policy developments, and (3) the Chinese economy bottomed out. It is still uncertain, however, whether the global economy will return to its 4 percent growth path, which is above the average of the past three decades, in line with the IMF's outlook. While there are many reasons for the uncertainty, the main one is that the global economy is still in the phase of balance-sheet adjustment following the bursting of credit bubbles that expanded in the late 2000s, and therefore the adjustments in both the public and private sectors are likely to dampen economic performance as a whole.

B. Balance-Sheet Adjustment Is Still on Track

If we review the long-term developments in the private-sector debt of major economies (as a percentage of nominal GDP), we can see that the debt's expansion and subsequent adjustment are synchronized on a global basis. Very roughly, we can observe credit cycles with ten years of expansion followed by ten years of adjustment (Chart 18-1). In the 1980s, the credit cycle was in an expansion mode with a few exceptions, and the 1990s were a period of adjustment followed by expansion again in the 2000s. Because of the global financial crisis following the Lehman shock in 2008, the expansion of private-sector debt has come to an end, and we are now in an adjustment phase on a global basis. As evident from developments in the U.S. household sector, the adjustment of excess capital stock is only halfway complete.

Meanwhile, regarding the total of private- and public-sector debt, the degree of fluctuation is smaller, and a major phase of deleveraging has not been observed except for Canada in the 1990s (Chart 18-2). This probably reflects the fact that when the private sector deleverages, public-sector debt expands.

Looking at the long-term developments in total debt, which includes both private- and public-sector debt -- with the latter on a net basis -- we find that (1) the debt ratio rose in many countries in the 1980s; (2) it stabilized in the 1990s as a whole; and (3) it rose in the 2000s led by Spain, the United States, and the United Kingdom, followed by Japan from around 2005. In addition, it should be pointed out that Japan does not stand out from the other countries if we look at the level of the public-sector debt on a net basis, unlike the case on a gross basis.

The fact that debt in the private and public sectors tends to have a negative correlation, and that the total debt is downwardly sticky has an implication for the relation between the debt and economic growth. In countries such as Japan, the United States, the United Kingdom, and Spain, the debt overhang in households, firms, and/or the government seems to be at a threshold point at which the debt will exert a severe restriction on the economy. Therefore, in considering the outlook for the global economy, it must be borne in mind that the high level of total debt could remain a major impediment to global economic development.

C. The Japanese Economy Is Expected to Return to a Moderate Recovery Path

The Japanese economy has shown some weakness since April 2012 mainly in manufacturing, because the European economy has receded and growth in the Chinese economy has slowed, and because domestic demand has been insufficient to offset the weakness in overseas demand. Although the trend of exports is still downward, the rate of decline has moderated compared to the situation during the July-September quarter of 2012. This movement is consistent with recent developments in the global Purchasing Managers' Index (PMI), which reflect the pick-up in the U.S. and the Chinese economies. Reflecting signs that the fall in exports has bottomed out, production in manufacturing is thought to be bottoming out as well (Chart 19). Looking at domestic demand components such as private consumption, the negative impact of the ending of environmentally friendly car subsidies has recently diminished, and consumption remains resilient despite several negative factors affecting income such as the decrease in winter bonuses (charts 20 and 21). The employment condition in the manufacturing sector still looks bad, but the negative spiral of weakness in manufacturing is not expected to spill over into the nonmanufacturing sector. In these circumstances, business fixed investment, which has recently shown some weakness on the whole, is projected to turn to a moderate increasing trend (Chart 22).

According to the production forecast survey by the Ministry of Economy, Trade and Industry (METI), it is becoming harder to identify the basic trend of production due to quirks in the seasonal adjustment unique to the January-March quarter and the Chinese New Year holidays in February. Nevertheless, at a minimum production is unlikely to show a further substantial decline. As overseas economies are somewhat more likely to return to a moderate growth path -- unlike in the period up to summer 2012, when there were high tail risks -- and the domestic economy is expected to enjoy the impact of fiscal stimulus measures, some degree of economic improvement is expected from the April-June quarter onward, though it should be temporary. Although care should be taken to avoid undue optimism, the economic recession that began in April 2012 seems to have ended in November, resulting in a "mini-recession" of eight months. Still, due attention should continue to be paid to tail risks, as it is difficult to foresee the effects of the fiscal drag in the United States even after the temporary resolution of issues related to the fiscal cliff and the debt ceiling, and it is possible that risk aversion will reintensify worldwide depending on developments in political events such as elections in Europe. In addition, the recovery path of the global economy should be fundamentally moderate, as a result of the adjustment of excess debt that has been accumulated globally, as I mentioned earlier. Given all these developments in demand both at home and abroad, in the recently conducted interim assessment of the October 2012 Outlook for Economic Activity and Prices, growth prospects are projected to be somewhat lower for fiscal 2012 but higher for fiscal 2013 compared with the October forecasts (Chart 23).

As for prices, the inflation rate for the core CPI (all items less fresh food) is currently around 0 percent on a year-on-year basis. Going forward, several factors are likely to affect price movements. One is the increased price competition in nondurable goods such as processed food among supermarkets, which renders the price trend somewhat weak. Another is the expected decline in the index due to the reversal of developments in energy prices, which surged last year, and in durable consumer goods prices, whose rate of decline slowed reflecting the change in the survey specifications that was made around the same time last year. Furthermore, the widening of the negative output gap caused by the earlier weak economic activity is likely to adversely affect price developments going forward with some time lag. All these factors are likely to increase the negative year-on-year margin of the core CPI inflation rate. The Bank has just set the 2 percent price stability target, but the outlook for prices is highly unfavorable for the time being.

Even so, the recent depreciation of the yen and changes in asset prices, such as the rise in stock prices, are expected to positively affect price developments through the improvement in the real economy. At any rate, it is important to foster a proactive effect on the real economy by fully implementing not only monetary policy but all available measures.

IV. Concluding Remarks

I would like to conclude this speech by briefly touching on the economy of Gunma Prefecture.

The pick-up in the prefecture's economic activity has come to a pause, and its economy remains more or less unchanged, owing to the prolonged deceleration in overseas economies. Compared with other prefectures in Japan, however, economic conditions in the prefecture are favorable on the whole, led by a healthy transportation equipment industry.

As for the outlook, Gunma Prefecture's economy is likely to pick up moderately again as overseas economies start recovering and as exports increase.

The prefecture enjoys a strong industrial foundation, with regional characteristics such as a very low vulnerability to natural disasters including earthquakes, bountiful water resources, and good access to the Tokyo metropolitan area. Due mainly to vigorous promotion by the prefectural government and cities of the advantages of Gunma Prefecture as a convenient site for corporate back-up facilities, the number and area size of new factories in the prefecture have reached the highest levels in Japan for the past several years.

Furthermore, Gunma Prefecture has great potential in the area of tourism. The prefecture enjoys ample resources including rich natural surroundings such as the famous Oze Marsh, historic and cultural assets such as the Tomioka Silk Mill -- which has applied to join the World Heritage List -- and the major hot spring resorts of Kusatsu, Minakami, Ikaho, and Shima. Regional efforts have been made to attract more tourists to the prefecture from all over Japan and abroad. I hope that these and other efforts will promote even further the development of tourism in Gunma Prefecture.