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Home > Announcements > Speeches and Statements > Speeches 1996 > Speech given by Yasuo Matsushita, Governor of the Bank of Japan, to the Japan National Press Club in Tokyo on June 14, 1996 (The Role of the Central Bank)
This article is excerpted and translated from a speech given by Yasuo Matsushita, Governor of the Bank of Japan, to the Japan National Press Club in Tokyo on June 14, 1996.
I am truly honored to be invited to address the Japan National Press Club.
Today, I would first like to discuss the recent economic situation and the Bank of Japan's views regarding monetary policy management. Then I would like to examine some issues concerning the institutional aspects of central banking, including the basic mission and role of the central bank and its status in a modern democratic society. As there has recently been much discussion on the revision of the Bank of Japan Law, I hope that today's talk will contribute to your understanding of central banking, which is fundamental to these discussions.
Starting with the domestic economic situation,the Bank of Japan's current view is that a moderate economic recoverycontinues. I will not go into the details of the situation orthe reasoning behind this view, as I spoke on these matters toyour colleagues at a press conference only a few days ago. ButI believe that most people will agree with the Bank's view thatthe recent developments in demand and production as well as theresults of the Bank's May Tankan--Short-Term Economic Survey ofEnterprises in Japan indicate that the Japanese economy is ona path of moderate recovery.
The question is whether this recoverytrend will gather momentum and spread throughout the economy,thereby laying a firm foundation for a self-sustained economicrecovery. To answer this question, I would like to discuss themajor points to be considered with regard to the immediate developmentsin the economy.
One can think of two channels throughwhich a self-sustained recovery led by private demand is generated.The first channel is a process in which improvements in corporateproduction and profits lead to a stronger and wider-ranging recoveryof business fixed investment. At present, profits of large manufacturingfirms are projected to increase in fiscal 1996 for the third consecutiveyear. Profitability itself has improved significantly, and thecurrent profits-to-sales ratio is likely to exceed 4 percent thisfiscal year. In past business cycles, this level of profits wasachieved about one year after the recovery began, when the strengthof the recovery was fairly well established. In the present recoveryphase, however, it has taken more than two and a half years toreach that same level. This indicates how severe the difficultiesaccompanying the present economic recovery are, namely, the aftereffectsof the bursting of the economic "bubble," and the pressuresexerted on the country's industrial structure for adjustment tothe new international economic environment.
It appears that these difficulties weremore severe for the non-manufacturing sector and for small andmedium-sized firms. In fact, the improvement in their performancelagged far behind that of the large manufacturing firms. Morerecently, however, economic recovery has at last started to spreadto the non-manufacturing sector and to the small and medium-sizedfirms. For example, large non-manufacturing firms, except forthose in the construction industry, expect an increase in profitsthis fiscal year. In addition, small and medium-sized firms projecta larger growth in profits than that of last fiscal year, althoughtheir level of profits remains low.
This spread of the recovery of businessperformance throughout the corporate sector is typically reflectedin business fixed investment. Large firms in both the manufacturingand non-manufacturing sectors plan to expand their fixed investmentthis fiscal year, and small and medium-sized firms are graduallystarting to follow this trend.
The second channel through which a self-sustainedrecovery is attained is where such recovery in business activityincreases employees' income, thereby stimulating the consumptionand housing investment of the household sector. In this respect,however, there has not been any major change in the basic trendof recent years, which has seen firms encumbered with excess laborand continuing to implement restructuring measures, includingthe reduction of labor costs. Therefore, compared with the firstchannel, the force of this second channel to generate a recoverystill seems limited.
Yet, if we sketch out the developmentssince 1995, it is fair to say that with the recovery of the economy,the employment situation has finally bottomed out and is startingto improve, although at a very slow pace. Macroeconomic employmentindicators in general are showing some improvement, and firms'attitude toward employment is gradually becoming positive as reflectedin the Tankan. Such changes in the employment situation also seemto have contributed to the recovery in consumer confidence andto the continuing high level of housing investment.
When considering the channels throughwhich a self-sustained recovery can be achieved, it is the Bank'sview that the process whereby strengthened business activity leadsto increased business fixed investment and to greater personalconsumption is beginning to come into effect, and this processis gradually spreading to a wider range of industries and to smallerfirms. In this regard, there is now a greater prospect of attaininga self-sustained recovery. Yet, to date, the pace of recoveryin general remains moderate, constrained by the various adjustmentpressures mentioned earlier. There are also other factors thatcall for due attention, such as (1) the question of whether thesubstantial reduction in the external surplus--that is, the decliningtrend in net exports--will continue and how it will affect theeconomy; (2) the implications of the easing market conditionsof semiconductors, an industry which has been one of the maindriving forces of the economy; and (3) developments in fiscalexpenditures.
The Japanese economy is thus at the criticalmoment when its transition to a self-sustained recovery is atstake. At this juncture, the Bank of Japan will continue, in themanagement of monetary policy, to monitor monetary and economicdevelopments closely, placing an emphasis on cementing the foundationfor an economic recovery.
Let me now explain the Bank's interpretationof market interest rate developments in the context of monetarypolicy management with an emphasis on securing an economic recovery.
Although the Bank has maintained sucha policy stance, long-term market rates have fluctuated ratherwidely since the beginning of 1996. The interest rate on governmentbonds with the longest remaining maturity, which had declinedto 2.8 percent in autumn 1995, rose to 3.5 percent in February1996. After declining to 3.1 percent thereafter, it rose againsomewhat after the release of the May Tankan results, and is nowat around 3.2 percent.
Whenever long-term interest rates fluctuatelike this, various comments and arguments are made to explainthe movements. However, the Bank bears the following two pointsin mind in observing long-term interest rate developments.
The first is that the market is constantlyseeking to settle at a reasonable interest rate level while assimilatingthe various information contained in a vast number of diversetransactions. Thus, it is necessary to focus on the relativelylong-term trend of market developments, without being preoccupiedwith short-term fluctuations.
The second point concerns the reasonableinterest rate level--in other words, what determines long-terminterest rates. The level of long-term interest rates is determinedbased on the market participants' projection of the rate of returnon investments or of the economic growth rate--in other words,their economic outlook. Also reflected in the interest rate levelis the participants' projection of the Bank's monetary policystance based on such economic outlook.
Since the autumn of 1995, the Bank hasconducted money market operations in a manner designed to developa stable market trend and to encourage a market-led formationof interest rates. Thus, the gradual rise in long-term interestrates since last year can be construed as reflecting the market'sassimilation of various information, particularly the market participants'view that the economy is recovering gradually.
When I express such views on long-terminterest rates, the media and the markets at times read too muchbetween the lines. However, my aim is to encourage a natural market-ledformation of market interest rates based on the economic fundamentals,which in turn enables the Bank to obtain greater information forassessing the economic situation. I very much count on your understandingof the policy and intentions of the Bank, since you are one ofthe important conduits between the Bank of Japan and the financialmarkets.
Another pressing issue for the Japaneseeconomy, alongside securing a self-sustained recovery, is to restoredomestic and international confidence in the financial systemand to strengthen the financial functions so as to support economicactivities.
As you are fully aware, bills concerningfinancial reforms, including those for establishing the jusenresolution scheme, have been passed by the House of Representativesand are currently under deliberation in the House of Councilors.In addition to the bills for solving the jusen problem are billsto establish a comprehensive framework for encouraging an earlysolution of the nonperforming-asset problem as a whole--such asthose bills for strengthening the functions of the Deposit InsuranceCorporation and those for introducing a system for taking promptcorrective actions against troubled financial institutions. Allthese are therefore significant in restoring the soundness ofthe financial system.
However, installing the above-mentionedframework will not bring an end to the problems in the financialsystem. In addition to the early disposal of nonperforming assets,individual financial institutions will need to make further effortsto heighten their creditworthiness domestically and internationallyby recovering impaired capital, improving public disclosure offinancial conditions, and promoting restructuring of their businesses.Should a financial institution face liquidity problems in theprocess of such efforts, the Bank of Japan, as the central bank,will take the necessary measures to maintain the stability ofthe overall financial system and, at the same time, will encouragethe financial institutions concerned to engage in more rigorousefforts.
Alongside the endeavors of individualfinancial institutions is another major task of reorganizing theJapanese financial system as a whole, including the system offinancial administration. Increasing attention on the revisionof the Bank of Japan Law is presumably attributable to this backgrounddevelopment.
I would now like to move onto the secondsubject of today's speech: institutional issues regarding centralbanking. The ruling coalition parties' project team publisheda report on financial administration reform on June 13. The reportincluded the revision of the Bank of Japan Law as one of the importantpillars of the reform and laid out the basic points at issue.
In response to rising interest in therevision of the law, the Bank has on occasion explained its fundamentalviews on central banking in order to gain the public's understanding.In doing so, however, I always feel that there are some aspectsof central banking which people find hard to understand. Therefore,I would like to take some of these up today and elaborate on ourview.
There are three major points to the issueof central banking: (1) the nature of central banking and thefundamental roles of the central bank; (2) the relationship betweenthe government and the central bank--in other words, the independenceof the central bank; and (3) relating to the second point, thestatus of the central bank in a democratic society.
As these points constitute the basisof any debate on central banking, I believe that a common understandingon them is a prerequisite for any deliberation on the revisionof the Bank of Japan Law.
Before going into the details of thediscussions in Japan, I would like to briefly mention the backgroundto the heated discussions that have recently taken place outsideJapan with regard to central banking, which have in fact led tolegal amendments and institutional changes in several countries.
Three factors prompted such an activedebate: (1) there was a need to establish a unified central bankamong the member countries of the European Union as part of themove toward an integrated Europe; (2) the establishment of a moderncentral bank at the core of the financial system was consideredto be an important task in the transition of former centrallyplanned economies to market economies; and (3) the experienceof stagflation in the 1970s and of the bubble economy in the 1980s--whichwas a global phenomenon not limited to Japan--has renewed recognitionthat the central bank's objective of maintaining price stabilitywas significant.
In the debates, the basics of centralbanking were seriously discussed: major outcomes were the provisionsfor the establishment of the European Central Bank included inthe Maastricht Treaty, and the ensuing amendment of the centralbank law in France and Italy. The European Central Bank is tobe assigned the objective of maintaining price stability and isto be granted a high level of independence from European Communityinstitutions and governments of member countries. The creationof this central bank through a political consensus has valuableimplications for Japan. I have no time to go into the details,but I wish to emphasize that serious and constructive debate regardingcentral banking took place and that this led to a consensus beingreached in Europe on the desirable nature of the central bank.
I will now go on to the first point atissue concerning central banking, namely, the fundamental rolesof the central bank.
The Bank of Japan is often characterizedas having three roles: (1) the issuing bank; (2) the banks' bank;and (3) the government's bank. Of these, the most fundamentalis its role as the issuing bank, that is, to issue currency suchas banknotes.
That this should be considered the primaryrole is easily understood by looking back at the historical processthrough which the organization and system of the central bankwere established.
Some central banks were established bythe government, as in the case of the Bank of Japan, whereas othersevolved from a private bank which, in the course of history, cameto perform the functions of a central bank, as in the case ofthe Bank of England. In either case, the central bank was establishedto stabilize the currency system by concentrating the issuingfunction to a sole institution and making it responsible for thecontrol of the currency.
In the case of Japan, currency was issuednot only by the government but also by private banks in the earlyMeiji era in the latter half of the nineteenth century, and variouskinds of currency were in circulation, including those issuedduring the preceding Edo era, which goes as far back as the seventeenthcentury. The currency system was thus in a height of confusionand a fall in the value of currency, or inflation, was accelerating.To resolve that situation, the Bank of Japan was established tocreate a stable currency system by acting as the sole issuer andcontroller of the currency, and through this, to lay the foundationfor economic development. As this example illustrates, the inherentrole of the central bank is to issue and control the currency--orone might say, to enable the people to use money confidently.
To this end, two requirements must besatisfied: first, the value of the currency must be stabilized--thatis, price stability must be maintained; and second, circulationof money and the functioning of the mechanisms through which monetarytransactions are processed--in other words, the settlement andfinancial systems--must be stable and efficient.
The mission of the central bank, therefore,is to fulfill these two requirements in order to preserve thesoundness of the currency, and to thereby provide a solid foundationfor sustainable economic growth and for an improved standard ofliving.
To fulfill this mission, the Bank ofJapan carries out diverse operations. Foremost, in order to stabilizethe currency value, that is, to achieve price stability, it managesthe monetary aggregates in the economy and interest rates. Thisis the essence of monetary policy, and I believe this point needsno further elaboration.
It is also an important task for theBank of Japan to make the yen more convenient to use and to therebyenable firms and households to confidently engage in daily transactionsand funds settlements. For example, the Bank ensures every daythat adequate money is supplied smoothly throughout the nationto meet the needs arising from transactions, and it also controlsthe physical quality of money to ensure the supply of banknotesof a high standard. While these tasks might not stand out, theyare nevertheless important in upholding people's fundamental confidencein the currency.
Alongside cash settlement, a large partof the daily transactions of households and firms are settledby means of funds transfers and remittances between banks. Inturn, banks' balances are settled across their accounts held withthe Bank of Japan. In other words, the majority of transactionsconducted throughout the country is eventually concentrated andsettled at the Bank. As a result, the amount settled across thecurrent accounts at the Bank totals more than 300 trillion perday. This means that an amount equivalent to approximately 70percent of Japan's annual GDP is transferred each day throughthe accounts at the Bank.
Therefore, the Bank is constantly workingto improve the settlement system so that such transfers of fundsare processed smoothly. For example, the Bank of Japan FinancialNetwork System, or the BOJ-NET, is a computer network for processinginterbank settlements via accounts at the Bank of Japan, and isthe product of continuous efforts made by the Bank over the yearsto realize a more efficient and sophisticated settlement system.
While I have used such words as "currency"and "money" to mean "cash," such terms todayare not limited to cash issued by the Bank of Japan. As mentionedearlier, most of the household payments of public utility chargesand settlements between firms are made by transferring funds betweenbank accounts rather than by cash. This signifies that bank depositsfunction as money based on the assumption that such deposits maybe exchanged for cash at any time at equal value.
Money held in this form is termed "depositcurrency" as opposed to "cash currency," and theamount held as the former far exceeds that of the latter. Theamount outstanding of monetary aggregates, as measured in Japanby M2+CDs, is approximately 550 trillion yen, of which more than500 trillion yen is in the form of deposit currency, while cash currencyonly accounts for about 40 trillion yen.
Such a currency system, as I have alreadymentioned, is built on the public's confidence that bank depositscan be exchanged for cash at any time. Japan's currency systemis thus founded on two kinds of credibility: that of the cashcurrency issued by the central bank, and that of the deposit currencyoffered by private banks.
Therefore, in order for this currencysystem to function effectively as a whole, the stable functioningof the overall financial system is essential. As deposit currencyis one of the liabilities of private banks, sound bank managementestablished on the principle of self-responsibility is fundamentalto maintaining its credibility. In addition, a safety net suchas the Deposit Insurance Corporation is provided to uphold thestability of the financial system by offering depositor protection.Furthermore, should a problem arise in any corner of the financialsystem with the risk of spreading throughout the entire system--thatis, when there is a risk that erosion of confidence in the systemmight spread through a chain reaction--the central bank is to provideemergency liquidity assistance as deemed necessary to preventa malfunction of the financial system and its serious negativeimpact on people's lives. The central bank's function to providesuch liquidity is known as the "lender of last resort."
To perform this lender-of-last-resortfunction smoothly and expeditiously, the Bank must not only encouragethe sound management of financial institutions, but must alsofully recognize at all times whether there is excessive concentrationof risks within the financial system, and whether the sequenceof settlements between financial institutions is conducted smoothly.It is also extremely important in the context of monetary policymanagement to understand and predict how the Bank's policy changeswill affect financial institutions' market behavior and how thatinfluence will in turn spread through the system.
Such function of the Bank of reviewingthe conditions of financial institutions is performed by meansof regular on-site examinations and daily monitoring. These arealso important operations for achieving the mission of the centralbank.
Having outlined a few of the diverseoperations of the Bank of Japan, I trust that you understand howthey are all closely linked to the Bank's two objectives of maintainingprice stability and ensuring financial system stability, and thatthese two objectives ultimately translate into the single objectiveof the appropriate control of the currency.
Next, I would like to explain why theauthority to control the currency is assigned to the central bankin major industrialized countries.
The reason for this assignment, in short,is that the authority to control the currency, or managing monetarypolicy, can in the short term be used for a variety of purposesif one so intends, but if utilized inappropriately, will invariablycause pernicious problems for the country in the long term.
History abounds with instances of heedlessincreases in the money supply and excessive interest rate cutsaimed at securing low-cost funding for the government or at forciblyadjusting the foreign exchange rate. These instances were followedin many cases by the undermining of price stability, triggeringsubstantial economic fluctuations, or by the impairing of fiscalprudence. Whichever was the result, the public was to pay theultimate costs.
Such historical experiences led peopleto conclude that the distinct duty of maintaining the value ofthe currency should be entrusted to the central bank, which isimpartial to the short-sighted interests of the times, and thatthe central bank's unbiased and professional judgment should berespected.
One of the reasons for granting independenceto the central bank derives from the nature of the objective ofmaintaining the value of the currency, that this objective canbe achieved only through detachment from short-sighted interestsin order to build a foundation for people's lives and the country'seconomic activity. This independence can be perceived as one ofthe ways devised for checking and balancing powers in a modernstate.
The two basic principles governing themodern state are "democracy" and "separation ofpowers." These principles are equally fundamental to a presidentialsystem and to a parliamentary system: in either system, the parliamentand, in turn, the people decide on the best way to achieve separationof powers--or, the best system for checks and balances. It is notonly the well-known separation of the three powers of legislation,administration, and jurisdiction which is founded on this conceptof checks and balances: in modern states, the concept is reflectedin various systems, such as the bicameral system of parliamentor the establishment of independent administrative bodies in theexecutive. The granting of independence to the central bank, orhaving an independent central bank, is also one of the systemsbased upon this concept.
Independence is granted to the centralbank in major industrialized countries, not only in countrieshaving a presidential system but also in those adopting the parliamentarysystem. While the cabinet is held primarily accountable to theparliament on economic policies in general under the latter system,independence has nevertheless been attached to the central bankby the judgment of the parliament in such countries as Germany,Italy, and Spain.
Of course, major industrialized countrieshave at the same time devised measures to coordinate monetarypolicy and other economic policies. Under these measures, on theassumption that adequately managed monetary policy and other economicpolicies are unlikely to clash, and that these policies do nothave widely different aims, the government and the central bankwill do their utmost to fulfill their respective duties whilefully embracing the concept of checks and balances. This given,a system for coordinating policy between the government and thecentral bank is also in place in case such coordination becomesnecessary. For example, in Europe, a number of countries haverecently adopted a system allowing the government to make policyrequests to the decision-making body of the central bank or toattend the meetings of the central bank board to present its views.
Granting independence to the centralbank, however, does not mean enabling it to manage monetary policywillfully outside the framework of modern parliamentary democracy.
Recent international debate over centralbanking, which I mentioned earlier, has highlighted the need toenhance public monitoring of the central bank through its reportingto the parliament together with the need to strengthen centralbank independence. This is one of the basic points of centralbanking on which a consensus has been reached.
This view, in short, sees independenceand accountability as indivisible. Since the word "accountability"is not familiar to the Japanese, allow me to take a moment todescribe it in some detail. The word "accountability"is commonly translated into a Japanese word meaning "responsibility."However, this translation does not fully reflect the true meaningof the word.
The word "accountability" derivesfrom "account," which has such meanings as to countmoney or to explain. In other words, "accountability"implies not simply responsibility but "responsibility toexplain properly."
Unfortunately, there is no correspondingJapanese word. This may be an indication of the fact that theconcept of this word was not recognized widely in Japan. Yet,it is an indispensable concept when discussing central bank independence.
The effects of monetary policy are transmittedthrough extremely complicated channels and they become visibleonly after a substantial period of time, in certain cases afterseveral years. This necessitates that monetary policy be managedfrom a long-term perspective, and also complicates the debateover the responsibility for monetary policy.
In managing monetary policy, therefore,the central bank is mindful of the need to properly explain thecontents, the objectives, and the fundamental thinking regardingits policy management. This makes it possible for the bank tolater review its policy stance and objectives, and to therebylearn valuable lessons.
Such an approach can be considered amechanism for encouraging the central bank to manage monetarypolicy adequately and responsibly, and in a way that makes policymanagement clearer to the public. Furthermore, such an attitudeshould foster a better mutual understanding between the government,the parliament, and the central bank regarding the economic situationand their respective policy management, and it should thus alsocontribute to achieving a higher level of consistency in the country'seconomic policies.
Some people express the concern thatincreased independence of the central bank might turn it intoan untethered kite. However, the basic thinking today on centralbanking is that by adopting the above approach, the central bankwill be able to manage monetary policy adequately without beingbound by short-sighted interests or external pressures, and withoutthe danger of becoming a tetherless kite. Many of the major industrializedcountries actually employ such a mechanism in an attempt to harmonizecentral bank independence and democracy.
The Bank of Japan has made various effortsto improve its accountability for monetary policy management.For example, in 1995, we began to announce all significant changesin our market operations with a view to clarifying our thinkingbehind such changes and our immediate policy on the directionof money market rates. In addition, when changing the officialdiscount rate, we have tried to provide in official statementsa more detailed explanation than before on the Bank's economicoutlook and the reasoning behind the policy change. Furthermore,from this year, we have upgraded the contents of the Policy Board'smonthly and annual reports to include details of the policy decisionsby the Board and the thinking behind those decisions.
Yet we believe much remains to be done.We will continue to study possible ways to further promote thetransparency of our policy management and to improve our accountability.
I have discussed today the Bank's basicthoughts on central banking, making reference to the recent debatein major industrialized countries on this issue. The issue centerson the appropriate status of the central bank in a modern democraticsociety and on the establishment of a mechanism that will encouragethe central bank to adequately perform its inherent duties.
According to a report by a project teamof the ruling coalition parties, a forum is to be establishedunder the government for transparent and fair deliberations onthe revision of the Bank of Japan Law. Concrete discussions onthe issue are yet to be held. When deliberations are launched,it will be required that the fundamental thinking on central banking,which I have explained, be shared broadly and that the debatebe founded firmly on that common understanding.
When such a forum is established, theBank of Japan intends to contribute constructively to the discussions,and to that end will be pleased to benefit from any constructivecomments or suggestions you might care to offer.
I am most grateful for your attentiontoday.