Home > About the Bank > Speeches and Statements > Speeches 1996–2010 > Speeches 2000 > Speech given by Eiko Shinotsuka, Member of the Policy Board of the Bank of Japan, at the Meeting on Economic and Financial Matters in Nagano on February 4, 2000 (Monetary Policy and Structural Reform of the Japanese Economy)
Monetary Policy and Structural Reform of the Japanese Economy
Speech given by Eiko Shinotsuka, Member of the Policy Board of the Bank of Japan, at the Meeting on Economic and Financial Matters in Nagano on February 4, 2000
April 25, 2000
Bank of Japan
Contents
I. Introduction1
It is a great honor to have been invited to speak at this meeting and exchange views with you, the leaders in various sectors in Nagano Prefecture. I would like to take this opportunity to express my gratitude for your kind consideration extended to our branch and office in this prefecture.
The Bank of Japan conducts monetary policy and its business operations under the new Bank of Japan Law, which has been established on the two principles of "independence" and "transparency." It is, therefore, a major responsibility of the Bank to give the general public an adequate explanation of the thinking behind its monetary policy and business operations. The Bank's executives and staff, including myself, must have a good understanding of the Bank's policy and business operations and actively exchange views with people in various fields, thereby deepening mutual understanding between the Bank and the public. I hope today's meeting will help enhance this mutual understanding.
Let me start by discussing the Bank's thinking and my personal view, which is somewhat different from that of the majority of the Board, on the Bank's implementation of monetary policy. Later, I will turn to issues I consider to be important for the structural reform of the Japanese economy.
- This article is excerpted and translated from the speech given in Japanese.
II. The Zero Interest Rate Policy
A. What Is a Zero Interest Rate Policy?
The Bank implements monetary policy by adjusting the supply of funds in line with demand for them in the money market through market operations. Since February 1999, the Bank has kept the uncollateralized overnight call rate, the operating target, at virtually zero percent--this is the so-called zero interest rate policy. Viewed from another angle, this means that the Bank will inject funds into the money market without limit whenever necessary. In fact, the Bank is supplying funds in such large volume that excess funds continue to remain in the market.
The Bank, at its Monetary Policy Meetings (MPMs), decides the guideline for market operations that covers the intermeeting period of about half a month or a month ahead. Market participants, on the other hand, often engage in funds transactions that become due in three or six months. This requires them to forecast movements in the overnight call rate during the period between the next MPM and the maturity date of their transactions. Consequently, when the outlook for interest rates is uncertain, interest rates on term instruments, such as three- or six-month instruments, could become substantially higher than the prevailing overnight rate.
To avoid such an outcome, the Bank has announced its intention of maintaining the zero interest policy "until deflationary concern has been dispelled," suggesting possible continuation of the policy beyond subsequent meetings. This announcement aims at ensuring that the effects of the zero interest rate policy permeate the economy. As a result, money market rates, including those on three- to six-month instruments, have stayed around zero percent.
When the Bank adopted the zero interest rate policy about a year ago in February 1999, there was an extremely strong unfavorable interaction between the economy and the financial markets. Sluggish economic activity had made market participants increasingly worried about the stability of the financial system. Had extreme pessimism spread in the financial markets, Japan's economy could have plunged into a crisis. This situation could have overly restrained economic activities, such as business fixed investment and household spending.
The zero interest rate policy effectively stopped the unfavorable interaction between economic activity and the financial markets by removing concerns among market participants that they might face difficulties in fund-raising due to a liquidity shortage in the market. In the meantime, the Financial Function Early Strengthening Law and other legislation enacted in the autumn of 1998 provided the framework for the stabilization of the financial system. In March 1999, approximately one month after the adoption of the zero interest rate policy, major banks were recapitalized by injection of public funds. Moreover, fiscal spending was increased significantly to support economic activity. Thanks to the synergy generated by these policy measures, a considerable degree of stability has been restored in the financial markets in the past year.
B. What Does the Phrase "Until Deflationary Concern Has Been Dispelled" Mean?
Japan's economy, which had stopped deteriorating, has recently started to improve, with exports and production increasing. The economic environment surrounding private demand is gradually improving as seen in the continuing increase in corporate profits. Despite these developments, the Bank judges that clear signs of a self-sustained recovery in private demand have not been observed yet, and therefore continues the zero interest rate policy.
Under these circumstances, the timing of a policy change and the meaning of "until deflationary concern has been dispelled," which is generally regarded as the criterion for terminating the current policy, have again become the focus of attention.
What then does "until deflationary concern has been dispelled" mean? It may be understood as to mean "until a self-sustained recovery of the economy driven by private demand could be forecasted with a certain degree of probability." Generally, deflation is defined as a spiral of declining prices and contraction in economic activity: an overall decline in the level of prices brings about a fall in corporate profits and wages; and this fall leads in turn to a contraction in economic activity, resulting in another price decline. This indicates that the economic momentum behind price developments is an important criterion in identifying the risk of prices declining further.
Misinterpreting the phrase "deflationary concern," some people seem to focus only on price indicators. However, factors affecting price declines include technological innovation and increased management efficiency. These factors would increase production and create a positive momentum in the economy. In such circumstances, a strong deflationary concern will not be confirmed despite the fall in prices.
C. Personal View on the Zero Interest Rate Policy
I hold an opinion different from the majority of the Policy Board. I believe that the Bank should terminate the zero interest rate policy and change the guideline for money market operations back to that employed before the adoption of the current policy on February 12, 1999. I believe this for two reasons.
First, I see that abatement of deflationary concern is already in prospect. I expect a self-sustained recovery in private demand, triggered by a recovery in business fixed investment. And although it is still difficult to forecast when business fixed investment will clearly turn upward, the environment has gradually become favorable since last autumn.
Corporate profits, which provide the wherewithal for business fixed investment, have become more likely to increase, reflecting reductions in personnel expenses and debts. Japan's labor market has been known to be less responsive to changes in the supply and demand balance of labor, i.e., there is relative inflexibility in both wages and the number of employees. In the 1990s, Japanese firms' return on capital deteriorated sharply due primarily to a considerable rise in labor's relative share. This rise was a result of a combination of the decline in the growth rate of the economy and a climb in hourly wages reflecting a reduction in working hours and a rise in the average age of employees paid under the seniority-based wage system. Recently, however, labor's relative share has been declining slowly as a result of a review of the seniority-based wage system and the increasing proportion of part-time workers.
Around last spring, many people were concerned that reduction of personnel and other expenses by firms would depress employees' income and hence private consumption, which, in turn, would prevent corporate profits from increasing as expected. However, while cost reductions have continued, private consumption has in fact remained virtually unchanged. This owes much to the improvement in consumer sentiment brought about by abatement of uncertainties over the stability of the financial system, and a recovery in stock prices.
Given this situation, it would be quite reasonable for firms to increase fixed investment if an increase in sales could be expected. Meanwhile, an improvement in business sentiment in general is reported in the Bank's Tankan--Short-Term Economic Survey of Enterprises in Japan--and other surveys.
A large number of firms are now in the process of business restructuring, aimed at creating a new business model to improve return on capital on a sustained basis. For this, a mere cost reduction is not sufficient. It is essential to establish a new core business and to strengthen it by concentrating management resources. Business fixed investment has been restrained to a certain degree, but this situation is not expected to last for long. Moreover, various stimuli to business investment are recently being observed, such as the dramatic technological innovations in new areas including information technology (IT), environmental technology, and biotechnology. I believe that a certain critical level at which business fixed investment turns upward is close.
There is an argument that, even if cash flow improved, the cash gained would not be directed to business fixed investment but instead to the repayment of debts. However, progress in reducing excess debts varies greatly from industry to industry, or even company to company. I therefore expect industries or firms whose debt burdens are relatively light and the sectors characterized by rapid technological innovation to lead a recovery in business fixed investment.
Firms are expected to continue to hold down wages. However, given the improvement in corporate income, the source of wages, I believe that there is now a smaller risk of a drop in private consumption caused by deterioration in income conditions and consumer sentiment.
The second reason for advocating a termination of the zero interest rate policy is the intensification of its adverse effects. There has been a distortion in income distribution; this has negatively affected especially the household sector, which is being denied interest income it would have otherwise earned. Structural reform is being delayed; too much easing of the pain of structural reform is producing unintended effects. Market participants' risk awareness is being diluted. And institutional investors, such as life insurance companies and pension funds, are facing difficulty in finding good investment opportunities.
Japan's "bubble" in the latter half of the 1980s left the country with a load of projects with low profitability and productivity. Undoubtedly, part of this phenomenon is due to monetary policy. However, an equally important cause was the lack of proper awareness of the cost of capital among firms and financial institutions. Reflecting on this bitter experience, I feel that it is essential to heighten the awareness of the cost of capital of economic entities to promote the kind of structural reform being called for. Undeniably, an emergency measure like the zero interest rate policy is necessary in "abnormal circumstances" to stem an extremely strong unfavorable interaction between economic activity and the financial markets combined with a deep pessimism over the future of Japan's economy. In a capitalistic economy, however, the incentive for promoting structural adjustment is unlikely to grow if such an emergency measure is continued.
Needless to say, it is not fair to evaluate the zero interest rate policy by focusing solely on its adverse effects. However, while the disadvantages manifest themselves as time rolls on, the risk has been diminishing of the economy being pushed back to the verge of a deflationary spiral. I believe the prospect of a self-sustained recovery in private demand is growing. On a comprehensive judgment of the changes in the situation, I believe that the time is right to terminate the zero interest rate policy--an extreme measure.
I would also like to mention two points I consider to be particularly important in connection with the termination of the current policy.
First, although I am in favor of terminating the zero interest rate policy, I do not believe that the Bank should shift its monetary policy stance toward tightening in one stroke. The overnight call rate of 0.25 percent, which prevailed before February of last year, is still very low. Therefore, guiding the rate back to this level would still be an easy monetary policy that would accommodate the current economic situation.
Second, the shock of terminating the zero interest policy on the financial and capital markets should be contained at the minimum. One reason for this is the fact that long-term interest rates reflect expectations for future short-term rate developments--that is, they reflect forecasts for economic activity and monetary policy implemented in response to the resulting economic situation. Therefore, heightened uncertainty regarding monetary policy could cause a surge in long-term interest rates. Stock prices and the yen could also shoot up. To avoid such developments, the Bank will have to explain to the market its thinking regarding monetary policy with the utmost clarity upon termination of the zero interest rate policy.
III. Structural Reform of the Japanese Economy
Unfortunately, the 1990s are known as the "lost decade" for the Japanese economy. The prolonged economic recession is attributed not only to the after-effects of the economic "bubble" but also to the failure of the Japanese economy to adapt to structural changes: advances in information technology; the proliferation of market economies, particularly in Asia; the low birth rate; and the aging of Japan's population.
This does not mean that the Japanese economy has no capacity for further growth but that it should seek new frontiers. What Japan needs to do is to reform various systems that affect the decision-making of economic entities. Today, I would like to take up two themes among the numerous issues relating to structural reform: the so-called IT revolution and employment system reform. A look at Nagano Prefecture from these two aspects reveals the following. A relatively high concentration of IT-related industries in Nagano Prefecture is realizing more rapid production growth than that in the rest of the nation. With respect to employment, this prefecture boasts one of the highest active opening ratio of job offers to job seekers in the nation. I hope to hear your comments on this situation later.
A. Information Technology Revolution
Advances in information technology would have various economic impacts including an increase in demand for related information services, as well as for hardware such as IT-related equipment and parts. Apart from these direct impacts, they are also expected to promote restructuring of various systems.
Generally speaking, an economic and social system cannot remain entirely organization-specific and completely isolated from the broader economic environment and technological foundation. In Japan for many years, business transactions within each corporate group have been a common practice. However, with advances in information technology, information networking--where the greater the number of participants, the more useful the service becomes--may promote a rapid expansion of transactions across the conventional framework, as seen in the United States over the past few years. For the Japanese economy to place itself on a new path of growth, the existing systems--i.e., the structure of the whole economy as well as of individual organizations including firms and the government--should be broken down and constructed anew to enhance the productivity of the nation's labor and capital.
A reform in the business model is expected to increase the productivity of industries where it is said to be below international standards. Japan's nonmanufacturing sector is well known for its low productivity and low efficiency--a by-product of heavy regulation and protection from price competition. This inefficient nonmanufacturing sector is threatening the international competitiveness of the manufacturing sector, in which intermediate input from service and other nonmanufacturing industries is growing in importance. However, the expected expansion of business-to-business or business-to-consumer e-commerce--in other words, direct transactions between the producer and the final user--may improve the efficiency of the economic system as a whole.
Nevertheless, advances in information technology are just a necessary condition for a further growth in Japan's economy. It is up to each one of us to take advantage of them. Innovations in information technology are sometimes referred to as "the IT revolution." In order for them to have economic effects comparable to those of the Industrial Revolution, we will certainly have to completely change our way of thinking, as well as to radically reform areas such as regulation, the tax system, and employment policy.
B. Employment Problems
Employment conditions remain very severe despite some indicators suggesting a halt in the deterioration of the situation. In addition to over-employment, a cyclical problem, Japan faces the structural problem of a low birth rate and aging of its population. My focus in what follows will be on these structural issues. Prior to my appointment as a member of the Policy Board of the Bank of Japan in April 1998, I was conducting research on the labor market at Ochanomizu University, Tokyo, and I am currently a member of the Ministry of Labor's Central Employment Security Council. I should emphasize, however, that the views I am about to express are my personal thoughts on this subject.
1. A long-term shortage of labor
There are two underlying causes of a shortage of labor. One is the impact of the low birth rate and the aging of the population. The National Institute of Population and Social Security Research has estimated Japan's population based on the rather bold assumption that the average birth rate of 1.43 recorded in 1996 and the present average life expectancy will hold true eternally. Just for your information, the rate dropped further to 1.39 in 1997. The Institute projects that Japan's population will decline from the present approximately 125 million to approximately 49 million by the year 2100, approximately 300,000 by 2500, and just to one person by 3500. At the same time, the proportion of elderly people will increase further. The Ministry of Labor forecasts that, of the total labor force, those aged 55 years or older will make up 29 percent in 2010 compared to 23.1 percent in 1998.
Another potential cause of a shortage of labor is a mismatch between skills wanted and those available in the labor market. For example, Europe is beset by a high unemployment rate in the national economy as a whole, while individual firms are reported to face shortages of labor, ranging from highly skilled workers in the field of information processing technology to relatively unskilled workers required by service industries. Japan too could find itself unable to fill job openings in such fields as information and telecommunications, nursing care for the elderly and healthcare, and other areas.
2. Diversification of working style
Given the projected decline in Japan's labor force and the current mismatch between the supply and demand of labor, I believe that a system should be created to encourage women and the elderly wishing to work to actively join the labor market, in other words, to raise the total labor force participation ratio.
Japan's employment system had been based on a stereotypical division of labor between men and women, such as "man the breadwinner, woman the homemaker" or "men in core posts and women in supporting roles," but this should now change. The economy and the employment structure have changed, and people's sense of values is becoming more diversified. Workers, regardless of their gender or age, now wish to choose the working style that best suits their lifestyle from among many alternatives: part-time work, temporary work, and teleworking, besides conventional full-time employment.
For example, part-timers rose from 16.3 percent of those in employment in 1998 to 19.8 percent in the fourth quarter of 1999. Some people see this as a reflection of the harsh employment and income environment. They argue that some people are forced to take part-time jobs despite a desire to work full-time or that full-time homemakers are compelled to take a job to supplement the decreasing income of their husbands.
I do not mean to reject these arguments, but I see the diversification of working styles in a more positive light. The Netherlands is noteworthy in that it has successfully changed the structure of the labor market. For example, as a result of the promotion of part-time work, approximately 30 percent of workers are now part-timers. A typical household has two wage-earners: one full-time and the other part-time. This type of double-income family is said to have many advantages. It can withstand economic fluctuations better than a single-income family; its members can achieve a good balance between work and their family lives; and it allows a couple to take turns in receiving professional education to improve their productivity.
Those of the elderly wishing to work could also continue to participate in the labor market if they are given more choice of working styles, such as part-time or teleworking, rather than having to choose between full-time work and no job at all. I understand that Nagano Prefecture has the lowest per-capita medical expenditure for the elderly in the nation, while at the same time it is one of the prefectures with the longest average life expectancy. This, I attribute to the prefecture's high labor force participation ratio of the elderly--one of the highest in the nation. The favorable environment for the elderly is encouraging them to remain active members of society. I believe these proactive efforts on your part are significant, in that they provide a model of how to cope with the imminent aging of Japan's population.
The transformation of Japan into a society with various working styles to suit everyone will also benefit employers. They will be able to respond flexibly to the changing business environment as well as to hire competent employees with the knowledge, skills, and experience required.
3. Importance of human resources development
I believe that the diversification of working styles will gradually weaken the strong attachment to long-term employment both on the part of the employer and employees. Long-term employment is likely to be maintained in areas of core competence, where technology and know-how need to be accumulated and passed on to the next generation. Overall, however, labor mobility could well increase in the future.
A new employment environment should be created in the near future to allow both the employer and employees to act more freely on their own initiative. For example, it is essential to review various systems, including the tax and social security systems, to avoid putting those changing jobs at a disadvantage. At the same time, support should be extended to individuals to allow them to receive vocational training and other types of human resources development education to become more productive. As the structure of the Japanese economy changes dramatically, continuing education will become ever more important. For example, some middle-aged or older workers who have accumulated company-specific skills and know-how may wish to receive special education in computer and networking. To make it possible for these motivated people to realize their wishes, a system should be built in which individuals can develop their abilities on their own initiative according to their life plans.
In relation to this issue of human resources development, the government is currently reviewing the Employment Insurance Law. While unemployment benefits will continue to provide a social safety net, discussion is now underway to transform the employment insurance system into a more flexible one that encourages the acquisition or improvement of job skills to help workers find new employment. The primary function of the government's three types of employment insurance service, which is governed by the Employment Insurance Law, has been preventing unemployment. Under these insurance services, various subsidies to businesses were provided to prevent them from shedding workers. In the future, however, I believe that support should be extended to individual workers to help them develop their talents and skills on their own initiative throughout their working life, instead of providing employers with subsidies.
Thank you for your attention.