Summary of a speech given by Teizo Taya, Member of the Policy Board, at the Meeting on Economic and Financial Matters with business leaders in Kyoto on January 29, 2004
Bank of Japan
February 19, 2004

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Contents

1. I. Recent Financial and Economic Developments
   1. A. Overseas Financial and Economic Developments
   2. B. Economic and Financial Developments in Japan
2. II. Recent Conduct of Monetary Policy

I. Recent Financial and Economic Developments

With business fixed investment starting to increase against the backdrop of a recovery in exports and production, the Japanese economy has recently started to gain momentum for a cyclical recovery. However, with a number of structural issues still to be addressed, the pace of recovery is moderate and there is as yet no prospect of a self-sustained expansion in domestic demand. At the same time, although there has been a slight abatement of the downward trend in prices, the trend remains in evidence. Looking forward, whether or not economic and price conditions continue to improve is going to depend to a significant extent on whether or not the increase in exports continues. For this reason, I would like to begin by looking at financial and economic conditions overseas.

A. Overseas Financial and Economic Developments

Economic conditions overseas have recently been looking considerably brighter. With prices stable, expectations of growth have risen and, in spite of higher stock prices, interest rates have remained low. On the other hand, rises in commodity prices and a weakened U.S. dollar have been conspicuous features of the world economy. Since the middle of 2003, forecasts for the world economy have been repeatedly revised upward. Current average forecasts for real world economic growth have risen from just over 3 percent in 2003 to around the 4.5 percent mark in 2004. Moreover, this strengthening of sentiment is seen not only in the advanced economies, but also in the major emerging economies. Stock prices rose in 2003 in each of the major 15 advanced economies and 25 emerging economies. These rises were especially conspicuous in emerging economies. Although long-term interest rates in advanced economies climbed somewhat in the middle of 2003, they have since been holding steady, while the premium rates demanded for emerging economies in financial markets have fallen. On the other hand, prices have risen for a broad range of raw materials. Not only mineral resources such as crude oil, steel, and nonferrous metals, but also commodities such as rubber and cereals have seen price rises. There has also been a significant hike in shipping freight rates. These rises are partly the result of the increased demand for raw materials that has accompanied more vigorous production levels around the world. However, as I will be discussing below, they have also been influenced by the depreciation of the U.S. dollar, which has fallen against most currencies and in particular against the currencies of countries that produce raw materials.

Examination of various features of the global economy yields two factors which have provided the driving force behind the world economy in recent years. These are, firstly, the unfettered participation in the world economy of many emerging economies, first among which is China; and secondly, the deepening of the IT revolution. These factors have exerted pressure equally on all economies across the globe to change their industrial structures. There have, however, been differences in individual countries' capacities to respond to this pressure. These differences in responsiveness have depended firstly upon industrial structure. The higher the proportion of manufacturing industry in an economy, the more difficult it has been to respond. This explains the difference between the United States and the United Kingdom on the one hand, and Japan and Germany on the other. Secondly, responsiveness has depended on the degree of flexibility in the economic structure. Issues such as the state of corporate governance, the flexibility of the labor market, and the flexibility of the financial structure and the political administration have all proved relevant.

Chart 1 illustrates one of the single most important factors driving the world economy, the impact on the world as emerging and other economies have increasingly become market-riented. Instead of wages, the vertical axis shows per capita GDP, while the export share is placed on the horizontal axis. For the sake of simplicity, attention is restricted to those countries which account for more than 1 percent of world exports. As emerging economies become increasingly integrated into world markets, the existence of trade means that there is downward pressure on wages in high-wage countries, pushing them toward world levels. A glance at Chart 2 reveals this pressure to be potentially a highly significant force. The horizontal axis in Chart 2 exchanges export share for the population. Furthermore, a number of countries whose presence in the world economy has been felt increasingly strongly recently are not included here. Among the recently much-discussed BRICs-i.e., Brazil, Russia, India, and China-India and Brazil will be included into this chart sooner or later.

The influx, via international trade, of low-priced goods from emerging economies both to advanced economies and to the more advanced of the emerging economies has become a factor exerting downward pressure on prices. In response to this growing disinflationary pressure, advanced economies, particularly the United States, have adopted an increasingly loose stance regarding monetary policy. Moreover, as countries have responded to the pressure to restructure their economies, trade has increased in both directions, breathing renewed vigor into the world economy as a whole. Monetary easing and the rise in the expected growth rate are partially responsible for global rises in stock prices. At the same time, increased global production has given a sharp boost to the prices of raw materials. However, price rises in sectors upstream of the industrial manufacturing process continue to prove hard to translate into price rises in downstream final-goods sectors, due to the intensification of competition and the productivity gains which this has inspired in these downstream sectors.

The other factor driving the world economy has been the deepening of the IT revolution. The IT revolution has been one of the forces causing economic globalization. Recently the world economy has proved especially sensitive to shifts in demand for IT-related goods. One of the major factors behind the global boom and subsequent recession that occurred only a few years ago was a temporary explosion in demand for goods in IT-related fields and the excess investment that accompanied it. The bubble in stock prices that emerged, and its subsequent bursting, produced wild swings in economic conditions. The aftereffects were felt until around the middle of 2003 when things finally started to come together and both the economy and stock prices started to recover. The recent increases in Japanese exports and production are closely linked to exports of electronic components and related goods, meaning that the outlook for these is of critical importance to the economy. For this reason, we are highly dependent on the path of IT-related investment in the United States. U.S. orders for capital goods, particularly for IT-related goods, continue to evince an increasing trend. At the same time, the rally in U.S. stock markets, led by high-tech stocks, has been growing stronger, and at present markets seem to be taking a robust view of future demand for IT-related goods. Looking at the global situation with the benefit of our experience of the previous IT boom, there does not appear to be any danger of either a purely temporary demand surge or of excess investment. I would now like to look, in turn, at the economic situations prevalent in each of the countries that represent major destinations for Japanese exports.

First under the microscope is the United States. Since the second half of 2003, spurred by the effects of tax cuts, the U.S. economy has been registering an impressively high growth rate, and there is a broad consensus that growth in 2004 will continue to exceed 4 percent. However, the effects of tax cuts will start to wear off around the summer of 2004, and it is still uncertain whether or not a slowdown is taking place, and if it is, how extensive it will prove. On the positive side, since autumn of 2003 there has been an upward trend, albeit a modest one, in mainly IT-related business fixed investment, and there are also some encouraging developments in the employment situation. While such trends remain in place, the economic recovery may also be thought likely to continue. However, the recovery in employment has proved moderate to date, and in this regard there is a growing sense within the United States that there is a problem, with domestic job opportunities in "hardware," that is, sectors involved in manufacturing, shifting to China, and those in "software" sectors shifting to India. Having said this, corporate profitability is currently in good shape and stock prices look robust, so that it seems reasonable to expect the employment situation to begin to improve more rapidly. Certainly, the U.S. employment indicators will continue to warrant attention.

In spite of upward revisions in the outlook for growth, higher stock prices, and a weaker U.S. dollar, long-term interest rates have stabilized at a low level. This is not only the result of speculation that monetary easing is likely to remain for the long term; it is also related to the influx of funds from overseas financial authorities' U.S. dollar-purchasing interventions that have continued since 2002. Speculation that an accommodative monetary policy may last into the long term is due not only to established factors, which remain important, such as the rapid growth in U.S. productivity and the slack that exists in both labor holdings and production capacity, but may also be attributed to the continuing tendency for the core consumer price index (CPI) to grow at a slower rate than previously.

Turning to the weakness of the U.S. dollar, this may be partly explained in terms of adjustment pressure, springing from the large U.S. current account deficit, working itself out via the exchange rate. The exchange rate has come under pressure because adjustments on the income side have proved elusive in both the United States and its main trading partners. For the United States, it is currently difficult to impose policies to curb domestic demand, just as various reasons of their own have made it difficult for the main trading partners of the United States to stimulate demand domestically. Faced with a weak dollar and appreciation in their own currencies, a situation has evolved in which financial authorities mainly in Japan and other East Asian economies have been constantly engaged in dollar-purchasing interventions. Reflecting these interventions by overseas financial authorities, the amount of assets held in the United States by foreign authorities is thought to have increased by as much as US$200 billion in 2003. Even the increase alone may be thought a significant amount when set against the U.S. current account deficit in 2003, said to have reached some US$550 billion. However, while the growth prospects of U.S. trading partners have been gradually improving, the pace of U.S. economic expansion in 2004 is thought to have slowed in comparison with the second half of 2003. In these circumstances, we might reasonably expect that the effect on the trade balance of the devalued dollar, cheaper since 2002, will shortly start to be felt. The related questions of what will happen to the U.S. current account deficit and whether or not the trend of dollar weakness will continue are highly significant for the world economy. On the other hand, should there for some reason be a rise in long-term interest rates in the United States, there is a danger that this would have an extremely heavy impact not only on the U.S. economy but all over the world. Attention should not be restricted to the dollar's weakness, but should be paid to this point as well.

Exports and production remain buoyant in East Asian economies, particularly for IT-related goods. Among the major East Asian economies, the country with the smallest export share of GDP is China, although, even there, this figure is almost 30 percent, while in most of the other countries it is significantly higher. Comparison with Japan, where the equivalent figure is just over 10 percent, is indicative of the extent to which these economies are dependent upon exports. Growth rates in 2004 are thought to be around 8 percent in China, and 5-6 percent in the NIEs and ASEAN countries. Although the South Korean economy was hit by a variety of problems in 2003, it managed to avoid an extensive slowdown in domestic demand, with the second half of the year witnessing exports starting to grow at a comfortable rate and a recovery in stock prices. The problem has been China, where a rise in real estate prices is among the symptoms suggesting that investment has been overheating in some sectors of the economy. Indeed, since the middle of 2003, the Chinese monetary authority has already been hammering out a tighter monetary policy. In addition, at the end of 2003 China started taking specific measures to improve the strength of financial institutions, among which were injections of public funds into some state-owned banks. Future monetary policy and measures to stabilize the financial system, as well as the effectiveness of these, will remain under the spotlight.

Economic conditions in the euro area as a whole seem to have bottomed out, and the extreme pessimism that was prevalent in 2003 seems to have subsided. However, it is still external demand that is providing all the economic momentum, with domestic demand remaining sluggish. Furthermore, within the region there is some variation in economic conditions across different countries, with weakness particularly notable in countries such as Germany which have high wages and a proportionately large manufacturing sector. In addition to Germany, countries such as France have fiscal deficits exceeding the limit of 3 percent of GDP set down in the Stability and Growth Pact. Such deficits may well be another indication of both the extent of the pressure to restructure economies and the continued tardiness of growth. Adding to competition within the euro area, direct investment to date into central and eastern European countries such as the Czech Republic, Poland, and Hungary has resulted in a new export offensive from these countries. Needless to say, East Asian economies are also exporting aggressively. The point is that, just like Japan with its East Asian neighbors, countries such as Germany and France are building new relationships with neighboring emerging economies, and trade going both ways is now starting to expand. Recently, however, the impact on the euro area of the weaker U.S. dollar, against which the euro has continued to strengthen, has started to become a cause for concern. Meanwhile, the economies of the other advanced countries, the United Kingdom, Canada, and Australia, remain healthy. Monetary policy in the United Kingdom, for example, was recently even tightened slightly. These countries' currencies have all undergone substantial appreciation against the U.S. dollar. One of the causes of the rise in the U.S. dollar-denominated prices of crude oil and other raw materials may be thought to be the desire to claw back the losses imposed by a weaker U.S. dollar.

B. Economic and Financial Developments in Japan

Exports and production continue to trend upward. There may be a temporary decrease in these growth rates at the beginning of 2004, given the higher-than-expected growth recorded at the end of 2003, but the impact is likely to be minimal. The exporting environment is favorable: overseas economies are growing and demand for IT-related goods continues to increase. The impact of the yen's appreciation against the U.S. dollar on the economy seems to have been limited so far, since the yen's effective exchange rate has not increased as much as the yen's exchange rate against the U.S. dollar. The negative effect of the yen's appreciation is also expected to be cushioned by growth in exports to East Asian economies, just over half of which are denominated in yen, and by the increase in overseas production by Japanese firms. In the short term, the income effect, or the effect of the change in income of the importing country, is expected to have a larger impact than the price effect due to changes in the exchange rate. Production will continue to increase as long as the increasing trend in exports is maintained.

Corporate profits are increasing, particularly in the manufacturing sector, reflecting the increase in exports and production. Profits on a consolidated basis, i.e., including those at overseas subsidiaries, are high. As for listed firms excluding financial institutions, the current profits of large manufacturers on a consolidated basis are forecast to increase by a little more than 20 percent in fiscal 2003, and by slightly above 10 percent in fiscal 2004. Many small manufacturers are also likely to record increases in profits in fiscal 2003. As for nonmanufacturers, profits at large listed firms are forecast to increase by about 10 percent in fiscal 2003 and 2004 due to restructuring efforts. However, profits at very small firms, especially those in the nonmanufacturing sector, are not improving much.

Business fixed investment has been recovering since the end of 2002, especially at large manufacturers, where it reflects improvements in corporate profits, and this tendency seems to be becoming stronger. However, the increase in business fixed investment is unlikely to easily spread across other sectors for the following reasons. First, many firms, especially nonmanufacturers, are continuing efforts to reduce levels of excessive debt, which remain significant. Second, some firms are still cutting surplus capacity. In addition, although stock prices have been recovering recently, land prices continue to fall, and this, compounded with the forthcoming introduction of impairment accounting, is causing firms to be more cautious about investing.

Although firms' demand for funds remains weak as they keep business fixed investment below the level of their cash flow and continue to reduce debts, financial situations are improving for some suppliers of funds. Major banks have made progress in disposing of nonperforming loans (NPLs), and they are likely to achieve their stated aim of halving the March 2002 ratio of NPLs to total loans by the end of March 2005. In addition, their capital adequacy ratios have started to improve, after hitting bottom at the end of March 2003. In comparison, however, regional financial institutions are behind in disposing of NPLs, and they need to speed up the pace of their disposals as the removal of blanket deposit insurance is approaching in April 2005.

Financial institutions are beginning to ease their lending stance as disposal of NPLs progresses and constraints on risk taking imposed by capital adequacy considerations become less binding. Although somewhat marginal in nature, these changes in the lending stance of financial institutions are observed in surveys targeting both financial institutions and firms. In addition, financial institutions have enhanced their financial engineering techniques, allowing them to take more credit risk by using, for example, syndicated loans, non-recourse loans, commitment lines, covenants attached to loans (an additional set of agreements, aimed at borrowers, attached to the regular contract to maintain the integrity of the loan), and small, unsecured business loans. Financial institutions are also starting to be more aggressive in arranging asset-backed securities (ABSs) and asset-backed commercial paper (ABCP).

In contrast to the robustness observed in exports and production and the increasing trend in business fixed investment, private consumption remains flat. This is mainly due to the delay in improvement in the employment and income situation. Firms are burdened with excessive numbers of employees. Many firms that have posted profits owe these mainly to layoffs and business restructuring. Although the ratio of job offers to applicants and the numbers of new job offers are both increasing, the mismatch between supply and demand in the labor market has meant that the overall number of employees has failed to rise. While the declines in both the numbers of employees and in wages seem to be gradually coming to a halt, it is likely to take time for the employment and income situation to recover.

Steady increases in private consumption may not prove forthcoming, even if the number of employees and income were both to start rising. Nominal consumption expenditure in the national accounts has remained level for the past five to six years. However, disposable income has been on a declining trend, with especially large falls recorded in fiscal 2001 and 2002. As a result, the household savings rate has been declining. This is obvious from the fact that the savings rate of elderly people, whose proportion in the total population is rising, has been negative. However, this is not the main reason for the rapid fall in the savings rate in these past two to three years. Looking back on the 1990s, we observe that the household savings rate tended to increase as income increased and vice versa. This was because consumers sought to maintain the same level of consumption regardless of fluctuations in income. As long as this tendency persists, even if consumers' income starts to rise, they are likely to increase savings to prepare for the future rather than to increase consumption.

Such a situation makes it difficult for nonmanufacturers to improve their business performance. The difference between the business performance of manufacturers and nonmanufacturers will therefore take time to diminish. What we are seeing is that, in a situation where the economy is undergoing structural adjustments, it takes a long time for the effects of the virtuous cycle, starting from exports and production, to spread to the whole economy. However, it is also true that the current economic situation represents a significant improvement on the two economic recovery phases experienced since the beginning of the 1990s. Problems such as the excessive capital stock, debts, and numbers of employees, the NPL problem, and the fall in land prices are not as grave as they used to be.

In the Outlook and Risk Assessment of the Economy and Prices (the Outlook Report) released in October 2003, Policy Board members' median forecast for real GDP growth in fiscal 2003 and 2004 was around 2.5 percent. So far, developments in the economy seem to be basically in line with this forecast. The output gap is expected to continue narrowing, albeit marginally. The forecast is also consistent with developments illustrated in the Bank's Tankan Composite Indicator, which is a weighted average of the diffusion indexes of employment conditions and production capacity and regarded as a proxy for the output gap. It suggests a moderate decline in the degree of excess characterizing employment and capital conditions.

Downward pressure on prices normally weakens as the output gap narrows. The year-on-year change in the core CPI (excluding fresh food) has been fluctuating between minus 0.1 and 0.1 percent since the beginning of fall 2003. The pace of decline has slowed greatly from the rate of change of minus 0.8 percent in fiscal 2002. However, this is mostly due to special factors in fiscal 2003, such as the rise in medical costs, tobacco tax, and rice prices owing to adverse weather. In addition, the rises in the prices of beef, due to the BSE problem, and most recently chicken, due to the outbreak of bird flu, are likely to push overall prices up. Excluding the effects of these temporary factors, the year-on-year rate of decline in the CPI is likely to be about minus 0.5 percent for fiscal 2003. As for fiscal 2004, the year-on-year rate of decline is expected to slow to about minus 0.3 percent, not deviating much from the forecast made in the Outlook Report. Thus, we do not yet foresee an end to deflation.

II. Recent Conduct of Monetary Policy

I would like to turn to the Bank's conduct of monetary policy since late May 2003, when I had similar occasion to make a speech of this nature. Since then, the Bank has implemented the following three measures. First, the Bank has further enhanced its quantitative easing measures. Second, the Bank has started the purchase of securities backed mainly by small firms' assets, with a view to fostering the development of the ABS market and thereby promoting smooth corporate financing. And third, to enhance the transparency with which monetary policy is conducted, the Bank has improved its explanation of how it assesses developments in the economy and prices as well as providing a more detailed description of its commitment to maintaining the current quantitative easing policy.

I would like to start by considering the third of these recent measures. The Bank's commitment has been to maintain the quantitative easing policy until the CPI registers a stable year-on-year increase of zero percent or above. However, due to some one-off factors, the year-on-year change in the CPI recently rose close to zero percent, highlighting the need to provide a more detailed description of the commitment. At the October 9 and 10, 2003 Monetary Policy Meeting, the Bank therefore decided to specify the following conditions. First, it requires that, even if the year-on-year increase in the CPI registers zero percent or above, such a tendency should be confirmed over a few months. Second, many Policy Board members need to forecast that the CPI will continue to register increases exceeding zero percent. In other words, there should not be any immediate risk of the economy returning to deflation. These two conditions, however, are necessary but not necessarily sufficient conditions. There may be cases where the economic and financial situation is such that the Bank judges it inappropriate to terminate the quantitative easing policy, even if the above two conditions are met. Such a commitment to maintaining the quantitative easing policy inevitably restricts the flexibility of the Bank's conduct of monetary policy in the future. However, submitting to such a restriction may well be considered appropriate given the unprecedented situation currently facing the Bank. In addition, the conditions elaborate on the meaning of the Bank's commitment. I believe this will strengthen the effects of the Bank's commitment in terms of policy duration, lowering the current level of long-term interest rates by influencing market expectations of future short-term interest rates.

I would next like to comment on the second of the Bank's additional measures, its purchase of ABSs, which was introduced in summer 2003. Since then, the Bank has been exchanging views with market participants on ways to foster the development of the ABS market. Based on its actual experience with ABS purchases, the Bank decided to review the conditions governing the purchase of ABSs at the Monetary Policy Meeting held on January 19 and 20, 2004. I will not go into detail of the revision today, but its purpose was to foster the development of the ABS market while maintaining the financial soundness of the Bank, and simply not to increase the amount outstanding of the Bank's ABS purchases.

As for the first point discussed, the enhancement of the Bank's quantitative easing measures, in October 2003 the Bank raised the upper end of the target range for the outstanding balance of current accounts held with it, and on January 20, it again raised this target range. Under the quantitative easing policy, the Bank provides a surplus of liquidity through market operations, with a view to keeping financial institutions' current account balances at the Bank, which do not bear interest, well above the minimum reserve requirement. This is expected to bring about the following monetary easing effects. First, short-term interest rates are expected to remain stable at extremely low levels. Second, the policy affects the selection of assets by financial institutions holding current accounts at the Bank, and this triggers portfolio rebalancing. And third, the policy helps to remove any concerns that financial system instability may arise as the result of a liquidity shortage. Furthermore, the Bank also increased outright purchases of Japanese government bonds (JGBs) as it raised the target of the outstanding balance of current accounts, and this is also considered to have an impact on long-term interest rates.

The first of these three effects of the quantitative easing policy has already been observed: that is, short-term interest rates have been stable. Given that concerns that the financial system might become unstable have subsided, market participants continue to feel strongly that there is an abundance of liquidity in the money markets. There has been no evidence that money market conditions have become tight despite the shift of funds among financial institutions as a result of U.S. dollar-purchasing operations. Bid-to-cover ratios in the Bank's funds-absorbing operations for short-term funds have been high, and interest rates on instruments in these operations continue to stay at 0.001 percent. As these show, money market conditions have eased considerably. However, it is conceivable that financial institutions' demand for funds held in current accounts at the Bank could decline. Recently some major Japanese banks have reportedly been raising funds in the money market more aggressively than before, encouraged by the increase in their own stock prices and the upgrading of their credit ratings. Meanwhile, there has been an improvement in the net balance of deposits against loans, while investment opportunities for financial institutions remain scarce. Furthermore, in the current situation, it is even conceivable that the Bank's funds-supplying operations may become under-subscribed if dwindling concerns about financial system stability were to cause a decline in the demand for funds held in current accounts at the Bank not only by Japanese banks but also by foreign banks. This is because the latter, like major Japanese banks, are currently said to be holding sizeable current accounts at the Bank.

As for portfolio rebalancing effects, the second of the quantitative easing effects discussed above, these have been seen at some financial institutions, as they try to shift a large amount of the funds held in their current accounts at the Bank to other financial assets in order to put their surplus of such funds to more productive use. This is likely to have placed further downward pressure on interest rates on treasury bills (TBs) and financing bills (FBs) and to have been at least partially responsible for the narrowing of yield differentials between JGBs and corporate bonds. Portfolio rebalancing under the quantitative easing framework occurs through changes in the composition of assets on financial institutions' balance sheets. Since financial institutions holding large current account balances have low liquidity constraints, they are more likely to increase their holdings of assets with high returns, despite the latter's lower liquidity. According to data on the assets and liabilities of domestically licensed banks from March 2001 when the quantitative easing policy was introduced, total assets have declined substantially due mainly to the decrease in loans. Against this background, purchases of Japanese government securities including TBs and FBs have increased while those of corporate bonds and foreign bonds have risen only slightly. The effects of quantitative easing on TB and FB rates and credit spreads on corporate bonds, if indeed there have been any, are considered to have been small. At present, TB and FB rates with three-month or six-month maturity have declined to or below 0.01 percent, and credit spreads on corporate bonds rated AA have already declined to the range of 0.1-0.2 percent.

The third effect of quantitative easing, its contribution to financial system stability, was not paid much attention at the time when quantitative easing was introduced. However, the significance of this effect has increased as current account balances have grown. Financial institutions hold liquid assets in preparation for sudden runs on deposits, and in this regard, current accounts held at the Bank represent the most appropriate type of reserves available. There are some who point to the large amount of current accounts accumulated at the Bank as one of the reasons why the financial system was extremely stable when Ashikaga Bank was temporarily nationalized pursuant to Article 102 of the Deposit Insurance Law. However, I believe the number of financial institutions anticipating current account balances to have a significantly stabilizing effect is few, so I doubt that a higher target for the outstanding balance per se will increase this stabilizing effect.

Whether to raise the target for the outstanding balance of current accounts at the Bank should be decided in light of the above three effects. At its Monetary Policy Meetings, the Bank should raise the target if it deems it effective to do so; but if the effects of such a raise are expected to be limited, the target may be left unchanged. Apart from the three effects discussed above, there is also the vexed question of whether raising the target influences people's expectations and thereby strengthens the effects of the Bank's commitment in terms of policy duration. Personally, I am doubtful that these commitment effects can be strengthened on a sustainable basis. The current aim of the Bank's monetary policy is to overcome deflation as soon as possible. In the current situation where there is still no prospect of the economy overcoming deflation, the Bank should not hesitate to implement any effective monetary easing measure whose merits outweigh its demerits. Furthermore, while the prospect of overcoming deflation remains out of sight, the Bank should maintain this stance even when economic developments suggest a positive deviation from the standard scenario described in the Bank's Outlook Report. At the same time, it is essential that market participants have a correct understanding of the Bank's monetary policy measures so that the credibility of the Bank's conduct of monetary policy is ensured.

Lastly, I would like to comment on the recent decline in the growth rate of the money stock, which has been pointed to as a cause for concern. Data show that the growth rates of cash, M1, and M2+CDs have been declining. This is, however, believed to be merely an instance of readjustment, after various factors had sent the growth rates of the monetary indicators a little too high. The growth rate of cash is slowing mainly because the effects of the lower cost of holding cash have played themselves out and the financial system has become more stable. Indeed, given these circumstances, further declines in the future growth rate of cash would be far from unexpected. The falls in the growth rates of M1 and M2+CDs are also due mainly to the increasing stability of the financial environment, which has led investors to shift funds into vehicles offering higher returns. Broadly-defined liquidity, however, has maintained a relatively high growth rate, which suggests that preoccupation with the decline in the growth rates of narrowly-defined monetary aggregates is not necessarily appropriate. Recently, the lending attitude of financial institutions has become slightly more accommodative, and they are varying the channels of credit extension. I consider it important that the Bank makes efforts to further promote credit extension by financial institutions, and consequently to increase the growth rate of the money stock.

The quantitative easing policy was not introduced for the purpose of raising or maintaining the growth rate of the monetary base (cash in circulation plus current account balances at the Bank), much less for the purpose of deliberately raising the growth rate of the money stock by increasing the monetary base. In normal circumstances where money market rates are well above zero, concentrating efforts on stabilizing the growth rate of the monetary base may be considered a viable policy option. However, in the current situation where money market rates remain at virtually zero percent, the relationship between the monetary base or the money stock, and the economic growth rate, the inflation rate, or the exchange rate, cannot be explained theoretically. This relationship is empirically especially unclear since the middle of the 1990s. The Bank is extremely keen that these points should be thoroughly understood, and will therefore persist in its efforts to explain them.

Thank you for your kind attention.