- Jun. 30, 2022
- Jun. 30, 2022
- Jun. 30, 2022
Deputy Governor of the Bank of Japan
June 1, 2022
Good morning. It is a great pleasure for me to meet with local leaders in Okayama Prefecture today. This is my first face-to-face meeting with local leaders in two years and four months. This year marks the 100th anniversary of the establishment of the Okayama Branch of the Bank of Japan. It is an honor to hold this meeting in such a momentous year. I would like to express my deepest gratitude for the great support provided for the branch's activities over the past 100 years. I would also like to ask for continued support over the next 100 years.
I will begin my speech by describing the current situation of the global and Japanese economies, followed by the conduct of monetary policy. In particular, I will examine inflation, which has been a major topic recently, by making comparisons with the Great Inflation to draw lessons for today. Lastly, I will talk about the current economic situation and outlook for Okayama Prefecture.
I would like to start by talking about the global economy. The growth rate of the global economy saw a substantial decline of 3.1 percent for 2020 due to the spread of the novel coronavirus (COVID-19) but registered high growth of 6.1 percent for 2021, mainly on the back of the widespread vaccinations (Chart 1). The latest World Economic Outlook released by the International Monetary Fund (IMF) shows that, although they are projected to decelerate from the growth rate for 2021, the global economic growth rates for both 2022 and 2023 are expected to be 3.6 percent, staying at around the long-term average. However, this outlook entails high uncertainties, and the following three factors warrant particular attention.
The first is heightened geopolitical risks as a result of Russia's invasion of Ukraine (Chart 2). Since Russia and Ukraine together only account for about 2 percent of the global GDP, the direct impact of these countries' economic downturns on the global economy is limited. That said, in terms of their export shares in commodities, Russia accounts for 12 percent and 19 percent of global exports of crude oil and natural gas, respectively. In addition, Russia and Ukraine together export around 25 percent of the world's wheat. As it has been viewed in the market that factors such as economic sanctions imposed on Russia will lead to a decline in the supply of these commodities and grains, international commodity prices have risen significantly of late. It should be noted, however, that the impact of this rise on the economy differs considerably between countries that export commodities and those that import them. That is, for commodity importers like Japan and Europe, the rise in international commodity prices leads to an outflow of income to commodity-exporting countries in the form of deterioration in the trade balance (Chart 3). This puts downward pressure on domestic demand of commodity-importing countries through deterioration in households' real income and corporate profits. On the other hand, unlike in the past, the rise in commodity prices does not have a negative impact on the United States, which has become the world's top oil producer as a result of the shale revolution.
The second factor is the impact of COVID-19. In the United States and Europe, economic activities have been normalizing as approaches to living with COVID-19 have been taken, but in countries where strict restrictions have been imposed, the economies have remained under considerable downward pressure from COVID-19. In particular, China has continued to take the so-called zero-COVID strategy, and it decided to impose lockdowns on large cities such as Shanghai, reflecting the spread of highly contagious variants. This has not only pushed down the Chinese economy; its adverse impact has also spilled over to the global trade and production activities, including in Japan, through disruptions in distribution networks and supply chains.
The third factor is the impact of the reduction in monetary accommodation in advanced economies facing a continued rise in inflation on global financial and capital markets and the global economy. In particular, the Federal Reserve raised its policy interest rate by 0.25 percentage points in March and 0.5 percentage points in May, and it has been communicating that ongoing increases in the rate will be necessary to curb elevated inflation. It has also started reducing the size of its balance sheet.1 Under these circumstances, it is necessary to pay attention to downside risks to the global economy that could be posed if global financial and capital markets become unstable through, for example, global adjustment of stock prices and capital outflow from emerging economies.
Let me now turn to Japan's economy. It has picked up as a trend, although weakness has been seen in part, mainly due to the impact of COVID-19 and the rise in commodity prices. Its real GDP for the January-March quarter of 2022 was minus 0.2 percent on a quarter-on-quarter basis, registering negative growth for the first time in two quarters (Chart 4). This is because business fixed investment and durable goods consumption were constrained due to the effects of supply-side constraints such as semiconductor shortage, and because services consumption, including dining-out and travel, had been under increased downward pressure due to the spread of the Omicron variant. Thereafter, although the effects of supply-side constraints on automobile-related goods in particular have been prolonged, due in part to the impact of lockdowns in China, private consumption has started picking up again as downward pressure on face-to-face services stemming from pandemic-related restrictions has waned.
For the time being, Japan's economy is likely to follow a recovery trend, with the impact of COVID-19 and supply-side constraints waning and with support from accommodative financial conditions and the government's economic measures, although it is expected to be under downward pressure stemming from a rise in commodity prices. In terms of the medians of the Policy Board members' forecasts, Japan's real GDP growth rate is expected to be relatively high, at 2.9 percent for fiscal 2022, and then decelerate to 1.9 percent for fiscal 2023 and 1.1 percent for fiscal 2024; thus, the economy is projected to continue growing at a pace above its potential growth rate throughout the projection period.
As mentioned earlier, for commodity importers like Japan, a shock of rising commodity prices puts downward pressure on income -- such as households' real income and corporate profits -- through higher energy and food prices, and therefore would normally act to constrain spending (Chart 5). In the current phase, however, it is expected that Japan's economy will be resilient to this negative income shock, instead of falling into a vicious cycle from income to spending. As the background to this, the government's economic measures, such as gasoline subsidies and subsidies for low-income households, are likely to mitigate the negative impact on income. In addition, households and firms have accumulated a large amount of "standby" funds during the pandemic, and this is expected to support the materialization of pent-up demand.2 In sum, the baseline scenario is that Japan's economy is likely to continue recovering as the positive effects on spending associated with a waning of the impact of COVID-19 and supply-side constraints are projected to outweigh the negative effects on income due to a rise in commodity prices. From the middle of the projection period, as the negative impact of high commodity prices wanes at a gradual pace and a virtuous cycle from income to spending intensifies gradually, Japan's economy is projected to continue growing at a pace above its potential growth rate and underlying upward pressure on wages and prices is expected to increase.
That said, this outlook is based on the assumption that, with the impact of COVID-19 and supply-side constraints waning, firms' and households' growth expectations will increase moderately and their medium- to long-term inflation expectations will also rise. In other words, if the impact of COVID-19 and supply-side constraints becomes more prolonged than expected and the two sets of expectations are pushed down, there is a risk that "standby" funds will transform into precautionary savings to prepare for future uncertainties and spending activity will not improve.
I will move on to price developments in Japan. The year-on-year rate of change in the consumer price index (CPI) for all items excluding fresh food rose from 0.8 percent for March to 2.1 percent for April (Chart 6). On the surface, the rate of increase reached 2 percent. However, this primarily owes to rising energy prices, and the Bank does not consider that it has achieved its price stability target in a sustainable and stable manner. The year-on-year rate of increase in the CPI is projected to be 1.9 percent for fiscal 2022 but then decelerate as the positive contribution of a rise in energy prices wanes, registering 1.1 percent for both fiscal 2023 and fiscal 2024.
To understand the background to this outlook, it is crucial to make a distinction between developments in individual prices and those in general prices. Statistically, a price index is created by weighting the rates of change for individual prices to generate a weighted average. Thus, if the individual prices of, for example, energy experience a significant rise, this may lead to a figure of 2 percent in the CPI. However, inflation driven by such individual price rises lacks sustainability. To achieve the price stability target of 2 percent in a stable manner, the prices of a broad range of items have to rise, supported by improvement in the output gap and an increase in inflation expectations. In other words, general prices need to go up.
From this perspective, work needs to be done to accurately determine developments in underlying inflation, by screening out the effects of various temporary volatile factors from the actual price index movements. In this regard, the Bank constructs and examines various measures of core inflation, mainly through two approaches. The first is to identify items with large price fluctuations in advance and examine measures of core inflation that exclude those items. The Bank has traditionally put emphasis on the CPI excluding fresh food, for which prices fluctuate significantly due to weather conditions. Recently, due in part to the situation surrounding Ukraine, crude oil prices have seen large fluctuations. Since energy prices are directly susceptible to such fluctuations, the Bank decided to release its outlook for the CPI excluding both fresh food and energy starting with its April 2022 Outlook for Economic Activity and Prices (Outlook Report). The year-on-year rate of change in the CPI excluding both categories has been only around 1 percent recently. This is clearly below the rate of change in the CPI excluding fresh food alone. Nevertheless, with operation of the virtuous cycle that I explained earlier, it is likely that the output gap will improve and medium- to long-term inflation expectations and wage inflation will rise. Therefore, the year-on-year rate of change in the CPI excluding fresh food and energy is projected to moderately increase in positive territory, from 0.9 percent for fiscal 2022, to 1.2 percent for fiscal 2023, and 1.5 percent for fiscal 2024.
The second approach to measuring underlying inflation does not involve excluding specific items in advance. Rather, it is to monitor the distribution of price changes of items that make up the CPI, and construct and examine measures for which the impact of outliers is automatically excluded from the distribution. In this regard, comparing the price change distribution by item before the pandemic with that at present shows that the distribution itself has shifted in the direction of price increases in the United States and Europe, and that the range of items increasing in price has also broadened (Chart 7). In Japan, meanwhile, there has been no major change to date to the fact that the distribution of price changes for many items has been centered on 0 percent, and that price increases are skewed toward certain items, such as energy. The differences between distribution in the United States and Europe and that in Japan seem to be mainly a reflection of disparities in medium- to long-term inflation expectations (Chart 8). In other words, short-term inflation expectations have indeed seen an increase in Japan, reflecting rising energy prices. Compared with the United States and Europe, however, medium- to long-term inflation expectations in Japan are still low. This can be confirmed in various measures of core inflation calculated from the price change distribution. While the trimmed mean of the year-on-year rate of change in the CPI has recently increased to the range of 1.0-1.5 percent, the mode and weighted median have been only slightly positive.3 The Bank will pay close attention to whether the price change distribution by item will shift in the direction of price increases and the rate of change in various measures of core inflation calculated from it will also increase as medium- to long-term inflation expectations rise.
With the arrival of inflation for the first time in a long time, some are concerned that the world will return to a period of very high inflation, such as experienced during the 1970s. However, to start with my conclusion, I am skeptical that we will see a return to an era of high inflation. Leaving other countries aside, my greater concern for Japan, at least for the present, is still continued low growth, low interest rates, and low inflation -- a situation that has come to be called "Japanification."4
Let us take a moment to look back in history and examine the Great Inflation. There is now a consensus among academics about the Great Inflation on the following points.5 First, although the Great Inflation is often thought to have occurred in the 1970s, an international comparison shows that the timing at which it began differed across economies. Price developments in the United States, the United Kingdom, West Germany, and Japan from the mid-1950s through the 1980s show that, while the inflation rates of the economies are broadly correlated, a closer look reveals some differences across economies (Chart 9). In the United States, an acceleration in inflation was observed from around 1965, whereas in Japan, inflation accelerated after the turn of the 1970s. In addition, while double-digit inflation was seen in many economies, inflation in West Germany did not reach 8 percent even at its peak. Moreover, inflation in Japan peaked at 23 percent in the first half of the 1970s, specifically 1974, but the United States experienced its peak in inflation in 1980.
Second, and related to the first point, the oil shocks were not the primary cause of the Great Inflation. In Japan, there is a persistent belief that the two oil shocks were the cause of the Great Inflation. While it is true that inflation accelerated partly due to the oil shocks, the consensus among academics is that the main cause of the Great Inflation was actually excessive monetary easing. In Japan, the main reason for the acceleration in inflation was the 25-30 percent annualized increase in money supply from the end of 1970 through 1973, before the first oil shock occurred in October 1973.6 In fact, inflation rates during the Great Inflation for both the United States and Japan show that prices of items other than energy, including for services, had increased considerably, indicating that the main cause of inflation was not a rise in energy prices (Chart 10). Contrary to popular belief, the reality of the Great Inflation was that demand-pull factors played a greater role than cost-push factors. In the first half of the 1970s, when Japan experienced the Great Inflation, nominal wages increased significantly, at a pace even faster than that of prices, and inflation expectations also rose (Chart 11).7
Third, while various hypotheses have been proposed as to the causes of the excessive monetary easing, including errors in the real-time measurement of the output gap, disagreements among policymakers, and political motives, the prevailing hypothesis is that there was no theoretical agreement on inflation expectations or that the role of monetary policy in the formation of inflation expectations was not fully recognized.8 Central banks at the time did not share the view that monetary easing and the rise in inflation expectations under such easing were the main causes of inflation.9
Central banks' responses today are based on the lessons of this era; that is, monetary policy is important for price stability, central banks are responsible for conducting such policy, and inflation expectations play a major role in sustaining inflation. These lessons have led central banks to try to conduct their policies in a way that influences and stabilizes expectations. It is no exaggeration to say that inflation targeting, under which central banks conduct monetary policy based on a price stability target, was born from the experience of the Great Inflation.
Taking the aforementioned lessons into account, the Bank's monetary policy is aimed at achieving the price stability target of 2 percent. What is important here is the sustainability and stability of inflation. As I have already mentioned, in order to achieve the target in a sustainable and stable manner, it is extremely important to determine underlying inflation. In addition, it is necessary to carefully analyze the economic developments behind price developments.
Two major factors affecting underlying inflation are wage inflation and inflation expectations. For prices to rise in a sustainable and stable manner, wages and inflation expectations need to increase.
In an international and historical context, the interaction between prices and wages has been observed both in Japan and the United States (Chart 12). However, this interaction seems to have changed in Japan in recent years. Specifically, while the causality from prices to wages remains, that from wages to prices seems to have almost disappeared.10 It can be said that there are still scarring effects of prolonged deflation on the economy.
However, while much emphasis tends to be placed on clarifying whether prices precede wages or vice versa and the causal relationship between the two, what is important is creating an environment in which both prices and wages rise. Firms that are cautious about raising wages, including base pay, seem to have a variety of reasons, such as poor performance, concerns that once they raise wages, they will not be able to lower wages in the event of future poor performance, and a lack of confidence that economic conditions will improve. All of these reasons suggest that it is necessary for the economy to see sustainable growth in order for wages to increase.11
The other major factor affecting underlying inflation is inflation expectations, which have risen both for the short term and the medium to long term. However, as we have already seen, medium- to long-term inflation expectations have risen only moderately and have not yet reached 2 percent.
Most prices have not yet risen much, while some energy and food prices have risen significantly. Although it is possible to some extent that higher energy and food prices will push up prices overall, low inflation is currently coexisting with price increases in some items.12 In policymaking, it is generally considered desirable to have the same number of policy measures as policy objectives. This means that, to address low inflation, it is necessary to persistently continue with monetary easing and thereby continue to steadily support the virtuous cycle in the economy and maintain an environment in which wages rise. In addition, if downside risks to the economy materialize, the Bank should not rule out taking the necessary additional easing measures without hesitation.
On the other hand, since the price rises in energy and food are mainly caused by cost-push factors from abroad, it is desirable to respond to them through measures other than monetary policy, which is aimed at managing aggregate demand. Possible options include fiscal policy and energy policy to reduce dependence on petroleum and natural gas. Such appropriate division of labor in policymaking is required to deal with low inflation and price increases in some items.
Lastly, as caveats to conducting monetary policy, let me note common challenges that central banks around the world now face. As the experience of the Great Inflation indicates, it is not easy to identify developments in the output gap and determine underlying inflation in real time. Moreover, if inflation rises far beyond the price stability target due to spiraling wages and inflation expectations, undesirable inflation will persist. The experience of the Great Inflation also led to the revision of the traditional theories. I think that it is necessary to constantly reexamine, without any preconceptions, whether the current situation can be explained and analyzed with the current theory of monetary policy.
Next, I would like to talk about the economy of Okayama Prefecture. The prefecture is characterized by a relatively higher share of the manufacturing industry, but at present its economy has seen more or less the same developments as Japan's economy that I mentioned earlier. That is, although downward pressure on services consumption from COVID-19 and the effects of supply-side constraints such as semiconductor shortage continue to be observed, private consumption and production have been on a pick-up trend amid ongoing social and economic activities.
Like other regional economies in Japan, the significant challenge Okayama Prefecture has to address from a medium- to long-term perspective is a declining and aging population. However, I have long asserted that the negative impact of this factor has been overestimated in economic debates. In Okayama Prefecture, gross prefectural product per capita has been on an uptrend (Chart 13).13 I also believe that, to achieve economic growth in this situation of a declining and aging population, the starting point would be to make the region more attractive in terms of livability for residents. From this perspective, I would like to highlight three points with regard to the strengths and expectations for Okayama Prefecture.
The first is the prefecture's wealth of cultural value. The Kurashiki Bikan Historical Quarter has the long-standing Ohara Museum of Art. I am aware that the Okayama Culture Zone in Okayama City's center, with its cluster of cultural facilities, will be hosting the Okayama Art Summit this year and adding a new performing arts theater next year. Meanwhile, a new pavilion has been built using cross-laminated timber (CLT) in the northern part of the prefecture, on the Hiruzen highlands, which are blessed with natural abundance. In addition to the permanent exhibition of the modern art collection, the Setouchi Triennale art festival is being held this year across the islands that dot the Seto Inland Sea to the south of the prefecture. Okayama Prefecture has also long been a major transportation hub, and historic townscapes in various areas like Katsuyama, Yakage, Fukiya, and Tsuyama have been preserved as places where people still live. Such proximity to cultural value enriches the lives of residents and attracts prospective residents. Enhancing the competitiveness of its tourism resources is expected to bring more visitors to the prefecture.
The second point concerns the prefecture's education and healthcare. Okayama Prefecture boasts a robust educational and medical care infrastructure, as seen in the fact that it has one of the highest per capita numbers of universities, junior colleges, and major hospitals in Japan. In a society with a declining and aging population, the hope is that the prefecture will make the most of such a robust infrastructure from an economic perspective through greater collaboration between industry and academia and a strong healthcare network, leading to developing and securing human resources for firms in the region and extending the healthy life expectancy of residents. In the area of healthcare, Kibichuo Town has been designated as a rural digital health special zone. It has the potential to become a model case for approaches that use digital technology to address health and medical issues in the community.
The third point concerns initiatives to increase sustainability in the region. Livability depends to a large extent on a society's sustainability. While the manufacturing industry is the economic driver in Okayama Prefecture, with its Mizushima Coastal Industrial Zone, a transition to a decarbonized society is likely to affect the competitiveness of the industry. It is important to see this as an opportunity for innovation and new business creation rather than as simply a constraint on economic growth. I heard that the Okayama Consortium for Regional Decarbonization Creation is positioned to support regional decarbonization efforts through cooperation among those in industry, academia, government, and finance. My hope is that this will lead to revitalization of the prefectural economy.
As mentioned at the beginning of this speech, the Bank's Okayama Branch marked its 100th anniversary in April. The Bank will endeavor to contribute to economic developments in Okayama Prefecture by continuing to conduct central banking operations on the front lines of the region while exchanging views with our counterparties and contacts in the region.
Low inflation is currently coexisting with price increases in some items. Since this low inflation is connected to low wage inflation, it is necessary for the Bank to continue with monetary easing to stimulate the economy and thereby realize a virtuous economic cycle where an increase in income leads to that in spending. In addition, it is extremely important to determine the sustainability and stability of inflation. Although the rate of change in the CPI reached 2 percent for April, if this lasts only about six months to a year, the price stability target of 2 percent cannot be said to have been achieved in a sustainable and stable manner. It is necessary to carefully assess underlying inflation by examining various price measures, including the price change distribution, the trimmed mean, and the mode, while paying close attention to factors affecting underlying inflation; namely, developments in the output gap, wage inflation, and medium- to long-term inflation expectations. In addition, to help the public gain a better understanding of monetary policy, the Bank decided to present an outline of the Outlook Report in an easier-to-understand manner from this May (Chart 14).14 The European Central Bank and the Bank of England have already introduced this kind of communication strategy, and the Bank has followed their attempt. I hope this will encourage the public to have a better understanding of and greater interest in developments in Japan's economic activity and prices as well as monetary policy.