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On Price Stability

October 13, 2000
Bank of Japan

Preface

Price stability is an indispensable prerequisite for a market economy to function smoothly.Indeed, as witnessed by experience in various countries during the past several decades, if price stability is impaired, sustainable economic growth is hampered by ensuing inflation or deflation.Against such a background, the view that monetary policy should contribute to sustainable economic growth through price stability has come to be generally accepted worldwide.In the context of Japan, the new Bank of Japan Law, effected in April 1998, states that "currency and monetary control shall be aimed at, through the pursuit of price stability, contributing to the sound development of the national economy."

As the importance of price stability in the conduct of monetary policy has become widely recognized, central banks are urged more than ever to explicitly define what price stability means and to clarify how monetary policy achieves it.In response, central banks in various countries have been making strenuous efforts to answer these questions with the view to enhancing transparency of the conduct of monetary policy.Measures that central banks have taken to enhance transparency vary from country to country, depending on the economic situation, historical setting, and institutional framework.For example, some make public the minutes of policy-making meetings and the assessment of the economic and financial outlook, while others adopt inflation targeting.

Since the enactment of the new Bank of Japan Law, the Bank of Japan has actively effected measures to enhance transparency of the conduct of monetary policy by, for example, releasing the minutes of Monetary Policy Meetings and the "Bank's View" of economic and financial developments.At the Monetary Policy Meeting of March 8, 2000, Policy Board members agreed to initiate an in-depth study of issues related to price stability from the viewpoint of enhancing transparency of the conduct of monetary policy.Based on various studies including ones newly undertaken by the Bank's staff, they examined the following issues:

  • Being a prerequisite for "the sound development of the national economy", what is price stability in concrete terms?Is it possible to express price stability in terms of a specific numerical value of a price index?If so, what would it be?
  • What criteria can we use to judge whether or not price stability is maintained?
  • How can monetary policy achieve price stability?In the process of achieving price stability, what should be done to enhance transparency in the conduct of monetary policy?

This report summarizes the results of the discussions of Policy Board members on the above issues, and was approved at the Monetary Policy Meeting of October 13, 2000.Needless to say, issues related to price stability are wide-ranging and complex.There are still many unresolved issues from the viewpoint of economic theory as well as problems in the compilation of price indexes.Furthermore, since Japan's economy is currently experiencing dramatic structural change, it may well be the case that the answers will gradually change in line with the development of the economic environment.Therefore, with this report as one important step, the Bank of Japan will continue examining issues related to price stability.

Masaru Hayami
Governor, Bank of Japan

Summary

  1. Price stability is important for the stability of national life and is an indispensable prerequisite to ensure sustainable development of the economy.As stated in the new Bank of Japan Law, the aim of the Bank of Japan's monetary policy is to contribute to the sound development of the national economy through the pursuit of price stability.
  2. Price stability, a situation neither inflationary nor deflationary, can be conceptually defined as an environment where economic agents including households and firms can make decisions regarding such economic activity as consumption and investment without being concerned about the fluctuation of the general price level.
  3. Based on the above conceptual definition, members of the Policy Board of the Bank of Japan have discussed whether it is possible to express price stability by specific numerical values.In the discussions, the following points were noted:
    • Price indexes entail bias, but it is not easy to obtain a reliable estimate of the magnitude of bias.Furthermore, the magnitude can vary.
    • Considering that nominal interest rates cannot be reduced below zero, monetary policy should be conducted carefully with due attention given to preventing the economy from falling into a deflationary spiral.From such a viewpoint, it is worthwhile examining a policy whereby the central bank conducts monetary policy aiming at a small but positive measured inflation rate.
    • The conduct of monetary policy may change depending on whether price fluctuation is due to demand-side or supply-side factors.
    • In light of experience during the bubble period, fluctuation in asset prices may have a big impact on the economy even though measured price indexes are stable.
  4. Bearing in mind the above points, Policy Board members have examined the past development of prices in Japan.They have observed that (1) low inflation in the 1990s largely reflected weak demand amid the economic slowdown, and (2) such supply-side factors as technological innovation, deregulation, intensification of global competition, and the distribution revolution have more recently put additional downward pressure on prices.
  5. Following intensive discussions, Policy Board members have reached the following conclusions with regard to a quantitative definition of price stability:
    1. (1) In view of the current movement of prices in Japan, an inflation rate which is consistent with the sound development of the economy is likely to be lower in the short term than in the long term.
    2. (2) If some numerical values are adopted as the definition of price stability, they are expected to be valid for a very long period of time.In view of the current development of prices in Japan, it is difficult to set specific numerical values to the definition of price stability that are consistent with the sound development of the economy.Furthermore, even if some numerical values were announced, they would not serve as a reliable guidepost in the conduct of monetary policy, and the exercise would not likely contribute to enhancing transparency of the conduct of monetary policy.Therefore, it is not deemed appropriate to define price stability by numerical values.
    3. (3) While paying due attention to changes in the economy, the Bank of Japan will nevertheless continue to explore whether price stability can be expressed by some numerical values.
  6. Policy Board members have concluded that while it is not appropriate to express price stability in terms of numerical values, it would be feasible and useful to disclose the viewpoints from which they judge price stability, which are:
    • Characteristics of price fluctuations in light of various indexes related to prices
    • The sustainability of price stability
    • Consistency with the sound development of the economy
  7. To enhance transparency of the conduct of monetary policy, the Policy Board plans to regularly issue Outlook and Risk Assessment of the Economy and Prices, which will give an assessment of price movements from the above three viewpoints.It includes "Forecasts of Policy Board Members" with respect to the outlook for inflation and economic growth.