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Statement by Toshihiko Fukui, Governor of the Bank of Japan, concerning the Bank's Semiannual Report on Currency and Monetary Control

before the Committee on Financial Affairs, House of Representatives, on March 10, 2006

April 7, 2006
Bank of Japan



The Bank of Japan submitted its Semiannual Report on Currency and Monetary Control for the first half of fiscal 2005 to the Diet in December 2005. I am pleased to have this opportunity to present an overall review of the Bank's conduct of monetary policy. At the Monetary Policy Meeting (MPM) held on March 8 and 9, 2006, the Bank decided to terminate the quantitative easing policy and shift the operating target of money market operations from the outstanding balance of current accounts at the Bank to a short-term interest rate, namely, the uncollateralized overnight call rate. Today, I will explain recent developments in economic activity and prices, which are the background to the decisions, and the Bank's conduct of monetary policy.

I. Developments in Japan's Economy

Japan's economy continues to recover steadily.

Exports and industrial production have continued to increase. Business fixed investment has continued to increase against the background of high corporate profits. In the household sector, household income has been rising moderately, as the number of employees has been increasing and wages have picked up. With this improvement in the employment and income situation, private consumption has become solid.

Looking forward, exports are expected to continue rising against the background of the expansion of overseas economies. Domestic private demand is likely to continue increasing reflecting high corporate profits and the moderate rise in household income, while structural adjustment pressure, such as the excess debt of firms, has almost dissipated. Given that an environment in which a virtuous cycle can start operating has been established with the recovery both in domestic and external demand and in the corporate and the household sectors, the economy is likely to experience a sustained recovery. Nevertheless, risk factors such as the continuing surge in crude oil prices and its possible effect on overseas economies should continue to be monitored closely.

The environment for prices has become favorable reflecting the continuing economic recovery. The year-on-year rate of change in the consumer price index (CPI; excluding fresh food, on a nationwide basis) has turned slightly positive since November 2005 and recorded a relatively clear increase in January 2006. The output gap is gradually narrowing, and unit labor costs generally face weakening downward pressures. Furthermore, firms and households are shifting up their expectations for inflation. In this environment, year-on-year changes in the CPI are expected to remain positive. Meanwhile, domestic corporate goods prices have increased on a year-on-year basis mainly reflecting the rise in international commodity prices, and are expected to continue increasing.

On the financial front, the environment for corporate finance is becoming more accommodative on the whole. The lending attitude of private banks is becoming more active and the decline in credit demand in the private sector is coming to a halt. Under these circumstances, the year-on-year rate of increase in the amount outstanding of lending by private banks, after adjusting for the liquidation of loans and loan write-offs, has been accelerating since August 2005 when the year-on-year rate of change turned positive.

II. Conduct of Monetary Policy

In March 2001, with a view to preventing a sustained decline in prices and preparing the basis for sustainable growth, the Bank introduced the quantitative easing policy. The Bank had supplied extremely ample liquidity under this policy, with the current account balance at the Bank as the main operating target. It also made a clear commitment to maintain the policy until the CPI (excluding fresh food, on a nationwide basis) registers stably zero percent or an increase year on year. The Bank had maintained firmly the policy according to this commitment for about five years.

Under such circumstances, Japan's economy has improved considerably and continues to recover steadily. Concerning prices, year-on-year changes in the CPI have turned positive and are expected to remain so.

Given the improvement in economic and price conditions, at the MPM held on March 8 and 9, 2006, the Bank decided to terminate the quantitative easing policy and shift the operating target of money market operations from the outstanding balance of current accounts at the Bank to the uncollateralized overnight call rate. The Bank also introduced a new framework for monetary policy conduct, including clarification of its thinking on price stability with a view to ensuring the continued transparency of monetary policy.

Specifically, the Bank decided to set the following guideline for money market operations for the intermeeting period: The Bank of Japan will encourage the uncollateralized overnight call rate, which is the operating target of money market operations, to remain at effectively zero percent. Given that the effects of short-term interest rates being zero had already become the main effect of the quantitative easing policy on economic activity and prices, there will be no abrupt change as a result of the policy decision. On the future path of monetary policy, there will be a period in which the overnight call rate is at effectively zero percent, followed by a gradual adjustment in the light of developments in economic activity and prices. In this process, if it is judged that inflationary pressures are restrained as the economy follows a balanced and sustainable growth path, an accommodative monetary environment ensuing from very low interest rates will probably be maintained for some time.

The Bank also decided to introduce a new framework for the conduct of monetary policy. Three elements underlie the new framework. First, the Bank will review its basic thinking on price stability, and disclose a level of inflation rate that its Policy Board members currently understand as price stability from a medium- to long-term viewpoint, in their conduct of monetary policy. Second, the Bank will examine economic activity and prices from two perspectives: examining economic activity and prices one to two years in the future; and examining, in a longer term, risk factors that are most relevant to the conduct of monetary policy. And third, the Bank will, in the light of deliberations from the two perspectives just described, outline the current view on monetary policy and disclose it periodically.

Under the new framework, the Bank will continue to conduct monetary policy appropriately in a highly transparent manner and contribute to sustainable economic growth with price stability.