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on May 19, 1998(English translation prepared by the Bank staff based on the Japanese original)
June 30, 1998
Bank of Japan
A Monetary Policy Meeting of the Bank of Japan Policy Board was held in the Head Office of the Bank of Japan in Tokyo on Tuesday, May 19, 1998, from 9:00 a.m. to 11:58 a.m., and from 12:50 p.m. to 4:10 p.m.1
Policy Board Members Present
Mr. M. Hayami, Chairman, Governor of the Bank of Japan
Mr. S. Fujiwara, Deputy Governor of the Bank of Japan
Mr. Y. Yamaguchi, Deputy Governor of the Bank of Japan
Mr. Y. Gotoh
Mr. S. Taketomi
Mr. T. Miki
Mr. N. Nakahara
Ms. E. Shinotsuka
Mr. K. Ueda
Government Representatives Present
Mr. S. Nakamura, State Secretary for Finance, Ministry of Finance 2
Mr. T. Shioya, Director General of the Coordination Bureau, Economic Planning Agency
Mr. A. Nagashima, Executive Director
Mr. J. Yonezawa, Executive Director
Mr. I. Kuroda, Executive Director
Mr. I. Yamashita, Director, Financial Markets Department
Mr. M. Sugita, Director, International Department
Mr. M. Matsushima, Director, Research and Statistics Department
Mr. K. Yamamoto, Chief Manager, Planning Division 1, Policy Planning Office
Secretariat of the Monetary Policy Meeting
Mr. T. Mitani, Director, Secretariat of the Policy Board
Mr. S. Watanabe, Secretariat of the Policy Board
Mr. K. Momma, Manager, Policy Planning Office
The Policy Board discussed and approved unanimously the minutes of the Monetary Policy Meeting held on April 9, 1998, for release on May 22.
Market operations in the period since the previous meeting on April 24, 1998 were conducted in accordance with the guideline decided at the meeting, which was to encourage the uncollateralized overnight call rate to remain on average slightly below the official discount rate.
When overnight rates showed signs of a rise from the end of April to early May reflecting heightened demand for funds for long weekends including national holidays, the Bank conducted morning operations to supply excess reserves in the market. As a result, the rates stabilized at around 0.45 percent. After the long weekends, the return of banknotes to the Bank and anticipation of additional monetary easing temporarily pushed the overnight rates down below 0.4 percent. To contain this fluctuation, the Bank conducted morning operations to neutralize these factors or in some cases to create a shortage of reserves in the market. As a result of these operations, the uncollateralized overnight call rate in the previous reserve maintenance period (from April 16 to May 15) settled at an average of 0.43 percent. In the last few days, however, the Bank again conducted operations to provide excess reserves to hold down upward pressure on the overnight rates reflecting intensified turbulence in Indonesia.
The Bank's forecast of money market conditions for the immediate future was that there would be no significant excess or shortage of reserves. The Bank would therefore conduct flexible market operations using CP operations and bond-borrowing ("repo") operations to supply reserves and bill-selling operations to absorb reserves, based on careful assessment of the market conditions.
During the intermeeting period, interest rates on term instruments declined gradually to a level close to that of November 1997, reflecting such factors as growing anticipation of further monetary easing based on a weakening of economic indicators.
In the period since the previous meeting, the yen depreciated gradually against the U.S. dollar, with some fluctuation. The yen recently moved in the 136-137 yen range, a level previously marked in September 1991. The depreciation mainly reflected the interest rate differential between Japan and the United States, which resulted from the difference in economic fundamentals. The decline also seemed to have been propelled by (1) a weakening of other East Asian currencies reflecting the instability in Indonesia, and (2) diminishing market anticipation of foreign exchange intervention following the Birmingham Summit, which did not put forward any new measures to prevent the yen from depreciating further. The foreign exchange markets took little notice of the expansion in Japan's current account surplus in the January-March quarter, which reached 3 percent of nominal GDP. The yen also weakened against the deutsche mark to the 76-77 yen range, a level seen previously in February 1993.
During the same period, the values of other East Asian currencies declined in general. In particular, the Indonesian rupiah plunged amid the anti-government rioting. With this appreciation of the yen against other East Asian currencies offsetting the yen's depreciation against the U.S. dollar and the deutsche mark, the effective exchange rate of the yen was more or less unchanged. As for other currencies, the Russian ruble had fallen sharply recently.
In the United States, the economy showed no signs of a slowdown despite declines in net exports. Real GDP in the January-March quarter marked an annual 4.2 percent growth from the previous quarter reflecting continued strength in domestic demand, particularly in household spending. A view prevailed that economic growth would decelerate in the April-June quarter to somewhere between 2 and 3 percent, due to continued declines in net exports, adjustment of inventory that accumulated in the January-March quarter, and deceleration of business fixed investment. Labor indicators in general remained strong, and the unemployment rate was at a low 4.3 percent. Prices, however, had been stable on the whole. Growth of money supply accelerated further due to expansion in bank credit and active trading in the stock market. With regard to climbing stock prices, alarm had been raised outside the United States that the market was overheating, but inside the country, an argument persisted that the development could be justified by increased productivity.
Turning to Europe, a moderate economic recovery continued in Germany. The French economy also remained on a recovery path, spurred by private consumption and industrial production. In the United Kingdom, there were signs of an economic slowdown, especially in net exports and private consumption. The labor market remained tight, however, as the unemployment rate declined and wages increased, and this had rekindled expectation that the Bank of England would raise interest rates.
In East Asia, economic adjustments continued. The current account balances of Thailand and Korea started to improve reflecting moderate recoveries in exports, which were in part supported by the depreciation of their currencies. The development of instability in Indonesia, however, posed concerns. It was uncertain whether Indonesia would be able to satisfy by the end of June the conditions for continued financial support imposed by the International Monetary Fund (IMF), such as a raising of energy prices. What effects the riots would have on economic activity were another source of uncertainty. While there were various views as to the influence of developments in Indonesia on neighboring countries, there was a general concern about the impact on Korea, a large creditor of and investor in the country. Turning to China, economic growth continued to slow while the trade balance continued to run a surplus.
With respect to final demand, public-sector investment seemed to have bottomed out and deterioration in household expenditure appeared to have slowed. Exports declined, however, hit by ongoing economic and financial adjustments in other Asian countries. Business fixed investment continued to decrease. Reflecting such weak final demand, inventory accumulated further and industrial production continued to decline. As a result, corporate profits were decreasing and deterioration in employment and income conditions was becoming more conspicuous. Thus, production, income, and expenditure continued to interact negatively, placing strong downward pressure on overall economic activity.
As for the outlook, adjustment in business fixed investment was likely to continue, and accordingly, there was little prospect in the immediate future of a notable recovery in private final demand. Inventory adjustment was likely to persist in a wide range of industries, and this was expected to continue squeezing corporate profits. In these circumstances, the government decided to implement a comprehensive economic package with expenditures totaling more than 16 trillion yen, and submitted the necessary fiscal 1998 supplementary budget bill to the Diet. If the bill was passed, favorable effects could be expected to materialize gradually from summer into the latter half of the fiscal year and alleviate the downward pressures on the economy. An estimation had shown that the package would boost real GDP growth in fiscal 1998 by 1.0-1.5 percent, even when the effects of measures that were difficult to quantify were excluded, such as the effects of promoted land transactions and loan securitization, support for small and medium-sized firms, and employment policy. It was still uncertain, however, whether it would shore up corporate and household confidence, and thereby lead to a self-sustained economic recovery driven by the private sector.
With regard to prices, developments in the immediate future were likely to be weak, affected by endogenous downward pressure from the expanding output gap. The increase in the output gap, however, was expected to slow in the second half of fiscal 1998 as the comprehensive economic package was implemented. Thus, the risk of the economy falling into a deflationary spiral had been reduced by the announcement of the package.
In the financial markets, money market interest rates on term instruments declined more rapidly from late April, falling recently to around 0.6 percent, which was close to the level prevailing before mid-November 1997. Long-term interest rates also declined on the whole. While the yield differential between private-sector bonds and government bonds had remained relatively large since autumn of last year, a further decrease in government bond yields was bringing about a decrease in overall long-term interest rates including private-sector bond yields. Meanwhile, stock prices had been softening since mid-April. These developments indicated that the market concern about credit risk was almost unchanged, and that anticipation of further monetary easing had emerged against the background of persistently weak economic outlook.
With respect to monetary aggregates, the average amount outstanding of private bank lending (of city banks, long-term credit banks, trust banks, regional banks, and regional banks II) posted a sharper fall in April than in previous months. Although the decline might have been amplified by the massive loan write-offs and reduction of loan assets at the end of the accounting term on March 31, it was apparent that private bank lending remained sluggish. This seemed attributable to the continued cautious lending attitude of banks aiming to improve their medium-term profitability and financial soundness, as well as a further contraction of financing demand reflecting sluggish economic activity. In fact, growth in financing by private firms, including that through capital markets, showed a significant slowdown. Reflecting the above developments, the growth in M2+CDs decelerated. Under these circumstances, the difference in fund-raising costs according to firms' creditworthiness remained relatively large. This indicated a strong possibility that some firms, especially small and medium-sized firms, faced difficult financing conditions. It was considered that the influence of this situation on the economy should be monitored carefully.
In the Board's discussion of the current economic situation, one of the focal points was the assessment of developments in private consumption, which had deteriorated rapidly since autumn 1997, and of the closely related developments in employment and income conditions. The majority of the members pointed out that although some indicators suggested that private consumption had stopped deteriorating, many elements injected uncertainty into the assessment of private consumption. They agreed that, in particular, developments in household expenditure should be evaluated cautiously in view of the recent worsening of employment and income conditions. Comments made included the following.
With regard to other aspects of final demand, several members referred to declines in exports and business fixed investment. The members shared the view that reflecting weak final demand, inventory was piling up and industrial production was sliding, and thus the negative interaction between production, income, and expenditure persistently placed strong downward pressure on economic activity.
One member raised concern about the strength of the downward pressure. Coincident indicators showed that economic activity had fallen to the 91-92 level from the peak of 100 around May 1997, and this steep decline was similar to the pace of adjustment following the collapse of the "bubble" economy, which peaked in February 1991. A few other members commented that there did not seem to be any signs of the economy bottoming out.
The Board then discussed the economic outlook taking into account the scale and content of the comprehensive economic package announced formally after the previous meeting on April 24.
Many of the members commented that if the necessary supplementary budget was passed by the Diet, the comprehensive economic package, the largest ever, could be expected to produce effects gradually from the summer and thereby alleviate the downward pressure on the economy. One member expressed the view that positive indicators could not be expected until summer considering the current level of inventory. However, the implementation of the package would likely contain the downward momentum of the economy in the autumn, mainly in sectors most influenced by increased public-sector investment. Another member was of the opinion that the favorable outcomes of the package from the summer would prevent industrial production from decreasing further after dropping significantly in the April-June quarter. A different member pointed out that final demand decreased substantially in the second half of fiscal 1997, and due to a resulting deterioration in production and income, the economy was now entering a second contraction phase. However, as the second round of decline is usually less severe than the first, and this one would be countered by favorable effects from the economic package, the member considered that there was no need to be pessimistic about the economic outlook for the immediate future. Another member emphasized that the package would have sizable effects, even by modest estimates which excluded the effects of measures that were difficult to quantify, such as promotion of land transactions and loan securitization. Therefore, there was some prospect of the economy bottoming out in another two or three quarters and heading toward a moderate recovery.
The members agreed, however, that even if the downward momentum was successfully contained, it was difficult to judge whether the economy would subsequently resume a self-sustained recovery led by private demand. One member expressed little optimism about the package's ability to significantly boost private demand considering the adjustment in business fixed investment, which seemed to have started in autumn 1997, and the recent further deterioration in employment conditions. Another member considered that with the economy in the adjustment phase of a 10-year business fixed investment cycle which peaked in February 1991, and in view of an estimation that there was a 30-trillion-yen output gap, it was uncertain whether a stimulus package of 16 trillion yen would lead to a self-sustained economic recovery. A few members pointed out that the current sluggishness in private demand could be due to pessimistic views about the long-term economic outlook. Therefore, in order for private demand to lead the economy onto a recovery path, appropriate measures should be taken with regard to the tax system, social security system, and nonperforming-asset problem. Further, some members suggested that a persistent risk to the economy, even with the implementation of the comprehensive economic package, would be prolonged adjustments in other Asian economies, which could exert negative impacts on Japan's economy through various channels, such as a deterioration of household sentiment and an increase in nonperforming loans of financial institutions.
Members also referred to the risk of the downward pressure on the economy intensifying before the effects of the package materialized. One member commented that various reasons could be considered as to why the stock markets gave little credit to the package (discussed later), but regardless of the reason, the Board should be aware of the possibility that sluggish stock prices would negatively affect economic activity. The same member pointed out that the financial system remained vulnerable, and in this situation, there was a risk that any significant shocks would give rise to market disruption again.
Members also deliberated on the risk of the economy falling into a deflationary spiral based on recent price developments. One member stressed that the rapid slowdown of economic activity, the downward trend in wholesale prices, and the recent deceleration in money supply growth pointed to the possibility that the economy would fall into a typical deflationary spiral in the near future, or that it was already experiencing one. Another member pointed out that the recent fall in prices was due to reduced demand, while the price decline in 1995 was considered to reflect firms' efforts to reduce costs and develop new products under pressure from large differentials between domestic and overseas prices. In addition, corporate profits were decreasing. In view of these developments, the member considered that the economy was on the verge of a deflationary spiral. The same member also argued that the projection of corporate profits for fiscal 1998 displayed in the March Tankan survey was too optimistic. For the 357 firms that had already published their financial statements for fiscal 1997, net income for the term had dropped by 30 percent from the previous year. According to this member, profits in the first half of fiscal 1998 were likely to decline still further considering the continued deterioration in business conditions.
The majority of the members, however, emphasized that the risk of the economy going into a deflationary spiral in the immediate future had been reduced due to the announcement of the comprehensive economic package. One member pointed out that the recent declines in domestic wholesale prices and in the prices of consumer goods reflected falls in international commodity prices as well as a large domestic output gap. The member commented that the comprehensive package, by preventing the output gap from expanding further, would manage to avert a deflationary spiral. Another member commented that a deflationary spiral could be avoided if people's confidence in the economic outlook improved as the effects of the package gradually materialized, even though there would not be a significant narrowing of the output gap in the next two to three months. A different member remarked that it was unlikely that the recent price declines would translate into a full-fledged deflationary spiral in view of the results of the March Tankan survey, which forecasted that the current profit-to-sales ratio in fiscal 1998 would be at the average level of the past, although, as mentioned earlier by another member, there was a need to examine carefully whether the survey results were too optimistic.
Despite these comments, the members generally shared the view that it was necessary to watch price developments closely, because it was highly likely that the weak trend would continue. One member commented that the fall in import prices, one factor causing the domestic price decline, could have a positive influence on corporate profits, but required attention as the weakening of international commodity prices was due to deteriorating market conditions in the Asian economies as a whole, including Japan. The same member also pointed out that although it was often said that price decreases in electric machinery were the fruit of improved productivity, there was no clear evidence that productivity had increased recently. The member suggested that the decreases might in large part be due to sluggish demand.
One of the features of a deflationary spiral is an uncontrolled rise in real interest rates resulting from price declines occurring when there is limited room for reductions in nominal interest rates. With this in mind, the members also deliberated on the recent level of real interest rates. One member pointed out that real interest rates calculated from the consumer price inflation rate had increased somewhat reflecting a narrowing rate of increase in consumer prices, but were still low compared with the levels of 1992 and 1993. By contrast, another member argued that real interest rates should be calculated based on the expected inflation rate, in which case there may well be a calculation error of approximately 1 percent either way. According to this member, a fall in the expected inflation rate would create a larger upward risk to real interest rates now than it would have in 1992 and 1993, as there was currently little room to reduce nominal interest rates, already close to 0 percent. In 1992 and 1993, it was possible to hold down increases in real interest rates by lowering nominal interest rates, which were at a higher level.
In the discussion on financial market developments, members focused on the long-term interest rates and stock prices, both of which generally remained at low levels despite the announcement of the comprehensive economic package. One member gave three possible explanations for the sluggish response to the package in the stock market.
The member elaborated that if the first assumption were correct, future releases of favorable indicators would bring about a rise in stock prices. The member, however, considered that perhaps all three factors were contributing to the weak response. Another member pointed out that the Nikkei 225 Stock Average had dropped from its peak of close to 39,000 yen to a bottom of 14,000 yen, and since then had rarely recovered even one third of this decline. Should business failures increase significantly amid such medium-term sluggishness, it could not be denied that one undesirable consequence might be a further fall in stock prices.
On the recent conspicuous declines in interest rates on term instruments and long-term interest rates, one member commented that they reflected sluggish demand for funds and growing market anticipation of prolonged monetary easing. Another member pointed out that the lower long-term interest rates were flattening the yield curve, which could be indicating a strengthening of the market's deflationary expectations amid a lack of indications of an economic upturn. A different member argued that although it was certain that the long-term interest rates decreased in reflection of the weak economic condition, such autonomous working of the market mechanism would have the effect of supporting the economy.
This member commented that the recent decline of the yen in foreign exchange markets could, like the reduction in long-term interest rates, be regarded as an autonomous working of the market mechanism to support the economy. Another member was in favor of this argument. However, one member pointed out that although a depreciation of the yen might have a favorable impact on Japan, it was necessary to bear in mind the negative effects it could have on other countries, especially on other Asian countries faced with unstable economic conditions.
With regard to monetary aggregates, many members referred to the recent weak developments in lending by private financial institutions and money supply growth. One member expressed concern that if the recent deceleration of money supply growth, considered to be a leading indicator of economic activity, was overlooked, it might negatively affect the economy. Another member commented that the underlying trend of M2+CDs was hard to grasp as it was influenced by a shift of funds from investment trusts to deposits. The member, therefore, focused on the growth of broadly defined liquidity, which had been unaffected by this shift, and expressed concern about how it had followed a downward trend since mid-1997, and then further fallen considerably this April. Another member emphasized the need to give careful attention to the difference in financing conditions faced by various firms, specifically the severe conditions faced by small and medium-sized firms, in addition to the above-mentioned monetary aggregate figures.
Based on the Board's assessment of current economic and financial developments, the members discussed the basic thought behind monetary policy for the immediate future.
With regard to a raising of interest rates, a member emphasized that the central bank should manage monetary policy from a macroeconomic viewpoint despite arguments that advocated the policy action focusing particularly on depositors and pensioners. Another member stressed that the current conditions precluded the possibility of increasing interest rates, as it would have adverse impacts on the real estate, construction, and financial industries and on employment in general. Further, a member expressed strong anxiety that higher interest rates could have a downward influence on asset prices or could lead to intensified concerns about the stability of the financial system. Thus, all of the members shared the view that at present, raising interest rates was not a subject for further discussion.
With respect to a reduction of interest rates, all of the members remained hesitant about taking action immediately, although they agreed to continue to consider the policy move depending on the economic and financial developments in the future.
Some members pointed out that various downside risks to the economy remained despite an increased possibility that the downward momentum would be contained by the implementation of the comprehensive economic package. These members, therefore, considered that they should leave room for further monetary easing in case of emergencies. There was also the observation that the Board could still afford some time to evaluate the scope of the deflationary risk. Commenting from a different perspective, a few members considered that the stabilization of interest rates on term instruments and the decline in long-term interest rates had essentially produced some kind of monetary easing effects in the markets. Accordingly, the need for the Bank to take monetary policy action to further ease monetary conditions had been reduced. It was also pointed out that if the Bank was to lower interest rates, the effects would be best drawn out if the action was taken in coordination with the comprehensive economic package, following the passage of the fiscal 1998 supplementary budget. Another member called to attention a view that although a lowering of interest rates would contribute to decreasing firms' funding costs, it could also adversely affect household confidence.
In the course of this discussion, which pointed to continued cautiousness about a further reduction of interest rates, at least in the immediate future, some members referred to other possible ways of monetary easing. One member suggested that, in view of the government's decision of a large-scale economic package and its firm stance on the financial system problem, the Bank should consider reducing the reserve requirement ratios as one possible measure, as it might contribute to a recovery in corporate and household confidence. Another member argued that an expansion of government bond-buying operations should be considered in view of its positive effects on monetary aggregates, rather than lowering the reserve requirement ratios, which might have a side effect on smooth money market operations. Following this discussion, a few members remarked that although a conclusion could not be reached at this point, it might be useful to give further thought to various policy options in case it became necessary to implement additional monetary easing.
One member suggested that it might be desirable to encourage the overnight call rates to move around the lowest possible level under the current policy stance, paying careful attention to the market's reaction.
Many members emphasized the importance of promptly solving the problems in the financial system, an issue closely related to monetary policy. A few members pointed out that one of the critical factors for successfully placing the economy on a self-sustained recovery path was how much progress could be made in the disposal of nonperforming assets while the stimulus from the economic package was at work. One member commented that even if the Bank injected ample liquidity into the banking system, it would not translate into an increase in bank lending or money supply as far as the credit creating functions of banks were impaired by the nonperforming-loan problem. The member stressed, therefore, that the key was to make effective use of the 30 trillion yen available for financial system stabilization, and that the Bank should continue to do its utmost to contribute to this aim. Another member commented that the Bank should also make every possible effort to promote land transactions and loan securitization, which had proved to be very effective in solving the nonperforming-asset problem in the United States. There was also the observation that the effects of monetary easing as a macroeconomic policy would be greater if the financial system was in a better condition, which could be realized with a good combination of measures to promote land transactions and loan securitization and capital injection to financial institutions.
Following the Board's discussion, Mr. Nakamura, State Secretary for Finance of the Ministry of Finance, made a few remarks. The outline of his comments was as follows.
At the conclusion of the Board's discussion, all of the members agreed that in the implementation of monetary policy for the intermeeting period ahead, the Bank should maintain the current easy stance of monetary policy. In doing so, the Bank should examine closely economic and financial developments, including the effects of the comprehensive economic package.
Based on this agreement, the chairman formulated the following policy proposal, on which votes were taken.
The guideline for money market operations in the intermeeting period would be as follows, and publicized by the attached press release.
The Bank of Japan would encourage the uncollateralized overnight call rate to remain on average slightly below the official discount rate.
At the end of the meeting, the Policy Board discussed "The Bank's View" on recent economic and financial developments, and put it to the vote.
The Board unanimously determined "The Bank's View," which would be published on May 21, 1998 in the Monthly Report of Recent Economic and Financial Developments (consisting of "The Bank's View" and "The Background").4
For immediate release
May 19, 1998
Bank of Japan
The Bank today held a Monetary Policy Meeting, a regular meeting of the Policy Board on monetary policy.
By unanimous vote, the Policy Board decided to leave monetary policy unchanged.