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Minutes of the Monetary Policy Meeting

on July 16, 1998
(English translation prepared by the Bank staff based on the Japanese original)

August 14, 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 Thursday, July 16, 1998, from 9:00 a.m. to 11:26 a.m., and from 12:11 p.m. to 3:50 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. H. Matsunaga, Minister of Finance2
Mr. E. Kawade, Director-General of the Coordination Bureau, Economic Planning Agency3

Reporting Staff
Mr. I. Kuroda, Executive Director
Mr. M. Matsushima, Executive Director
Mr. I. Yamashita, Director, Financial Markets Department
Mr. T. Murakami, Director, International Department
Mr. S. Murayama, Director, Research and Statistics Department
Mr. H. Hayakawa, Research and Statistics Department
Mr. K. Yamamoto, Adviser and Chief Manager, Planning Division 1, Policy Planning Office

Secretariat of the Monetary Policy Meeting
Mr. K. Koike, Director, Secretariat of the Policy Board
Mr. S. Hida, Manager, Secretariat of the Policy Board
Mr. K. Momma, Manager, Policy Planning Office
Mr. E. Maeda, Manager, Policy Planning Office

  1. The minutes of this meeting were approved by the Policy Board at the Monetary Policy Meeting held on August 11, 1998. Those present are referred to by their titles at the time of the meeting.
  2. Mr. Matsunaga was present from 9:00 a.m. to 10:00 a.m.
  3. Mr. Kawade was present from 9:00 a.m. to 3:50 p.m.

I. Approval of the Minutes of the Monetary Policy Meeting Held on June 12, 1998

The Policy Board approved unanimously the minutes of the Monetary Policy Meeting held on June 12, 1998, for release on July 22.

II. Remarks by the Minister of Finance

The Minister of Finance made the following remarks on the government's thinking on economic policy management, elaborating its stance on the solution of the nonperforming-asset problem including the implementation of the Total Plan.

  1. (1) The government acknowledged that the economy remained sluggish, and continued to be in a severe situation. To cope with the situation, the government had adopted the comprehensive economic package. Following the recent passage of a supplementary fiscal 1998 budget that allowed for this package, the government was determined to implement the measures swiftly and steadily to realize an early materialization of the effects.
  2. (2) Meanwhile, in order to reinvigorate the Japanese economy and bring the ongoing financial system reform to successful completion, it was necessary to promote the solution of the nonperforming-asset problem and thereby bring about a prompt recovery of the inherent functions of the financial system. To this end, the government had prepared a first report on the Total Plan for promoting land transactions and asset securitization, followed by a second report.

The second report outlined four main policies: (1) establishment of an institutional framework for promoting active disposal of nonperforming assets; (2) improvement of transparency and disclosure practices; (3) reinforcement of bank supervision and prudential standards; and (4) stabilization and enhancement of the functions of the financial system, including the introduction of "bridge banks."

The "bridge bank" system would place the government in charge of resolving financial institution failures, and thereby (1) ensure depositor protection and financial system stability; (2) facilitate expeditious management of financial crisis; and (3) strengthen support for sound borrowers in good faith.

  1. (3) The government requested that the Bank continue smooth provision of ample liquidity in the markets taking financial market conditions into account, to ensure the stability of the financial system. It was important that through this the Bank dispel concerns of financial institutions about liquidity shortages and realize smooth corporate financing.
  2. (4) The Ministry of Finance was determined to ensure the stability of the financial system and to revitalize financial intermediation, together with the Financial Supervisory Agency and the Bank of Japan.

III. Summary of Staff Reports on Economic and Financial Developments4

A. Money Market Operations in the Intermeeting Period

Market operations in the period since the previous meeting on June 25 were conducted in accordance with the guideline determined at the meeting, which was to encourage the uncollateralized overnight call rate to remain on average slightly below the official discount rate.

On June 26, immediately after the previous meeting, upward pressure was exerted on the overnight rate despite the Bank's injection of excess reserves worth 2 trillion yen into the market. This was due to (1) market anticipation of tighter reserve market conditions reflecting demand for funds for summer bonus payments and for end-of-month settlements; and (2) intensified concern about the condition of a bank. Therefore on the following business day, June 29, the Bank provided excess reserves of over 3 trillion yen in the market, one of the largest amounts ever provided. This, together with abatement of anxiety about the stability of the financial system following an announcement of a bank merger, encouraged the overnight rate to decrease to around 0.35 percent. In July, the rate was generally stable, although it showed some temporary rises. As a result, the weighted average of the uncollateralized overnight call rate in the reserve maintenance period from June 16 to July 15 was 0.42 percent.

Meanwhile, interest rates on term instruments increased toward the end of June reflecting increased concern about the stability of the financial system. Subsequently the rates fell back somewhat but remained high compared to the level before mid-June.

B. Recent Developments in Foreign Exchange Markets and Overseas Economic and Financial Conditions

1. Developments in foreign exchange markets

In the period since the previous meeting, the yen depreciated against the U.S. dollar, reaching the 143-144 yen level in late June, reflecting heightened anxiety about the stability of the financial system. From the end of June to the beginning of July, the yen rebounded slightly following the announcement of the Comprehensive Plan for Financial Revitalization, the so-called Total Plan, and an increase in expectation of tax system reforms, and fluctuated around the 140-141 yen level. The yen weakened again on July 13, immediately after the election of the House of Councilors (the Upper House), but then recovered to the 140-141 yen level reflecting stabilization of stock prices and anticipation of intervention.

During the same period, the deutsche mark depreciated gradually against the U.S. dollar to the DM1.83-1.84 level reflecting instability in Russian financial markets. Subsequently, however, in the week starting on July 13, the deutsche mark advanced to the DM1.80-1.81 range due to improvement in the Russian situation.

Among East Asian currencies, the Korean won appreciated against the U.S. dollar while the Singaporean dollar, Indonesian rupiah, and Malaysian ringgit depreciated. Other East Asian currencies remained more or less unchanged.

2. Overseas economic and financial developments

In the United States, household spending showed sustained strength. However, there were also indications of a slight slowing of economic growth, such as a continued decline in net exports, particularly to Asia, and a deterioration in the National Association of Purchasing Management (NAPM) index of manufacturing industry. Meanwhile, prices remained stable. The yields on 30-year U.S. Treasury bonds declined, reaching 5.57 percent on July 6, the lowest since they were first issued in the 1970s. This was partly due to a "flight to quality" reflecting concern about the situation in Russia and slower economic growth mainly in the manufacturing sector. Since July 13, the yields had shown an upturn following an easing of the turmoil in Russia. Stock prices were recording historical highs, propelled by a surge in technology stocks.

In Europe, Germany, France, and the United Kingdom exhibited strong economic performance.

In East Asia, economic adjustments continued. Economic growth forecasts were revised downward considerably in Singapore, Indonesia, and Malaysia. Some countries, including Singapore and Malaysia, introduced policy measures to boost their economies.

The Russian government, the International Monetary Fund (IMF), and the World Bank agreed to an economic adjustment program for Russia. With the heightened prospect of additional financial support from the IMF following this agreement, the currency and financial markets gradually regained stability.

C. Economic and Financial Developments in Japan

1. Economic developments

Public-sector investment seemed to have bottomed out. However, business fixed investment decreased significantly, and housing investment remained weak. Private consumption showed little sign of a recovery, although a further decline had been prevented. Meanwhile, net exports remained level. Reflecting the weak final demand, inventory was being accumulated and firms were implementing sizable production cutbacks. These led to a decrease in corporate profits and continued conspicuous deterioration in employment and income conditions, as seen in a fall in wages below the previous year's level. In these circumstances, corporate confidence continued to weaken. Meanwhile, domestic wholesale prices continued to fall and consumer prices, excluding the effects of institutional changes (such as the rise in the consumption tax rate and the medical and insurance system reform in fiscal 1997), showed slight declines from the previous year's levels. Summarizing these developments, final demand, more specifically business fixed investment together with private consumption and net exports, had decreased since the end of 1997, and had come to exert a stronger downward influence on production, employment, and income. Consequently, the pace of the recent economic decline, as indicated by real GDP growth and industrial production, had exceeded the pace of adjustment following the bursting of the "bubble" economy, and was approaching that of the recession after the first oil crisis in 1973.

As for the outlook, it could still be expected that the effects of the comprehensive economic package of April 24 would contain the downward trend in the economy at least temporarily some time after the early autumn, and thereby prevent a deflationary spiral. There was, however, a high probability that the adjustment in business fixed investment would intensify, especially in small and medium-sized firms, and little prospect of the downward trend in the income conditions of firms and households being reversed in the immediate future. Under such circumstances, the implementation of the economic package could not be expected to give much stimulus to private-sector demand. Therefore, it was likely that the economy would exhibit only a slight recovery in the second half of the fiscal year, and it was vulnerable to any additional shocks.

2. Financial developments

Stock prices and yields on long-term government bonds rebounded in mid-June, following the announcement of the Total Plan and the emergence of expectation of tax system reforms. Stock prices recovered to the level of the end of March. These developments suggested a slight recovery in market sentiment, although still weak, reflecting heightened anticipation of progress in the solution of the nonperforming-asset problem and continued fiscal support for the economy.

Meanwhile, interest rates on money market term instruments and the Japan premium rose sharply at one point in response to media reports on the condition of a bank. With constant provision of ample funds by the Bank and the announcement of the Total Plan, however, market anxiety eased, but interest rates on term instruments were still somewhat high compared to the level before mid-June. The yield spread between corporate and government bonds remained more or less unchanged, while that between bank debentures and government bonds expanded. This suggested that market participants' awareness of the credit risks of financial institutions in particular had strengthened.

With respect to monetary aggregates, growth in M2+CDs slowed reflecting persistent sluggishness in private bank lending. It was considered that, in addition to the continued cautious lending attitude of private-sector banks, a decline in firms' financing demand reflecting the weakening of overall economic activity contributed considerably to this weakness. In these circumstances, it was thought that firms with a relatively low credit standing would continue to face severe financing conditions, with limited availability of funds and high funding costs. The repercussions of this situation on overall economic activity required careful monitoring.

  1. 4Reports were made based on information available at the time of the meeting.

IV. Summary of Discussions by the Policy Board on Economic and Financial Developments

In the Board's discussion of the current economic situation, many members expressed the view that the momentum of the negative cycle in the economy had strengthened somewhat since the previous meeting. The view was based on newly released indicators, most of which suggested that there had been further declines in business fixed investment, industrial production, and employment and income conditions.

Many members judged that business fixed investment continued to decline at a more rapid pace than expected, on the following grounds: (1) the investment plans of small and medium-sized firms were not revised upward in the June Tankan survey as much as in the average year, thus posting sizable year-to-year declines; and (2) machinery orders were also falling at an accelerated pace. One member made the observation that the slide in business fixed investment marked the materialization of one of the previously anticipated potential threats to an economic recovery.

The following arguments were put forward in the discussion on business fixed investment. One member pointed out that in past adjustment phases, it was frequently observed that small and medium-sized firms boldly started fixed investments prior to an economic recovery, when interest rates and materials prices were still low. The member expressed concern that such action was not observed in the current phase. The member considered that this was partly attributable to the increased burden on household spending caused by the fiscal consolidation measures in 1997, and to the prevailing concern about the stability of Japan's financial system. Another member expressed the view that a recovery in business fixed investment was unlikely as long as firms had deflation concerns, even if there were a further reduction in interest rates or if firms were able to secure the necessary funds. Another member pointed out that, in a normal medium-term cycle pattern, business fixed investment and construction investment would still have been in the expansionary phase which started in 1993. The member remarked that these types of investment were in fact contracting, displaying an unprecedented development. The member ascribed this to the fact that adequate adjustments indispensable for an economic recovery, including the adjustment to the bursting of the economic "bubble," had not been achieved. The member, referring also to the lower rate of return on investment compared to real interest rates, added that the declining trend in business fixed investment was likely to continue, with a 6.0-7.0 percent drop projected for fiscal 1998.

With regard to private consumption, members generally agreed that it showed little sign of a recovery, although the deterioration had been brought to a halt.

In the Board's assessment of developments in private consumption, one member mentioned that the recent hot weather had contributed positively to consumption. The member also expressed a view that the potential replacement demand for passenger cars had increased in view of the fact that passenger cars had been used for an average of 5.0 years in 1996 as compared to 4.5 years in 1992. Another member also cited the positive impact of the hot weather on the sale of certain goods such as air-conditioners. Further, referring to an estimate that an average summer temperature 1°C higher than usual would boost private consumption by 0.5 percent, the member suggested that, if the hot weather continued, it would providentially support the economy until the effects of the comprehensive economic package appeared, which was expected to be in the early autumn.

Some members, however, including these members, noted that industrial production had declined further and employees' income had decreased conspicuously recently, stressing the need to pay attention to the repercussions of these developments on private consumption. In addition, some members pointed out that one factor constraining a recovery in private consumption was the strong anxiety of households about their future. They considered that there were various issues causing the uncertainty, including concern about the stability of the financial system, an inadequate safety net for the unemployed, anxiety about the pension system, and apprehension about future tax burdens. One commented that the long-term decline in the propensity to consume since the mid-1980s might be attributable to the difficulty faced by the young in planning their future, which reflected their apprehension about the pension system. The member also expressed concern about the slowing growth of disposable incomes in high-income households (the upper two quintiles), which was considered to have contributed most significantly to overall consumption until then.

On the sluggishness of housing investment despite the low interest rates, one member commented that this was influenced by households' anxiety about future employment and income, as in the case of private consumption, and also by asset-price deflation, which was restraining replacement demand. The member emphasized the considerable impact that asset-price deflation could have on household expenditure by citing an estimate showing that the propensity to consume of households repaying housing loans had declined and sluggish consumption by high-income households. The member further expressed the view that decisive tax measures that would promote housing purchases might be necessary, as housing investment produces significant ripple effects, stimulating consumption of durable goods, for example.

With regard to exports, some members stressed the negative impact of the drop in exports to Asia. Specifically, one member pointed out that exports to Asia were posting year-to-year declines of close to 20 percent in terms of volume, and if such a sharp fall continued, it would reduce GDP by about 1 percent.

On the other hand, many members argued that the weaker yen and favorable economic performance in the United States and Europe seemed to be bringing about a moderate upswing in Japan's exports. A member supporting this argument pointed out that there was increasing demand for Japan's exports in Latin America and the Middle East, important markets for European goods, as European countries had to first meet the robust demand in Europe. The member added, however, that an increased share of Japanese products in the U.S. and European markets might lead to a rekindling of trade friction, and therefore, exports could not be expected to serve as a driving force for an economic recovery.

On production and inventory, one member made the observation that the nearly completed inventory adjustment in the automobile industry had reduced somewhat the risk of a double-dipping of production in the July-September quarter. However, another member presented the results of a simulation analysis that inventory adjustment was unlikely to be completed before the end of the year even if production continued to be cut by 2 percent each quarter, the pace observed between autumn 1997 and spring 1998. The member further introduced an estimate that such falls in production would create adjustment pressure leading to an increase in the unemployment rate to about 5 percent and a reduction in business fixed investment by approximately 20 percent. Many other members shared the view that, although production cutbacks were more substantial than forecasted, inventory adjustment was slow to progress except in the automobile industry reflecting weak developments in final demand, such as sizable declines in business fixed investment.

In view of such developments in final demand, production, and inventory, members generally agreed that the negative cycle in the economy involving final demand, production, and income and employment conditions had intensified somewhat.

In the Board's discussion of the economic outlook, many members commented that, in view of the stronger-than-anticipated operation of the negative cycle in the economy spurred by the adjustment in business fixed investment, the prospects for a self-sustained recovery in the immediate future had been reduced. In relation to this point, one member remarked that the Japanese economy was in the process of becoming a true market economy, in which the market mechanism constantly produces winners and losers. The member mentioned the high probability that firms' efforts to improve productivity during this process would continue to exert medium- to long-term adjustment pressure on employment and capital for some time. Based on this perception, the member forecasted that GDP would decline by more than 1 percent in fiscal 1998 and by about 0.5 percent in fiscal 1999 even if tax reduction and public works were increased by 3 trillion yen each. The member also mentioned the downside risks to the Japanese economy associated with a possible decline in U.S. stock prices. The member projected that U.S. stock prices would plunge after peaking at around the U.S.$9,600-9,700 level sometime in the summer or the autumn. Citing an estimate that a 20 percent fall in U.S. stock prices would bring the United States' GDP down by 1.5 percent, the member drew attention to the possibility that the collapse in the U.S. stock market would also negatively affect the Japanese economy.

Most members, however, gave emphasis to the forthcoming factors, such as the effects of the comprehensive economic package and of the yen's depreciation, generally agreeing that the downward pressure on the economy would be contained, at least temporarily, in the second half of the fiscal year. One member considered that additional deflationary pressure created by such factors as the fall in business fixed investment was considered to push GDP down by about 0.5-1.0 percent, and this could in large part be offset by the increased prospect of tax system reforms.

Regarding the risk of a deflationary spiral occurring, some members commented that the weaker yen and the bottoming out of international commodity prices had reduced the risk somewhat. As to the remaining risk associated with domestic market conditions, they expressed the view that as the downward pressure on the economy diminished later in the fiscal year, such a risk would decrease. However, many members emphasized the need to remain alert to the risk, one commenting that the Japanese economy was still on the verge of a deflationary spiral.

Members also exchanged views on the recent modest rebound in stock prices and the yen's exchange rate following the announcement of the Total Plan and increasingly active discussions on tax system reforms. The announcement of the Total Plan indicated the firm stance of the government and the ruling Liberal Democratic Party on the fundamental solution of the nonperforming-asset problem.

A member commented that one element behind the downside risk to the economy requiring careful attention was the negative effects of a possible further fall in stock prices on the financial system and the economy, but this fortunately had not materialized. The member added that, although confidence in the stock market had not been fully restored, if the current stability was maintained, the economy would be prevented from weakening further before the comprehensive economic package started producing effects.

On the yen's exchange rate, one member commented that the current exchange rate level was generally comfortable to exporters as long as it did not impair the stability of the financial markets. Another member noted that, currently, the markets somehow tended to believe that a weaker yen would lead to lower stock prices. This member, therefore, considered that the recent modest rebound in the yen's value and its subsequent stability at the current level realized a delicate balance between support for exports and prevention of an adverse impact on stock prices in Japan and other Asian countries. By contrast, one member cited an argument raised overseas that it would not be surprising to see the yen fall to 160 yen or 200 yen to the U.S. dollar considering the current weakness of the Japanese economy.

Members also deliberated on the government's economic policy management as an important element in assessing the economic outlook.

Members agreed that the current stagnation of the economy was largely due to the fact that firms and households could not form a positive view of the future. Therefore, they considered it important to restore corporate and household confidence by changing the tax and pension systems and by implementing a fundamental solution of the nonperforming-asset problem. In relation to this point, some members commented that the recent improvements in stock prices, long-term interest rates, and the yen's exchange rate were evidence that the markets had thus far evaluated positively the various measures under deliberation by the government. They stressed that the government should therefore not fall short of the markets' expectations in its implementation of policies.

Some members expressed the view that the fiscal 1999 budget, to be discussed by the Diet thereafter, should be constructed to give adequate support to the economy. One member specifically pointed out that, under the Fiscal Structural Reform Act of 1997, the size of the fiscal 1999 budget would unavoidably be constrained compared to the initial fiscal 1998 budget, bringing about a significant drop from fiscal 1998 on a post-supplementary budget basis. According to the member, this would mean a historically large fiscal drag on the already weakened economy. The member added that, while due consideration should be given to the weakness of the economy in deliberating the initial fiscal 1999 budget and tax system reforms, it was important, in order for the tax system reforms to be highly effective, to clearly indicate a medium- to long-term commitment to realizing small government by, for example, clarifying budget priorities.

In the discussion on financial market developments, many members continued to attribute the weakness of monetary aggregate indicators, such as money supply and private bank lending, mainly to sluggish demand for funds. One member, however, drew attention to the possibility that the lending attitude of banks would become even more cautious as the nonperforming-asset problem was addressed decisively. Another member pointed out that financial institutions' raising of lending margins depending on borrowers' creditworthiness could be construed as normalization of lending practices. This member, however, also noted the probability that such developments would have negative repercussions on the economy, and therefore emphasized the need for careful monitoring. The member further stressed that financing conditions had recently become severer especially for small and medium-sized firms, reflecting a deterioration in their business performance, and therefore, it was necessary to keep a closer watch on corporate financing toward the semi-annual settlement at the end of September. There was also a comment that, although expeditious solution of the nonperforming-asset problem would contribute positively to the Japanese economy in the long term, it was necessary to be alert to the possibility that it would cause significant risks to the economy in the short term.

V. Summary of Discussions on Monetary Policy for the Immediate Future

Based on the Board's assessment of the economic and financial situation, the members discussed the basic thought on monetary policy for the immediate future.

As mentioned earlier, many members were convinced that the economic condition had worsened somewhat in the intermeeting period, but most were of the view that, in the management of monetary policy, the Bank should maintain interest rates at the current level.

The view was expressed on the following grounds: (1) there was still some prospect that the comprehensive economic package would bring about an economic recovery, albeit a moderate one; (2) financial markets evaluated favorably the announcement of the Total Plan and active discussions on tax system reforms, and therefore the materialization of the downside risks to the economy had been prevented; and (3) with limited room for further interest rate reductions, the effects and side effects of further monetary easing needed to be examined carefully.

Specifically, one member, while acknowledging that various sources including the June Tankan survey revealed a greater-than-anticipated decline in business fixed investment, pointed out that there was still some prospect of an economic recovery in the second half of the fiscal year due to the effect of the comprehensive economic package. This member therefore expressed the opinion that the Bank should maintain the current easy monetary policy. Some members focused on the likelihood that the details of the Total Plan would be determined in the near period, following the announcement of the framework, and on the projection that the government's deliberation on tax system reform would intensify. They emphasized that, in view of these developments, the Bank should adopt a wait-and-see posture for the immediate future. They also pointed out that the rebound in stock prices reflecting such prospects suggested that the downside risks to the economy had been reduced.

Many members further remarked that it was important to consider possible emergency monetary policy measures in case the risks materialized. On this point, one member stated that if the probability of a deflationary spiral occurring increased in the future, it would be appropriate to take some monetary easing measure, such as a reduction of the reserve requirement ratios. Some other members also expressed the view that it would be necessary to consider a wide variety of measures if further monetary easing were to be implemented as an emergency measure. Specifically, there was a suggestion that, to deal with an emergency, the Bank should coordinate a policy package containing every possible measure, such as a reduction of the reserve requirement ratios and lowering of the overnight call rate to 0 percent. There was also an opinion that the Bank would have to provide an unlimited amount of liquidity if a risk emerged that financial system problems would not be managed adequately, causing shock waves in the Japanese and overseas financial markets. There was, on the other hand, a comment that such significant monetary expansion would only be necessary if fiscal measures implemented in fiscal 1999 failed to prevent the economy from slipping into a double-dip decline.

Members also discussed the effects and side effects of additional monetary easing. Specifically, members emphasized the need to examine carefully whether the transmission channels of monetary policy functioned properly even when there was so little room for additional interest rate reductions--namely, such channels as (1) improvements in the rates of return on investment and rises in asset prices reflecting lower interest rates; (2) a decline in the currency's exchange rate (a depreciation of the yen); and (3) enhanced financial intermediary functions.

Regarding the exchange rate channel, some members acknowledged the possibility that even a slight interest rate reduction would induce the yen's depreciation. They then questioned whether a decline in the yen would bring favorable effects on balance to the Japanese economy when there was a strong belief in the markets that a weaker yen would trigger a decline in Japan's stock market and a depreciation of other Asian currencies. In a discussion on how to weigh this issue in the management of monetary policy, one member pointed out that a depreciation of the yen reflects a weak Japanese economy, and it was improper to refrain from implementing monetary policy solely out of consideration for a possible fall of the yen. However, another member, while acknowledging that it was inappropriate for monetary policy decisions to be umduly constrained by exchange rate movements, argued that implementation of policy that might induce a decline in the yen would require convincing reasoning since other Asian countries were extremely nervous about the yen's depreciation. Further, another member commented that, generally speaking, transmission of monetary policy effects through exchange rate movements should not be discussed negatively, but it was necessary to give consideration to the specific conditions in the market.

Meanwhile, one member pointed out that the potential impact of an interest rate reduction might have been reduced, as suggested by the sluggishness of housing investment, one of the most interest rate-sensitive economic activities. With regard to the possible influence on firms, some members, including this member, mentioned that there had been surprisingly few requests from firms for a monetary easing, as reported at the Bank's quarterly meeting of branch general managers in July.

Further, one member commented that, as shown by the combination of the extremely low interest rates of about 0.5 percent and the weak yen of approximately 140 yen per U.S. dollar, monetary policy had been quite stimulative to the economy, and therefore, reasons for the continued weakness of the economy should lie elsewhere. Based on this point, the member argued that implementation of further monetary easing at this point, including an expansion of the monetary base, would not necessarily be effective because it was like fuelling a car with a defective engine. The member remarked that it was necessary to first repair the engine by, for example, implementing fiscal policy measures including tax system reforms and restoring the functions of the financial system. Another member remarked that it was obvious that the impairment of financial intermediary functions was impeding the effectiveness of monetary policy, mentioning that a 10 percent growth in the monetary base was accompanied by only a 3.5 percent increase in M2+CDs. The member commented that, therefore, it was important in the immediate future to keep a close watch on how the nonperforming-asset problem would be addressed.

To deal with the impaired financial intermediary functions, some members expressed the view that the Bank should consider ways to promote smooth direct financing, such as increasing CP operations or expanding market operations tools by possibly including the use of corporate bonds. Following this suggestion, many members commented that the monetary policy response to the situation would primarily be to provide ample funds in the money market and to thereby alleviate upward pressures on interest rates. They considered, however, that the Bank should also promptly deliberate on other possible measures such as expansion of market operations instruments, giving necessary consideration to technical feasibility.

In sum, many members commented that it would be appropriate to maintain the current easy monetary policy. One member, however, proposed lowering the target level of the uncollateralized overnight call rate to 0.35 percent. The member, having proposed in the previous two meetings that the target level be reduced to 0.40 percent, suggested a larger reduction this time in view of the additional deterioration in the economic condition. The member mentioned that coincident and leading indicators had plunged 12 percent and 18 percent, respectively, from their peak in March 1997, which underlined that the economy was undergoing quite a severe adjustment. The member further emphasized the need to show the Bank's determination to prevent deflation by all means. The member had some sympathy with the wait-and-see stance toward the economy in anticipation of the effects of the comprehensive economic package and progress in discussions on tax system reforms. The member, however, argued that the impact of these factors on the economy was uncertain, and even if they produced positive effects, it was necessary to support the economy with an additional monetary easing until the effects materialized. On the thinking that an additional monetary easing should be kept in reserve for an emergency, the member questioned the effect of a further easing once such an emergency had actually occurred, and therefore claimed that a slight monetary easing should be implemented preemptively.

Other members, however, as in previous meetings, remained cautious about the proposal in that such a small interest rate reduction would have limited effect. Meanwhile, some members, including the member who gave the proposal, referred to the possibility that keeping monetary policy unchanged despite continued deterioration in the economy would invite criticism that the Bank was not doing what it should in response to the situation. One member, however, dismissed the argument by claiming that the very fact that the Bank had maintained unprecedentedly low interest rates for as long as 34 months could be considered as the Bank's significant contribution to the economy in various ways, such as by supporting the profits of small and medium-sized firms.

Members also discussed the newly emerging argument on the so-called "adjusted inflation." One member remarked that the central bank's duty was to ensure price stability, which meant that neither inflation nor deflation was acceptable. Another member pointed out that if inflation were created, it would hinder adjustments that were indispensable to the Japanese economy, passing the burden onto the future.

Another member remarked that inflation targeting was worth considering as it could work on people's expectations, an opinion that the member had been expressing publicly. The member, however, showed dissatisfaction with the fact that this argument had come to be mixed up with "adjusted inflation," and therefore discussed inappropriately. The member had advocated that in an extremely severe economic situation in which an optimal monetary policy was to realize negative real interest rates, targeting inflation at a moderate rate, for example at 1.0-1.5 percent, would be worth considering as an effective way of dispelling deflation concerns. The member, however, believed that the generally discussed "adjusted inflation" aimed at realizing an inflation rate of 3-4 percent was unacceptable.

Some members, however, including this member, expressed the view that it was uncertain as to how much influence even inflation targeting would have on people's inflationary expectations, given the limited room for interest rate reduction.

VI. Remarks by the Representative of the Economic Planning Agency

Mr. Kawade made the following remarks:

  1. (1) The government was of the view that the economy remained sluggish, and continued to be in a severe situation.
  2. (2) To deal with the severe condition of the economy, the government was determined to implement swiftly the comprehensive economic package worth over 16 trillion yen and to realize a fundamental solution of the nonperforming-asset problem in accordance with the Total Plan.
  3. (3) The government, however, acknowledged the risk that the economy would weaken further before various measures started producing significant effects. Therefore, the government requested that the Bank manage monetary policy giving due consideration to sufficient availability of funds to firms.

VII. Votes

At the conclusion of the Board's discussions, most members supported the view that in the implementation of monetary policy for the intermeeting period ahead, the Bank should maintain the current easy monetary policy. They considered that, in doing so, the Bank should examine closely economic and financial developments, including the effects of the comprehensive economic package and developments in discussions on the Total Plan and on tax system reforms. There was, however, also a proposal that an interest rate change should be implemented toward a further easing of monetary policy. Therefore, two policy proposals were put to the vote.

Mr. Nakahara made a proposal to adopt a guideline for money market operations in the intermeeting period that the Bank should encourage the overnight call rate to be on average around 0.35 percent. The proposal was defeated with one vote in favor and eight against.

To reflect the majority view, the chairman formulated the following proposal.

Chairman's Policy Proposal:

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.

Votes for this proposal:
Mr. M. Hayami
Mr. S. Fujiwara
Mr. Y. Yamaguchi
Mr. Y. Gotoh
Mr. S. Taketomi
Mr. T. Miki
Ms. E. Shinotsuka
Mr. K. Ueda
Votes against this proposal:
Mr. N. Nakahara

Mr. Nakahara dissented because he considered that it was necessary to implement a modest interest rate reduction to alleviate the burden of ongoing adjustments in light of the continued deterioration in the economic condition and the uncertainty regarding the effects of government policies.

VIII. Discussion of the Bank's View on Recent Economic and Financial Developments

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 July 21, 1998 in the Monthly Report of Recent Economic and Financial Developments (consisting of "The Bank's View" and "The Background").5

  1. 5The original full text, written in Japanese, of the Monthly Report of Recent Economic and Financial Developments was published on July 21, 1998 together with the English version of "The Bank's View." The English version of "The Background" was published on July 31, 1998.

Attachment

For immediate release

July 16, 1998
Bank of Japan

The Bank today held a Monetary Policy Meeting, a regular meeting of the Policy Board on monetary policy.

By majority vote, the Policy Board decided to leave monetary policy unchanged.