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Minutes of the Monetary Policy Meeting

on September 9, 1998
(English translation prepared by the Bank staff based on the Japanese original)

October 16, 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 Wednesday, September 9, 1998, from 9:01 a.m. to 12:33 p.m., and from 2:35 p.m. to 5:41 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. Tanigaki, State Secretary for Finance, Ministry of Finance2
Mr. H. Imai, Parliamentary Vice Minister, Economic Planning Agency

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. T. Kurihara, Manager, Policy Planning Office

  1. The minutes of this meeting were approved by the Policy Board at the Monetary Policy Meeting held on October 13, 1998. Those present are referred to by their titles at the time of the meeting.
    The meeting recessed from 12:33 a.m. to 2:35 p.m. for lunch and Mr. Hayami's attendance at a Diet session.
  2. Mr. Tanigaki was present from 9:01 a.m. to 10:09 a.m.

I. Remarks by the Representatives of the Ministry of Finance and the Economic Planning Agency

Mr. Tanigaki, a government representative from the Ministry of Finance, made the following remarks on the current economic situation and fiscal policy management.

  1. (a) Currently, Japan's economy was in a prolonged slump and in quite a severe situation. Under these circumstances, the government would continue steadily implementing the comprehensive economic package of April 24 and the supplementary budget for fiscal 1998, and initiate as soon as possible the Comprehensive Plan for Financial Revitalization, the so-called Total Plan. Furthermore, with a view to realizing an economic recovery at the earliest possible time, the government planned to combine the second supplementary budget for fiscal 1998, having expenditures exceeding 10 trillion yen, and the initial budget for fiscal 1999 into one budget to realize uninterrupted fiscal spending into fiscal 1999.
  2. (b) As for the tax system, the government had decided to implement a permanent reduction of personal and corporate income taxes of over 6 trillion yen. Moreover, as for the general account budget requests for fiscal 1999, general expenditures, including a 4 trillion yen "Special Frame for Economic Recovery," were 11 percent higher than for the previous year.
  3. (c) With regard to the Total Plan, the government and the ruling LDP had submitted to the Diet six bills on five different issues. Subsequently, three opposition parties had together submitted their own bills on financial system stabilization on September 3. The ruling and the opposition parties had been exchanging opinions vigorously to reach a consensus. The government was determined to do its utmost to ensure that these bills would be passed at the earliest possible moment.
  4. (d) The Cabinet decided the outline of measures to support small firms suffering from the "credit crunch," including expansion of credit guarantee programs and government financial institutions' lending programs. As a result, the amount of money available for these firms now exceeded 40 trillion yen.
  5. (e) On September 4, the Minister of Finance of Japan and the Treasury Secretary of the United States met in San Francisco to exchange opinions frankly on market developments worldwide as well as the economic situation and economic policies of the two countries.

Mr. Imai, a government representative from the Economic Planning Agency, made the following remarks in addition to commenting on the government's efforts on financial system stabilization measures, the second supplementary budget for fiscal 1998, and tax system reforms.

  1. (a) Japan's economy was in a prolonged slump and in quite a severe situation. The world economy as a whole seemed to have entered a stage requiring careful attention, with Asian economies stagnant and the Russian economy unstable. As for Japan's economy, while the comprehensive economic package was expected to produce positive effects for Japan's economy, there were also concerns over employment conditions and the nonperforming-loan problem of financial institutions. Therefore, it was anticipated that the severe economic situation would continue for some time.
  2. (b) Amid such economic conditions, the Economic Strategy Council was established on August 24, 1998 to deliberate measures that would strengthen the public's confidence in Japan's future.

II.Approval of the Minutes of the Monetary Policy Meeting held on July 28, 1998

The Policy Board approved unanimously the minutes of the Monetary Policy Meeting held on July 28, for release on September 14, 1998.

III. Summary of Staff Reports on Economic and Financial Developments

A. Money Market Operations in the Intermeeting Period

Market operations in the period since the previous meeting on August 11 were conducted in accordance with the guideline determined at the meeting, which was to encourage the overnight call rate to remain on average slightly below the official discount rate.

In the reserve maintenance period from July 16 to August 15, the overnight call rate climbed to as high as 0.49 percent on August 14, the last deposit day of the maintenance period, as continued declines in stock prices raised concerns that financial institutions might face financing difficulty. The rate, however, had been generally stable in the rest of the period, and therefore, the average rate for the period was 0.43 percent.

In the following reserve maintenance period starting August 16, upward pressure on the overnight rate intensified, reflecting (1) moves by some market participants to hold excess reserves at the early stage of the maintenance period; (2) declines in stock prices from the end of August to early September; and (3) absorption of a substantial amount of tax money by the government sector. In order to stabilize the rate, the Bank injected ample funds into the market on a daily basis, maintaining the excess reserves as of each morning at around 1 trillion yen. As a result, as of September 8, the day before the meeting, the weighted average of the overnight call rate in the reserve maintenance period from August 16 to September 15 stood at 0.42 percent.

Interest rates on term instruments followed an upward trend throughout August as market participants gradually started to take the semiannual settlement in September into consideration amid continued declines in bank stocks. From the end of August, however, interest rates declined slightly reflecting the Bank's steady injection of funds maturing after the end of September through CP and other operations.

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

1. Developments in foreign exchange markets

The yen appreciated sharply against the U.S. dollar during the intermeeting period with some fluctuations, on account of the following factors: (1) a sizable drop in the U.S. stock markets reflecting increased uncertainty regarding the U.S. economy amid instability of financial markets worldwide triggered by the political and economic turmoil in Russia; and (2) closing of yen's short positions to realize capital gains by hedge funds that had incurred losses on investments in the emerging markets, such as Russia and Latin America.

Meanwhile, the deutsche mark dropped against the U.S. dollar reflecting deterioration in the situation in Russia, but rebounded sharply at the end of August as investors became cautious about buying U.S. dollars due to heightened uncertainty about the U.S. economy.

East Asian currencies in general remained steady against the U.S. dollar, with a notable continued appreciation of the Indonesian rupiah and a steep rise in the Malaysian ringgit. The markets' anticipation of a devaluation of the Chinese yuan had receded, while the Korean won followed a declining trend.

The Russian rouble plunged, causing apprehension of a decline in international commodities prices. As a result, the currencies of countries exporting primary commodities had started to decline conspicuously, as seen in the massive selling of the Canadian dollar and Latin American currencies.

2. Overseas economic and financial developments

Stock prices in the United States fell sharply reflecting concerns about a possible decrease in the earnings of U.S. firms in light of the economic and financial situation in Russia and Latin America. A view prevailed, however, that market participants had predicted an adjustment of the Dow Jones Industrial Average to around $8,000. Stock prices in European markets were also declining. Given this situation, "flight to quality" --that is, a marked shift to government bonds of industrialized countries--became increasingly conspicuous.

The U.S. economy had, on the whole, continued to expand steadily. Economic indicators such as private consumption and housing investment showed firm developments, although net exports and automobile sales were somewhat weak. Recently, however, more people were alert to the possibility that the situation in Russia and Latin America would exert negative influence on the U.S. economy by bringing about a deterioration in corporate earnings and a fall in stock prices. Mr. Greenspan, Chairman of the Board of Governors of the Federal Reserve System, remarked in early September that the risks of rising inflation and those of slower economic growth had become balanced, and therefore, the markets were starting to expect a reduction in interest rates.

In Europe, Germany and France continued to exhibit moderate economic expansion. In the United Kingdom, net exports declined due to the strong pound sterling and private consumption showed signs of deceleration. However, labor markets remained tight, and concerns about possible price increases persisted.

In East Asia, many countries were revising downward their projections of economic growth for 1998. Thailand and Korea, where steady implementation of economic adjustment programs proposed by the International Monetary Fund (IMF) were progressing, had started to ease gradually their tight macroeconomic policies to address the ongoing deterioration in their economies. In China, there were concerns about the negative effects of floods on production.

C.Economic and Financial Developments in Japan

1. Economic developments

With respect to final demand, net exports increased mainly due to a decline in imports, while business fixed investment continued to contract significantly, housing investment decreased further, and private consumption continued to fluctuate. Against the background of weakening final demand, firms continued to reduce production substantially, and as a result, inventory adjustment progressed to some extent, especially in durable consumer goods. Sizable production cuts, however, led to a decline in corporate profits and a drastic deterioration in employment and income conditions, as apparent in a decrease in employed workers and a reduction in wages.

With regard to prices, domestic wholesale prices continued to follow a downward trend as the output gap continued to expand. Consumer prices were also slightly below the previous year's level.

In sum, Japan's economic conditions continued to deteriorate. The recent trend featured drastic cuts in fixed investment and employment at firms, mainly small ones, reflecting declines in profits. The employment cuts were reducing household income at a faster pace than expected, and this served as one factor behind the persistent sluggishness in household spending despite the special income tax reduction for fiscal 1998.

With respect to the outlook, the reduction in income and the continued deterioration in final demand made it more likely that the economic growth rate would remain low in the second half of fiscal 1998, and that growth would be slower than previously estimated. Recently, however, such elements in final demand as household spending, exports to Asia, and business fixed investment, which plunged one after another during the period from the end of 1997 to the January-March quarter of 1998, had not shown signs of further deterioration. Therefore, the presumption still seemed to hold that the effects of the comprehensive economic package would gradually contain the economic deterioration and thereby prevent the economy and prices falling further into a downward spiral.

Given the very low level of economic activity as indicated by the decrease in corporate profits and the worsening of employment and income conditions, the economy was vulnerable to additional shocks. Also, the financial markets were extremely unstable, with widespread anxiety about the world's financial system triggered by a rescheduling of Russia's debts. It was necessary to be aware of the risk that these factors, increasing uncertainty about the economic outlook, could further undermine consumer sentiment and firms' willingness to spend.

The outcome of the Diet's deliberation on financial system issues, the increase in corporate bankruptcies toward the end of September, and the effects of these developments on stock prices and household and business confidence also required due attention.

2. Financial developments

The financial markets showed unstable developments in the period since the previous meeting on August 11, reflecting the worldwide plunge in stock prices triggered by the financial crisis in Russia, and heightened uncertainty regarding the problems in Japan's financial system. The yen rose approximately 15 yen against the U.S. dollar from the bottom a month earlier. Stock prices rallied after marking, at the end of August, the lowest level since the bursting of the economic "bubble," but were still approximately 1,000 yen lower than the level in early August. Yields on long-term government bonds set a new historic low.

During the same period, the markets became even more cautious about the credit risks of Japanese financial institutions. The "Japan premium," after expanding in late June following the surfacing of financial problems of a Japanese bank and then narrowing somewhat in July, had gradually trended upward since mid-July reflecting the uncertainty regarding the passage of bills related to the Total Plan. The interest rate spread between Euro-yen deposits and TBs, which is in arbitrage with the Japan premium, continued to widen. Considering the markets' concerns over Japanese financial institutions' funding toward the end of 1998, an immediate reduction in these risk premiums seemed unlikely.

Nevertheless, there had been gradual declines in TB rates and even in Euro-yen rates, especially rates on Euro-yen futures, even though the risk premiums continued to increase. These developments seemed to reflect the markets' growing expectation of monetary easing in view of the decline in stock prices.

In the long-term bonds markets, interest rate differentials also widened reflecting issuers' creditworthiness. Interest rate spreads between bank debentures and government bonds expanded further. The spreads between corporate bonds and government bonds also started to widen gradually following the drop in stock prices at the end of August, although they had previously been relatively stable.

Because stock prices plunged concurrently with the substantial decline in long-term interest rates, the yield spread--the differential between long-term bond yields and the expected rate of return on stocks--decreased to a historic low. This indicated that the markets revised their expectations for corporate profit growth downward and that the uncertainty regarding future stock prices increased, which meant an expansion in risk premiums.

With respect to monetary aggregates, the growth in money stock was around 3.5 percent, suggesting a pause in the declining trend. Demand for funds to be put into economic activities remained weak, but some firms, especially large firms, were making early moves to secure ample on-hand liquidity in view of the cautious lending attitude of financial institutions. These firms were increasing their issuance of corporate bonds and CP while also continuing to borrow from banks. These developments in firms' fund-raising were contributing to the growth in money stock. It should be noted, however, that some firms, especially small firms, continued to suffer from both high funding costs and limited availability of funds, and this situation continued to require careful monitoring.

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

A. The Current Economic Situation

In the Board's discussion of the current economic situation, members shared the view that economic conditions on the whole had continued to worsen. This judgment was based on the fact that economic indicators released after the previous meeting on August 11 deteriorated further, showing a significant decrease in business fixed investment, a further decline in housing investment, and a substantial reduction in employment and income. Members discussed various points, including whether this deterioration was faster than expected.

With regard to business fixed investment, a few members commented that recent declines had been precipitous, and there were no signs of a bottoming out. Another member mentioned that even large firms could not make investments leading to business rationalization because of the cautious lending attitude of banks. In view of the drop in machinery orders, which is a leading indicator of business fixed investment, the member forecasted that business fixed investment in fiscal 1998 might decline from the previous year by as much as 10 percent. A different member pointed out that firms that had become less resilient were reducing investment notably, and in addition, business fixed investment of listed firms was also decreasing, which was further squeezing the earnings of small firms. In sum, all of the members agreed that business fixed investment was in a very severe situation.

In the discussion on household spending, the focus was first placed on the continued decrease in housing investment. A few members commented that the recent drop in housing starts had been larger than projected. Another member expressed the view that because households' long-term expectations had dwindled, they did not feel bold enough to purchase housing. A different member expressed a concern that the annual figure for housing starts might fall short of one million.

With regard to private consumption, one member pointed out that sales of automobiles and household electrical appliances, particularly personal computers, appeared to have hit bottom. Another member also had the impression that private consumption as a whole had ceased to deteriorate. However, a different member remarked that the only automobiles that were selling well were new model cars and cars that had undergone full model change. A few members, including this member, pointed out that the special income tax reduction for fiscal 1998 of 4 trillion yen appeared so far to have produced little effect. Further, some members mentioned the probability that the ongoing deterioration in employment conditions would further depress private consumption. In sum, members generally agreed that private consumption had remained level, and there was still no prospect of a vigorous recovery.

In view of these arguments, one member noted that households repaying housing loans were restraining consumption, and accordingly suggested the necessity of making tax deductible the full interest paid on housing loans, to thereby stimulate housing investment and private consumption. Another member also expressed the view that the purchase of automobiles and housing were the main engines of recovery in private-sector demand, and it was therefore worth considering tax reductions in these areas.

On public-sector investment, one member pointed out that, although a representative of the Economic Planning Agency predicted in a Monetary Policy Meeting in June that the effects of the comprehensive economic package would start to appear in August, public works orders included in the package were slow to be placed, especially in regional areas, and on the whole seemed to be delayed by about two months from the initial projection. Another member remarked that, reflecting the delay in public works orders, inventory adjustment of construction goods, which was expected to near completion in the first half of the fiscal year, was also proceeding at a much slower pace than anticipated.

Many members also mentioned that production, employment, and income were in a severe situation, reflecting the weak final demand.

Regarding production, one member stated that progress in inventory adjustment of some durable goods was good news, but there were no indications of a halt in the declining trend in shipments and production of raw materials. Another member mentioned that shipments and production of capital goods were notably weak reflecting the fall in business fixed investment, and pointed out that the recent decrease in production in general was causing a sharp deterioration in business sentiment.

In the discussion on employment and income conditions, many members expressed a concern that the stagnant final demand and the low level of economic activity were starting to have evident repercussions on corporate profits, employment, and wages, and this could in turn lead to a further deterioration in final demand. One member noted that employment and wage adjustments were usually advantageous in the sense that they would support corporate profits. The member pointed out, however, that firms were currently adjusting employment and wages at a faster pace than expected and at the same time curtailing fixed investment because, with a rapid profit squeeze, they had become increasingly cautious toward spending, and therefore the adjustments could not be taken positively. A few other members expressed the view that abrupt adjustments in employment were becoming evident mainly in small firms, and these were causing household spending to dampen further.

A few members commented that recent employment adjustment indicated that the conventional Japanese-style management practices could no longer function adequately. For instance, one member pointed out that, although in the past--for example in the adjustment phases following the oil crises--small firms had buffered the shock of severe employment adjustments by absorbing labor, they could no longer afford to serve such a function.

In the discussion on current price developments, one member commented that domestic factors were evidently weakening prices, while the downward pressure arising from lower import material prices observed in the first half of 1998 had abated. Another member also remarked that, although the pace of decline in wholesale prices was slowing, the fall in consumer prices was becoming evident. A few other members, referring to the continued gradual expansion of the output gap, also expressed concerns over the softening of prices caused by domestic factors. A different member expressed the view that, although firms were somehow managing to maintain sales prices, if economic conditions continued to deteriorate in the latter half of the fiscal year, the severe business conditions might compel them to cut prices drastically.

Thus, with regard to the current economic situation, members generally agreed that a risk had emerged that the rapid deterioration in employment and income conditions, together with the faster than expected declines in business fixed investment and housing investment, would further depress final demand.

B. Financial Developments

In the discussion on financial developments, many members expressed concern about stock market developments.

One member commented that, although stock prices had recovered after falling at the end of August to their lowest level since the bursting of the economic "bubble," the stock markets were still unstable. The member added that this instability, if prolonged, could further undermine corporate and household confidence and thereby increase the downside risk to the economy and prices. Another member also stressed that it was important to note the ongoing deterioration in business performance, and not be distracted by the recent sharp rebound in stock prices. A different member pointed out that, while firms were considering unwinding cross-shareholding to improve the efficiency of fund management, they could not easily make the move in the face of takeover risks that had been amplified by the low prices of their own stocks.

Members agreed that they should pay careful attention to future developments in the U.S. stock markets in relation to stock prices in Japan. One member expressed the view that the Japanese stock markets had become even more vulnerable, hit by developments abroad before any progress in the solution of Japan's financial system problems was able to improve market participants' projections for the economy and thus push up stock prices. Another member pointed out that the turmoil in Russia had caused increases in risk premiums in financial markets worldwide including the United States, where higher risk premiums had in the past often been followed by a downturn in the economy. Further, a different member pointed out that it was necessary to watch closely whether the substantial increase in capital flight from Europe to the United States observed in the first half of 1998 would continue. The member was mindful of possible developments in the U.S. stock markets until the end of 1998, and stressed the need to examine carefully their impact on economic activities in the United States and Japan.

Some members also commented that the uncertainty regarding the problems in the financial system was hindering the recovery of financial markets and economic activity.

Specifically, one member stated that, although progress in Diet deliberations on bills related to the Total Plan was expected to dispel the uncertainty gradually, restructuring in the banking industry, which faced structural adjustment pressure, was likely to place downward pressure on the economy in the short term. A few other members expressed the view that the uncertainty regarding the prospects for solution of the financial system problem as a whole, including progress in Diet deliberations on bills related to the Total Plan and resolution of a troubled bank, had made households even more cautious about spending.

Members also had an active discussion on the credit risks of firms and financial institutions. One member noted that, following bankruptcies of large firms and reporting of net losses, financial institutions were adopting stricter screening criteria for firms' borrowing of operating funds and firms had become nervous about extending trade credits, increasing cash settlement as a result. The member expressed a concern that the contraction of trade credits might constrain business activity. Another member also expressed the view that availability of funds to small firms was limited due to the cautious lending attitude of financial institutions, and should trade credits become inaccessible, small firms would experience an even more difficult business conditions. A different member expressed the hope that the government's measures to support small firms suffering from the "credit crunch" would help ease the difficult financing conditions of small firms. These members added that it was currently important to support business activities by increasing the amount of available funds.

On developments in money stock, one member expressed the view that, although the growth rate was at a reasonable level, this could not be evaluated positively if it reflected the procurement of on-hand liquidity rather than demand for funds for economic activities, as mentioned in the staff report.

C.The Economic Outlook

Taking into account the faster than projected deterioration in economic conditions and the unstable developments in the financial markets, discussions on the economic outlook focused on whether the Board's judgment at the previous meeting on August 11, that flexible fiscal policy management would prevent the economy from falling into a deflationary spiral, was still valid.

Most members generally agreed that the effects of the comprehensive economic package, which would appear fully in the near future, the implementation of tax reductions of 6 trillion yen and uninterrupted public investments under the so-called "15-month budget" would contain the downturn of the economy.

Members, however, also pointed out the following risks to this outlook.

With regard to fiscal expenditure, one member remarked that the rapid decrease in private-sector demand such as a sizable drop in business fixed investment could possibly cancel out the effects of increased public investment. The member added that, with the current budget for public investment, most of it would have been used by the second half of fiscal 1999. Another member also expressed the view that, considering the expanding output gap and the fact that fundamental solution of the nonperforming-loan problem would exert a negative impact on the economy along the process, fiscal policy in the immediate future could be expected to do no more than prevent further economic deterioration. A different member noted that there was still a prospect that the strong fiscal support would bring about a moderate economic recovery. The member also commented, however, that the delay in public works orders included in the comprehensive economic package, together with the continued low level of economic activity, added to the uncertainty about when the downward trend in the economy would be reversed.

Another member, in summing up this discussion, introduced an estimate that the annual rates of real GDP growth in fiscal 1998 and fiscal 1999 excluding the carry over effect would register about 1 percent, taking into account (1) the recent fall in business fixed investment and housing investment; (2) ongoing adjustments in inventory; (3) the recent deterioration in income conditions; and (4) the stimulative effects of fiscal policy measures projected to appear into fiscal 1999. The member added that this estimate fell slightly short of the potential GDP growth, and therefore, the growth might not be sufficient to avert further expansion of the output gap. The member also stated that, since a large part of the second supplementary budget for fiscal 1998 would be implemented in fiscal 1999 and there was a delay in the implementation of the comprehensive economic package, the projected growth for the second half of fiscal 1998 would be revised further downward, with negative repercussions on growth in fiscal 1999. This member, however, expressed the view that, if Japan's financial system problem and exogenous problems such as the turmoil in Russia were solved instantly, the economy would start to recover immediately from the current adjustment phase, but the possibility of solutions materializing immediately was rather remote.

While members mentioned various risks to the effectiveness of fiscal measures, a different member remarked that, although it was true that tax reductions so far had not had conspicuous effects, only providing modest support for the economy, their actual impact was appreciable considering what the economy could have experienced without them. Based on this view, the member commented that the sizable fiscal spending through public works and tax reductions in fiscal 1998 and fiscal 1999 was certain to produce effects, and therefore deserved due attention.

In the discussion on net exports, members exchanged opinions on whether they could be expected to continue to serve as a supporting factor for the economy.

One member pointed out that net exports were the only element that supported Japan's economy in the first half of fiscal 1998. Another member mentioned that some major manufacturing industries had indeed focused on promoting exports against the background of the yen's depreciation and sluggish domestic sales, and that this had supported their profits. This member, however, was concerned about a possible rekindling of trade friction if the U.S. economy slowed in or after the second half of fiscal 1998, and projected that if this risk materialized, it might press those industries to restrain exports and curtail production.

On the recent rebound in the yen's exchange rate, many members expressed the view that the development had not been accompanied by any improvement in Japan's economic fundamentals. The members remarked that, considering the fact that net exports were the only possible source of an economic recovery, a higher yen could add to the downward pressure on the economy. Specifically, one member commented that the recent rebound in the yen would be a cause for concern for the automobile industry, where inventory adjustment was almost complete. Another member stated that the development could place stronger downward pressure on domestic wholesale prices by lowering import prices.

Many members remarked that Japan's economy was faced with severe structural adjustment pressures, including the problems in the financial system, and this was amplifying the uncertainty regarding the economic outlook. One pointed out that, to offer economic entities a clear prospect, it was necessary to implement permanent tax cuts and tax-cutting policy measures in specific areas, and also to present a future vision that would wipe out the anticipation of future tax increases to finance the tax reductions. This member also stated that the immediate impact of the conventional use of public works, in addition to the effects of structural reform of the fiscal system, could not be neglected. Accordingly, the member suggested that it might be effective to launch a plan to improve urban infrastructure and set forth a large-scale project to prepare for the 21st century.

In sum, members considered that the economic outlook was gloomier than at the time of the previous meeting, although they still had expectations for the effects of fiscal policy.

There were, however, differences of opinion among members regarding the overall judgment on the current economic situation and the outlook.

Specifically, some members indicated a bleak prospect that (1) Japan's economy was on the verge of a deflationary spiral, and (2) in view of the developments in economic activity and financial markets, the possibility could not be precluded that the economy would fall into a deflationary spiral in the future, from which achieving a recovery might be quite costly.

A few other members expressed an even gloomier view that the economy might already be in a deflationary spiral. One expressed a serious concern about the overall economic situation, pointing out that (1) the most recent Composition Index (CI) of the Economic Planning Agency suggested that the current pace of economic deterioration was as fast as that immediately following the bursting of the economic "bubble"; and (2) the Local Business Outlook (LOBO) of the Japan Chamber of Commerce and Industry indicated that small firms faced severe business conditions. Another member was also deeply concerned that the economy had continued to register negative growth, and remarked that it was following a severe downward path without any recovery in sight.

Regarding this view, another member pointed out that it was anticipated that the impetus for an economic recovery provided by economic policies would not be sufficient to counter the downward pressure on the economy, and the recovery would therefore be very slow. The member further remarked that the present situation was quite severe, and there was a risk that, if the economy were left unattended, a possible destabilization of the financial markets would prolong the economic adjustment.

A different member was of the opinion that, although it was true that the economy was now in the most difficult period since this April, the effects of the comprehensive economic package of 16 trillion yen were expected soon to permeate industries, and tax reductions could still produce favorable effects in the household sector.

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.

The few members who were more pessimistic about the economic situation claimed that the Board should decide on a further easing of monetary policy.

One member, emphasizing the need to take some measure to prevent a double-dip decline of the economy, claimed as in the previous meeting that the target level of the uncollateralized overnight call rate should be reduced to 0.25 percent. The member, pointing out that the lending attitude of financial institutions continued to be cautious and a "credit crunch" was observed in some parts of the economy, suggested that the Bank's injection of ample funds into the markets would relax the cautious attitude of financial institutions. And because the provision of liquidity had been limited to the extent that market interest rates remained at around 0.40-0.42 percent, the member stressed that additional injection of funds would require a lowering of the target level to about 0.25 percent. Moreover, the member stated that, with the yen appreciating against the U.S. dollar, implementation of monetary easing at this point was likely to have only a small impact on other Asian currencies. The member acknowledged that a reduction in interest rates might have a negative influence on households that rely on pensions and interests on deposits, but judged that, with unemployment rate rising rapidly, it was inevitable that priority be placed on supporting firms.

Another member was of the opinion that, having monitored carefully for over two months the risk of the economy falling into a deflationary spiral, it was time that the Bank promptly and boldly decided to take action to reduce such a risk, and accounted to the public for such action. This judgment was based on the fact that the effects of the comprehensive economic package were slow to permeate, establishment of a scheme for stabilizing the financial system was delayed, and developments in the financial markets were unstable. Specifically, the member considered that it would be appropriate to implement the following two measures together: (1) adoption of a guideline for money market operations requiring that the Bank encourage a lowering of the target level of the uncollateralized overnight call rate to about 0.25 percent and inject ample funds into the markets, while keeping the official discount rate unchanged; and (2) reduction of reserve requirement ratios to decrease the required amount of central bank reserves by approximately 1 trillion yen. The member stressed that the primary objective of this action was provision of ample liquidity, claiming that it was important to prevent a further weakening of corporate and household confidence and a contraction of the lending capacity of financial institutions by this action. The member also added that it was desirable to lay down a specific target level for the uncollateralized overnight call rate.

A few other members also concluded, taking into account the need to stabilize the financial markets and the effects and side-effects on the economy, that it was appropriate to further ease monetary policy.

One member mentioned that the economic conditions were extremely severe, and both fiscal policy and fundamental solution of financial system problems were needed to resolve this situation. Based on the extremely harsh judgment that the economy was on the verge of a deflationary spiral, however, the member was also of the opinion that it had become desirable to take possible monetary policy measures, unless it was evident that lower interest rates would not have any positive effect. The member added that, although the hope for an economic recovery in the second half of fiscal 1998 into fiscal 1999 did not need to be abandoned, if the likely scenario was a fall into a deflationary spiral, policy management should give due consideration to this. On the possible side-effects of a lowering of interest rates, this member had in previous meetings expressed concern about the impact of a decline in the yen on other Asian economies, but judged that such a risk had been reduced in view of the market sentiment behind the recent appreciation of the yen. The member also noted that, although the possible negative impact on household sentiment required continued attention, the intensified pressure on firms and the negative influence it had exerted on employment and wages implied that providing support for the corporate sector would also bring positive effects to the household sector. Based on these views, the member claimed that it was appropriate to lower the target level for the uncollateralized overnight call rate to 0.25 percent.

Another member stated that, until the previous meeting, the member had favored keeping monetary easing measures in reserve for when market disruptions occurred. This member, however, was strongly concerned that the risk of the economy falling into a deflationary spiral had gradually increased reflecting the delay in the effects of the comprehensive economic package, and that substantial cost would be necessary for achieving a recovery once the economy fell into such a spiral. Having such concerns and in view of the persisting uncertainty regarding the outlook for solution of the financial system problems and the volatile stock market developments since the end of August, this member noted that it had become increasingly important to implement monetary policy measures to stabilize market conditions. The member recognized that a lowering of interest rates could have negative repercussions on the interest incomes of households, but argued that it was difficult to respond directly to this problem through macroeconomic monetary policy, and top priority should be placed on revitalizing economic activity as a whole.

Another member also pointed out that the economic situation as well as the outlook had worsened somewhat since the previous meeting, and with the recent volatile movements in the financial markets, the downside risks to the economy and prices through a further deterioration in corporate and household confidence had increased. Based on this view, the member remarked that it had become essential to deliberate carefully whether it was appropriate to leave monetary policy unchanged. The member, acknowledging that it was controversial how much effect could be expected of a reduction in interest rates, believed that it was time for the Bank to show its determination to take measures, including those to stabilize the financial markets, amid persisting uncertainty surrounding the financial system. The member noted that, even if the Bank reduced interest rates, the probability of the action causing disruptions in other Asian economies through a decline in the yen had been reduced.

A different member remarked that the time had come to consider the appropriateness of further easing monetary policy on the following grounds: (1) the deflationary pressure in the economy was strengthening, and the risk that the trend would accelerate was not negligible; (2) economic activity was at such a low level that the effects of fiscal policy was unlikely to produce effects as initially anticipated; and (3) uncertainty remained with regard to the problems in the financial system and the financial markets had become unstable. On this basis, the member focused on the transmission mechanism of the effects of monetary easing, and made the following comments:

  1. (1) Under the normal circumstances, a lowering of interest rates and a resulting rise in asset prices could be expected to encourage economic entities to spend. However, with the nonperforming-asset problem burdening the economy, the policy action could not be expected to generate much effect; at most it would support housing investment.
  2. (2) Past experiences proved that a reduction in interest rates supported the domestic economy through a depreciation of the country's currency.
  3. (3) A reduction in interest rates accompanied by monetary expansion was likely to produce effects by influencing the expectations of economic entities.

The member also remarked as follows on the negative outcomes of monetary easing:

  1. (1) The argument concerning the negative effect on interest income should not be neglected, but such an impact should not be overemphasized.
  2. (2) Given the recent upward trend in the yen, the probability that a decline in the yen would unfavorably affect other Asian currencies was small.
  3. (3) However, because monetary policy effects materialize with a six-month to one-year delay, the outcomes of the policy action might coincide with fiscal policy effects, and therefore, it was necessary to be aware of the possibility that such mixed effects might have a destabilizing impact on the economy.

Based on such considerations, the member judged that, although a further monetary easing might not produce its maximum effects due to the already low level of interest rates, its side-effects, which had been the cause for concern, were unlikely to be substantial. Therefore, the member indicated a strong preference for a monetary easing.

Another member remarked that, although financial markets showed unstable developments, both short- and long-term interest rates were generally stable and the situation was not critical. Therefore, the member felt strong hesitation to take action at this meeting. This member, however, noted that the decline in the level of economic activity amid the lagged effects of fiscal spending should not be overlooked, and expressed a concern that the economy had become vulnerable to shocks. The member also commented that real interest rates were increasing as prices fell, and the economy might be on the verge of a deflationary spiral. As for monetary policy, the member concluded that it had become more important to implement measures to prevent deflation. The member added that the Bank needed to respond to the public's criticisms about the very low interest rate level by explaining that such policy action would be a historic move.

A member stated that the sluggishness of the economy was within the range predicted, but expressed a concern about the threats this imposed through disruptions in the financial markets. This member remarked that it was extremely important that the Bank distinctly show its determination to continue injecting ample liquidity into the financial markets, where uncertainty prevailed over the nonperforming-asset problem. The member explained that this would convince the public that the Bank was doing its utmost to support Japan's economy, which was at a historical turning point, and that in order to ensure provision of ample funds, it was necessary to allow for the resulting interest rate decline. The member noted that, especially in view of households that would be affected significantly by an interest rate reduction, lowering interest rates would be a difficult and painful decision for the Bank to make. The member added, however, that by giving adequate explanation why priority should be placed on the provision of liquidity, the Bank would be able to gain the understanding of such households.

A different member objected to such arguments for monetary easing, claiming that the guideline for money market operations should be left unchanged. This member pointed out that additional interest rate reduction was not desirable in that it would afflict households further, which were already forced to hold back on spending affected by firms' restructuring. The member acknowledged that the economy was in its worst situation since April 1998. However, citing the results of an opinion survey on lifestyle and financial behavior by the Central Council for Savings Information that households had been restraining consumption on account of decreased disposable income, the member expressed a concern that a decline in interest income would further depress household spending, which would negatively affect the entire economy. In addition, the member pointed out that there had been few requests from firms for a lowering of interest rates, and expressed a concern that the measure could not be expected to make sufficient funds available in all corners of the economy. In light of these demerits, the member concluded that a further monetary easing was not the best option at this point, and it was more important to await the effects of expansionary fiscal policy, which were expected to materialize in the second half of fiscal 1998.

In sum, many members expressed the opinion that it was necessary to further ease monetary policy, and it was appropriate to induce a lowering of market interest rates. The Board continued active discussion on the importance of clearly indicating to the markets that the Bank would continue to take a firm stance on addressing any further instability in the financial markets.

On the basic stance of monetary policy, a member who had a strong preference for an additional easing remarked that the policy action should be taken in a way that would produce significant effects, including an announcement effect. This view was based on considerations that the intensifying nonperforming-asset problem was affecting corporate financing, leading to a decrease in effective demand. In this context, the member suggested that it might be possible to establish a target range for market interest rates, for instance a range of 0.0-0.3 percent, and lower the target level within the range as necessary according to progress in deflation, falls in money stock, and disruptions in the financial markets.

Another member also remarked that, in light of the instability of the financial markets, it was necessary to allow for flexible provision of funds while setting a target level for interest rates. A different member expressed the view that there could be situations in which it was appropriate for the Bank to continue providing liquidity even if this should bring down market interest rates below the target level.

Another member who suggested that it was desirable to reduce the target level for market interest rates to 0.25 percent also stated that, to secure the stability of the financial markets, the Bank should show that it was resolved to inject reserves into the markets when liquidity shortages arose, even if this would induce rates to decline below the newly decided target level. The member remarked that this was similar in concept to setting a target range of 0.0-0.3 percent and gradually lowering rates within that range. The member who advocated the target range scheme also agreed to the similarity.

Another member raised a question of whether or not the Board should consider reducing the official discount rate if the Bank was to provide ample liquidity and allow for an entailing decline in market interest rates. Some members expressed the view that the financial markets were not in a disruptive state, and therefore, it was appropriate to lower just the market interest rates for the present. A different member added that only a few market interest rates were still linked to the official discount rate, and therefore, it was acceptable to set a target level for market interest rates as the main objective of monetary policy management.

In sum, many members shared the view that the Bank should provide liquidity as necessary to stabilize the financial markets, regardless of the newly decided target level for the uncollateralized overnight call rate. One member raised a question about the process of decision-making and implementation, about how to justify the Policy Board, the sole decision-making body in terms of monetary policy, entrusting the Bank's staff with judgments on the injection of funds regardless of the target level of interest rates. After a few members expressed views on this matter, all of the members confirmed and agreed to the following:

Since the financial markets were currently unstable, there was a possibility of abrupt movements. Therefore, the Board should indicate in the policy directive issued to the Bank's staff that the staff was able to supply ample liquidity flexibly without regard to the newly decided target level for the overnight call rate by judging the necessity of the policy action. When such liquidity provision was executed, the staff should report the action immediately to the Policy Board members. If any member decided it necessary after scrutinizing the action, the member would, pursuant to law, request the Chairman to call a Monetary Policy Meeting.

VI.Votes

At the conclusion of the Board's discussion, most members supported the view that, in the implementation of monetary policy for the intermeeting period ahead, the Bank should further ease the stance of monetary policy, encouraging the uncollateralized overnight call rate to decline to around 0.25 percent, while providing more ample liquidity when judged necessary to maintain the stability of the financial markets. This policy was aimed at (1) preventing any further deterioration in the economy and (2) securing the stability of the financial markets. Meanwhile, one member held a different view and another favored an additional measure for monetary easing. Therefore, three policy proposals were put to the vote.

Ms. Shinotsuka made a proposal to maintain for the intermeeting period ahead an unchanged guideline for money market operations that the Bank should encourage the uncollateralized overnight call rate to remain on average slightly below the official discount rate. The proposal was defeated with one vote in favor and eight against.

Mr. Miki made a proposal to adopt a guideline for money market operations in the intermeeting period that the Bank should encourage the uncollateralized overnight call rate to be, on average, around 0.25 percent, provide the markets with ample liquidity, and lower reserve requirement ratios to reduce the average amount of required reserves by approximately 1 trillion yen. 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.

The Bank of Japan would encourage the uncollateralized overnight call rate to move on average around 0.25 percent.

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

Ms. Shinotsuka dissented because, although she acknowledged that the economic conditions were deteriorating, a lowering of interest rates would further oppress households. She had not confirmed any serious unsettlement in the financial markets, and therefore, believed that no additional monetary policy measure was needed at this meeting.

VII.Discussion on the Press Release, "Change of the Guideline for Money Market Operations"

The Board discussed the content of the press release, "Change of the Guideline for Money Market Operations," and by majority vote, decided to publicize it as attached.3

Votes for the release:
Mr. M. Hayami
Mr. S. Fujiwara
Mr. Y. Yamaguchi
Mr. Y. Gotoh
Mr. S. Taketomi
Mr. T. Miki
Mr. N. Nakahara
Mr. K. Ueda
Votes against the release:
Ms. E. Shinotsuka.
  1. 3The Board discussed and voted on the Japanese original of the press release, based on which the Bank's staff produced an English translation.

VIII.Discussion on 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," for publication on September 11, 1998 in the Monthly Report of Recent Economic and Financial Developments (consisting of "The Bank's View" and "The Background").4

  1. 4The original full text, written in Japanese, of the Monthly Report of Recent Economic and Financial Developments was published on September 11, 1998 together with the English version of "The Bank's View." The English version of "The Background" was published on September 25, 1998.

Attachment

For immediate release

September 9, 1998
Bank of Japan

Change of the Guideline for Money Market Operations

(1) The Bank of Japan today held a Monetary Policy Meeting, a regular meeting of the Policy Board on monetary policy. By majority vote, the Policy Board determined to further ease the stance of money market operations for the inter-meeting period ahead as follows:

The Bank of Japan will encourage the uncollateralized overnight call rate to move on average around 0.25%.

Regardless of the above guideline for the call rate, the Bank of Japan will provide more ample funds, if judged necessary, to maintain the stability of the financial markets.

(2) The overall economic condition of Japan has been deteriorating, and prices on a downward trend. Private bank lending has been declining, and the growth of money supply rather moderate. The money and capital markets have shown unstable developments, such as those seen in the risk premium on interest rates and stock prices.

The pace of further deterioration of the economy is expected to gradually slow down by the implementation of the government's fiscal policy measures including the comprehensive economic package. However, the level of economic activity has already declined considerably. In addition, there is a risk that recent developments in the financial markets and the increase in bankruptcy might further weaken the confidence of corporate and household sectors. Bearing these in mind, we cannot entirely preclude the possibility that economic and price conditions will worsen more.

(3) The monetary policy objective of the Bank of Japan is to pursue price stability, avoiding both inflation and deflation. Taking into account the present economic and financial conditions, the Bank of Japan decided that the above-mentioned monetary easing measures be appropriate in order to prevent the economy from falling into a deflationary spiral and to ensure the slowdown of economic deterioration.

(4) The Bank of Japan, through continued injection of ample funds under the above-mentioned policy guideline, will make every effort to keep the stability of the financial markets, thereby accommodating the expansion of money supply.

(5) At present, recovery of business conditions and revitalization of the financial system are the imminent issues in the Japanese economy. The Bank of Japan strongly hopes that the decision to make money market operations more accommodative will facilitate the resolution of these issues and that all parties concerned will make their utmost efforts in surmounting the economic difficulties they face.