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Minutes of the Monetary Policy Meeting

on January 19, 1999
(English translation prepared by the Bank staff based on the Japanese original)

March 2, 1999
Bank of Japan

A Monetary Policy Meeting of the Bank of Japan Policy Board was held in the Head Office of the Bank of Japan in Tokyo on Tuesday, January 19, 1999, from 9:01 a.m. to 12:12 p.m., and from 1:03 p.m. to 3:34 p.m. 1

Policy Board Members Present
Mr. M. Hayami, Chairman, Governor of the Bank of Japan 2
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 Representative Present
Mr. T. Mutoh, Deputy Vice Minister for Policy Coordination, Ministry of Finance 3
Mr. S. Shimpo, Director-General of the Research Bureau, Economic Planning Agency 4

Reporting Staff
Mr. I. Kuroda, Executive Director
Mr. M. Matsushima, Executive Director
Mr. S. Nagata, 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

  1. The minutes of this meeting were approved by the Policy Board at the Monetary Policy Meeting held on February 25, 1999, as "a document which contains an outline of the discussion at the meeting" stipulated in Article 20, Paragraph 1 of the Bank of Japan Law of 1997. Those present are referred to by their titles at the time of the meeting.
  2. Mr. Hayami was absent from 9:01 a.m. to 9:17 a.m. to attend a meeting of the Ministerial Council which discussed issues including the Economic Planning Agency's Monthly Economic Report. During his absence, Mr. Fujiwara performed the duties of chairman pursuant to Article 16, Paragraph 5 of the Bank of Japan Law of 1997.
  3. Mr. Mutoh was present from 9:01 a.m. to 3:34 p.m.
  4. Mr. Shimpo was present from 10:33 a.m. to 3:34 p.m.

I. Summary of Staff Reports on Economic and Financial Developments 5

A. Money Market Operations in the Intermeeting Period

Market operations in the period since the previous meeting on December 15, 1998 were conducted in accordance with the guideline determined at that meeting:

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

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

As a result, the weighted average of the uncollateralized overnight call rate in the previous reserve maintenance period (from December 16, 1998 to January 15, 1999) stood at 0.25 percent. On January 18, 1999 (the day before the meeting), the first business day of the current reserve maintenance period, the uncollateralized overnight call rate was steady at 0.23 percent.

The uncollateralized overnight call rate rose in the transactions on December 30, 1998, the year-end. However, due to the Bank's active injection of ample funds into the market, the weighted average of the uncollateralized overnight call rate for that day was 0.32 percent, which was not especially high for the last business day of the year. In early January 1999, the key rate tended to rise because many contracts on term instruments maturing over the year-end became due. The Bank therefore supplied ample funds to stabilize the market. For the period following, the rate declined reflecting the fact that financial institutions had already secured sufficient reserves for the reserve maintenance period.

As for term instruments, interest rates on three-month contracts were rising slightly, due to the fact that the due dates for these contracts were after the fiscal year-end. However, excluding this factor, interest rates were generally stable. This unexpected stability in market conditions was partly because (1) market participants considered that injection of public funds, the amount of which was reported to be approximately 6 trillion yen, was likely to be realized by the fiscal year-end; and (2) the Bank's continued commitment to inject ample funds impressed the market favorably.

Nevertheless, the currently stable money market required close attention because financing conditions in the market might tighten again toward the fiscal year-end, reflecting the persisting uncertainty about the requirements for public funds injection and the instability in overseas economic and financial situations in such countries as Brazil.

The Bank would make its second loan disbursement under the temporary lending facility to support firms' financing activities (decided by the Board in November 1998) on January 20, the day following the meeting. The upper limit on loans to be disbursed, determined according to the increase in loans extended by financial institutions during the period from October to December 1998, was over 4 trillion yen. However, due to the rather stable conditions in the financial markets, the total of the actual request for the second disbursement and the first disbursement that had already been made amounted to only a little over 1 trillion yen. As a result, 3 trillion yen would remain unused. Nevertheless, this amount provided security to financial institutions since this could be used as a credit line should tension intensify in the markets toward the end of the fiscal year.

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

1. Developments in foreign exchange markets

The appreciation of the yen against the U.S. dollar accelerated from late December 1998 to early January 1999. This was partly due to (1) the surge in long-term interest rates in Japan; (2) the strengthened anxiety about the worsening economic and financial conditions in Latin America; and (3) the concern about the possible worsening of trade friction between Japan and the United States. As a result, on January 11, the yen jumped to the 108-109 yen level, the highest recorded in two and a half years. Thereafter, the yen weakened against the background of (1) a reported intervention (purchase of the U.S. dollar against the yen) on January 12 in the Tokyo market; (2) the concern about the possible contagiousness of the currency crisis to Asia from Latin America; and (3) the remark made by Mr. Rubin, Secretary of the Treasury of the United States, suggesting support for a strong U.S. dollar. Recently, the yen fluctuated around the 114 yen level.

The launch of the euro was smooth. The euro was firm against the U.S. dollar, due partly to the effects of the economic and financial problems in Latin America. In relation to this, government securities of Germany and France were being bought, and the yields of both marked new postwar record lows.

Meanwhile, faced with the weakness of the Brazilian real, the Brazilian monetary authorities devalued the currency and widened the target range on January 13. Further, on January 15, it was decided to abolish the target range itself, and a floating exchange rate regime was introduced on January 18. There had been some concern about the effect on other Latin American currencies and Asian currencies, but the markets were currently stable.

2. Overseas economic and financial developments

In the United States, household spending continued strong against the background of high stock prices and other favorable factors. Although labor markets were tight, the increase in labor cost remained moderate. As regards the future, there were risks such as (1) a possible detrimental effect of a fall in stock prices on household spending; (2) further constraints on business fixed investment due to the decline in exports; and (3) reemergence of the large risk premium in financial markets. However, the materialization of these risks had been avoided so far, and the pace of the deceleration of the economy would likely be more moderate than once expected.

In China, trust and investment companies, nonbanks backed by local governments, were facing difficulty in financing. Guangdong International Trust and Investment Corporation was revealed to be bankrupt, and some other trust and investment companies were already late or would possibly be late in repaying their debts. At present, stock prices and the currency were stable. However, a rise in the cautiousness toward China among overseas investors was inevitable, and the development and influence of such market sentiment required close attention.

C. Economic and Financial Developments in Japan

1. Economic developments

As for final demand, business fixed investment had been declining significantly. Private consumption and housing investment remained sluggish. Meanwhile, net exports were on a moderate upward trend, and public investment had started to increase. With such developments in final demand and progress in inventory adjustment, the decline in production was slowing. As a result, although firms' business sentiment was still worsening, the pace of the deterioration was decelerating somewhat. Meanwhile, prices were weak overall.

Although economic conditions continued to worsen, the pace of the deterioration was slowing, as reflected in the above developments. However, corporate profits were basically on a downtrend, and firms' spending activities were being constrained as there remained some uncertainty about the availability of funds toward the end of the fiscal year. As for household spending, although some positive factors were perceived, it remained stagnant as a whole under the increasingly severe income conditions where employment and wages were declining. Therefore, no significant change was observed in the persistent sluggishness in private demand.

With regard to the economic outlook, public investment was expected to underpin the economy for the time being. Tax reductions, principally in personal and corporate income taxes, were also expected to have some effect in supporting the economy. However, considering the above-mentioned conditions in corporate and household earnings, it was highly likely that such measures would have a limited effect on private demand. In other words, it was possible that the decline in business fixed investment and severe employment conditions would continue. Furthermore, if the surge in long-term interest rates and the current appreciation of the yen were to persist, there would be a risk that they would further push down corporate profits.

Continued monitoring was necessary of the effect of the ongoing decline in prices. Considering the likely persistence of the large output gap in the economy and the effect of the yen's appreciation, the decline in overall prices was expected to gradually accelerate in fiscal 1999. The private sector's anxiety about a possible deflation might strengthen as a result, and the rise in real interest rates might have adverse effects on the economy. These risks required to be taken into consideration.

2. Financial developments

In the financial markets, a slight increase was observed in the Japan premium and in Euro-yen interest rates, on three-month contracts in both cases, as these contracts would mature beyond the fiscal year-end. However, the premium and the rates were in general stable at a low level, compared to the same period of the previous year and the period toward the end of the previous semiannual accounting period in September 1998. The stability in the money market was partly against the background of (1) Japanese banks' successful procurement of foreign currency maturing beyond the year-end; (2) the weakening of the heightened anxiety in international financial markets; and (3) a clearer prospect of public funds being injected into major banks.

Yields on Japanese government bonds rebounded from late November 1998, due partly to the slowdown in economic deterioration. Furthermore, from the middle of December 1998, the rise in the yields accelerated in response to reports of massive issuance of Japanese government bonds planned for fiscal 1999. Many market participants attributed the rise in the long-term interest rates to the anticipated worsening of the supply-demand balance of Japanese government bonds. However, there were other possible factors to be considered including (1) improvement in business sentiment; (2) anxiety about inflation risks in the future due to the prospective expansion of the fiscal deficit; and (3) the swing back from the "flight to quality." Nevertheless, these factors did not seem to fully explain the rise in yields on Japanese government bonds especially that from the middle of December 1998. Thus, how the level of the yields would settle down warranted careful attention.

The tension in corporate financing seemed to have eased somewhat. This was due to (1) the weak demand for funds to be used in economic activities against the background of the significant decrease in business fixed investment; and (2) the active utilization of the credit guarantee system by private banks, although they were basically maintaining their cautious lending stance. The expansion of the credit guarantee system and the Bank's introduction of new measures for money market operations seemed to be facilitating corporate financing. Furthermore, due to the increase in the amount of credit guarantees and fiscal expenditures, the rising trend in corporate bankruptcy was subsiding.

  1. 5Reports were made based on information available at the time of the meeting.

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

A. The Current Economic Situation

In the Board's discussion on the current economic situation, many members commented that the economic situation was generally in line with what had been reported by the Bank's staff: economic deterioration had moderated and had come close to a halt. As reasons for this judgment, these members cited positive developments in the economy such as (1) the increase in public investment; (2) a slight recovery in private consumption in the October-December quarter; (3) a halt in the decrease in production; and (4) the recent amelioration in the stringent financing conditions faced by firms. Some members also mentioned developments in housing investment, saying that it might have hit bottom, considering the projected interest rate rise and the expected effects of the cuts in housing investment-related taxes.

At the same time, many members shared the view that the outlook for the economy remained unclear, given the distinctly unfavorable developments in corporate profits and in employment and income conditions, and the resulting continued weakness in business and household confidence. Many members considered the rise in long-term interest rates and the appreciation of the yen from around the end of 1998 as risks to the economy. Due to such developments, one member revised downward slightly the member's judgment on the economy made at the previous meeting.

One member, who was especially concerned about the negative effects of the rise in long-term interest rates and the appreciation of the yen, stressed that the economy was already showing signs of another downturn. This member noted the decline in the coincident indicators of the business conditions indexes. The coincident indicators had risen in September 1998 but had fallen back in October and November to a level below that in August. At this critical juncture where the economy could turn for the better or for the worse, the member took the decline as indicating that the probability was tilted toward an economic downturn.

B. Financial Developments

With regard to developments in the financial markets, members generally agreed that the money market was stable, but opinions varied on the assessment of the rise in long-term interest rates and the appreciation of the yen from around December 1998.

On long-term interest rates (yields on ten-year benchmark government bonds), many members noted the basic theory that, in the long term, rates are determined based on the economic fundamentals, and stated that the recent decline following a surge was in line with this theory. One member remarked that there was some room for further decline, based on the member's view of the outlook for the economy. Another member mentioned that a slight decline from the current level would be consistent with the weakness in demand for funds in the private sector. There was also an opinion that, if the current level of long-term interest rates was detrimental to the economy, it would not last long given proper functioning of the market mechanism.

Concerning the low level of long-term interest rates around autumn 1998, many members shared the understanding that it had been far too low, being perhaps affected by the "flight to quality." One of these members commented that the current rebound in long-term interest rates should be taken as part of a normalization process from a "bubble" in the bond market. Another remarked that the current level was not too high.

One member evaluated the level of long-term interest rates based on the economic fundamentals using a function employed in a paper included in the June 1998 issue of the Nippon Ginko Chousa Geppo (Bank of Japan Monthly Bulletin). This function includes explanatory variables such as the call rate, the inflation rate, and industrial production. Using recent economic data, the member estimated the appropriate level of long-term interest rates to be around 1.0-1.5 percent and commented that it was not far off the actual figure. According to this member, this result implied that the long-term interest rate level would not rise any further for some time as long as the current trend in prices and production continued, and that the level around autumn 1998, which went below 1 percent, was exceptionally low. On the second point, this member was of the opinion that it most likely reflected the "flight to quality" by financial institutions, which used their available funds to purchase government bonds instead of lending to the private sector.

On the other hand, some members were concerned about the rise in long-term interest rates, which did not seem to be fully explained by the developments in the economy, and focused on its possible relationship with the fiscal deficit. One member commented that, reflecting concern about the planned increase in the issuance of government bonds, some new kind of risk premium related to holding government bonds that had emerged in the markets might have translated into higher long-term interest rates. Another member remarked that the expansion of government debt outstanding might be pushing up long-term interest rates. According to this member's estimate, government debt outstanding was already very large, taking into consideration the debts related to public pensions, which had not yet surfaced, and contingent liabilities associated with the implementation of financial system revitalization measures. The member further commented that, in this fiscal situation, the markets might be concerned that an inflationary policy would be adopted some time in the future, and this might be adding to the upward pressure on long-term interest rates.

Another member who was especially concerned about the effects of the severe fiscal condition on long-term interest rates remarked that the recent rise in long-term interest rates should be understood as "a revolt of the market" against fiscal policy management. According to this member, long-term interest rates, which had generally followed a declining trend from 1990, had stopped falling late last year and turned to an upward one. This member warned that a surge in long-term interest rates could be triggered by rather trivial factors such as casual remarks by the policy makers.

As for foreign exchange markets, many members stated that close attention should be paid to the developments more than those of long-term interest rates, with due consideration given to whether the yen diverged from the fundamentals of Japan's economy. Specifically, some members stated that the recent appreciation of the yen could not be explained solely by economic developments in Japan. They noted that the foreign exchange markets were complicated by various factors such as the launch of the euro and the unclear outlook for the economies in Latin America. A different member attributed the recent rise in the yen to (1) the contrasting situation between the rise in long-term interest rates in Japan and the prospective interest rate fall in the United States and in the euro area; (2) concerns regarding the outlook for the economy and the stock prices in the United States; and (3) the recently emerging Japan-U.S. trade friction, which might intensify as the U.S. presidential election starting from early 2000 approached.

One member mentioned that there were reports on a proposal to stabilize the exchange rates between the three major currencies, i.e., the U.S. dollar, the euro, and the yen. The member commented that the progress of the discussion in this area should be closely monitored because it would inevitably have serious implications for countries' independence in monetary policy.

On bank lending and corporate financing, members generally agreed that the previously tight credit conditions had been alleviated by active use of the expanded credit guarantee system and due to the fact that public funds injection was to be carried out in the near future. One member pointed out that the decline in the number of corporate failures was one of the signs suggesting an abatement of the downside risk to the economy related to corporate financing.

C. The Economic Outlook

The discussion on the economic outlook focused on whether the prospective effects of various policy measures implemented so far would be strong enough to combat the weakness in private-sector demand. The majority of members concluded that public investment would underpin the economy for a while but that there was no clear prospect of economic recovery at this stage, given factors such as the weak private-sector demand and risks associated with economic developments overseas.

With regard to public investment, one member commented that the effects of the emergency economic package released on November 16, 1998 were expected to materialize especially in the April-June quarter of 1999, and that this would be immediately followed by the implementation of public investment included in the initial budget for fiscal 1999. This member therefore projected that construction related to public works would increase around the beginning of fiscal 1999 and remain high well into the year without any break. Other members generally shared the view that public investment would be the most important factor underpinning the economy in the immediate future. However, one member was more cautious about the effects of the fiscal support. The member estimated that additional stimulus from public investment and tax reduction in fiscal 1999 would be less than that in fiscal 1998, during which three supplementary budgets had been adopted, unless a supplementary budget was also adopted for fiscal 1999.

Members then discussed private-sector demand. On business fixed investment, members generally agreed that the sharp decline was likely to continue for some time. Comments supporting this view were that (1) firms were in the midst of a drastic stock adjustment process; and (2) the leading indicators of business fixed investment were weak. One of the members with the above opinion projected that the ratio of nominal business fixed investment to nominal GDP in Japan would decline close to the level in the United States.

Given the above discussion on the corporate sector in which members agreed that business fixed investment was undoubtedly weak, assessment of the household sector became all the more important in considering the economic outlook. With regard to private consumption, some members pointed out that there had been some improvement since autumn 1998. However, the majority, including these members, considered that private consumption was not likely to follow a steady upward trend. They based this view on the fact that employment and income conditions were projected to become even more severe and that introduction of new products and other stimulus measures had not been widely employed by the supply side.

As for housing investment, some members considered that the outlook could turn positive, given the increase in the number of applications for loans provided by the Housing Loan Corporation and the effects of the temporary housing investment-related tax reductions. However, even these members agreed that the severe employment and income conditions would hamper expansion in housing investment. A member stated that it was difficult to foresee an economic recovery driven by the household sector due to factors such as uncertainty regarding the future, including uncertainty about pensions, and the heavy housing-loan burden on some households.

Members then discussed corporate profits, which would greatly influence economic activities in the private sector. The majority were concerned about the declining corporate profits. Specifically, many members expressed concern over the various pressures from the financial markets, such as the recent appreciation of the yen, the rise in long-term interest rates, and the drop in stock prices, which were a burden on the already severe corporate profit situation. One of these members pointed out that the declines in both land and wholesale prices were aggravating firms' debt burden. Another member expressed extreme caution regarding the results and the effects of the fiscal-year-end settlement, in which firms' financial position--worsened by the decline in earnings together with the decrease in unrealized gains on firms' assets such as land, stocks, and bonds--would be revealed.

With regard to the effects of the appreciation of the yen on Japan's economy, some members noted positive aspects such as improvements in the terms of trade and an increase in imports from Asian countries. Most members however agreed that, in the current economic situation, negative effects should be given more attention, particularly those on the already weak corporate profits discussed above. One member claimed that many firms had drawn up their business plans based on an exchange rate of the yen against the U.S. dollar at the 120-129 yen level. The member continued that the appreciation of the yen to above the 110 yen level would therefore greatly damage firms' profits. Another member commented that the rise of the yen over a certain critical level would trigger another stage of economic adjustment as already experienced in the 1990s, when the yen surged twice amid economic stagnation.

Some members also pointed out that developments in credit extension by financial institutions did not provide any drive to push up private-sector demand. Specifically, one member noted that, although the earlier tightness in corporate financing was being alleviated, it remained unclear how public funds injection into banks would be realized by March, the end of fiscal 1998, and how this would affect corporate financing as a whole. Another member remarked that the injection of public funds would help to some extent to avert the extremely strong deflationary pressure that could arise from credit contraction. However, this member continued that it would still take a long time for the banking sector to produce any positive drive for the economy. A different member commented that, if long-term interest rates remained high, the negative effects would first surface in the profits of financial institutions rather than directly affecting business fixed investment, which would in any case decline due to stock adjustment.

Members were generally of the view that it was still too early to hold out a clear prospect for economic recovery considering the above discussion on the strength in public demand and the weakness in the private sector. One member remarked that in fiscal 1999, declines in business fixed investment might offset any positive effects that come from public investment and those that might come from private consumption and housing investment. This member then concluded that if declines in exports were added to the above developments, it would be extremely difficult to realize positive growth in fiscal 1999.

One member, who had the most pessimistic view, noted that the economy might enter an extremely severe stage in the first half of 1999 partly because the fiscal-year-end settlement might trigger large-scale corporate failures and further weakening in the financial sector including life insurance companies. This member continued that two leading indicators forecasting developments eight months and eleven months ahead respectively had not yet reached a level that suggested an economic upturn. The member therefore concluded that an economic upturn in the July-October period in 1999 could be hardly hoped for. Further, this member commented that the unemployment rate in Japan had become higher than that in the United States. As an analogy, this member referred to the possibility that, in the worst case, reversal could occur between figures of stock price indicators in Japan and the United States (the Dow Jones Industrial Average [DJIA] and the Nikkei 225 average) and long-term interest rates.

Several members were concerned about developments in exports as a source of down side risks to the economy. One member, noting that the current level of production was feebly supported by exports, projected that a decline in exports in fiscal 1999 would be inevitable considering (1) possible trade frictions between Japan and other industrialized countries; (2) instability in the emerging markets; and (3) the recent appreciation of the yen.

Some members were concerned about the effects on Japan of a possible reversal in the U.S. economy. One noted that the current vigor of the U.S. economy was mainly supported by the high stock prices, and commented that, due to this nature, the U.S. economy would either continue growing or plunge. Another also pointed out that there existed two contrasting outlooks for the U.S. economy. Further, this member stated that the existence of such uncertainty regarding developments in the U.S. economy might already be starting to affect the Japanese economy through foreign exchange markets, in which the yen was rising against the U.S. dollar.

One member mentioned two scenarios with regard to the possible mechanisms that would support economic recovery. One placed emphasis on the dynamism inherent in the economy. This member pointed out that once the economy bottomed out, expectations of firms and households might change, in turn encouraging further positive economic developments. The other involved injection of public funds into banks. The member commented that injection of public funds could accelerate progress in the banks' disposal of nonperforming assets, which would force the corporate sector to go through structural changes to become stronger, with smaller debt. On this point, the member added that, even though injection of public funds could intensify the deflationary pressure in the short term, favorable market reaction based on medium-term perspective could actually lead to positive developments in the economy.

Related to the above discussion, many members exchanged views on the structural reform in the corporate sector.

One member stated that, considering the extremely disappointing earnings picture projected for fiscal 1998, injection of public funds could be a good trigger for large-scale restructuring in the financial and corporate sectors. Some other members agreed on the point that the poor earnings of firms would trigger some kind of structural reforms. One of these members pointed out that a sense of crisis was spreading among firm managers that they must be prepared for "creative destruction," large-scale restructuring that would lead to a turnaround. This member generally welcomed this atmosphere and hoped for a successful outcome.

Concerning the large output gap, one member claimed that it would be impossible to balance demand and supply merely through demand-creating policies such as public investment. The member hoped that firms would create demand through development of new products and technology. This member also pointed out the importance of strengthening firms' international competitiveness through supply-side measures such as adjustment of capital stock, even though this could temporarily worsen the employment situation.

One member also commented on the structural reform in the corporate sector focusing on Japan's overall industrial structure. Specifically, this member reasoned that the economy posted negative growth as a whole because negative effects from the contraction of still large "conventional" industries--which this member referred to as the "Old Japan"--more than offset the high growth achieved by new businesses--the "New Japan." The member expressed the opinion that the continued demand-creating policies concentrating on public investment might hinder the necessary contracting process of "Old Japan," and therefore the government should shift its policies to those which encourage the expansion of new businesses more strongly.

Given the above discussion, another member remarked that the relationship between corporate restructuring and an economic recovery was not that simple, because restructuring at the microeconomic level, that is restructuring at each firm, could further weaken aggregate demand at the macroeconomic level. However, the member pointed out the possibilities that (1) scrapping the inefficient economic activities could encourage new types of production and technological development; (2) reduction in wages could enhance expansion in firms' activities by reducing production cost; and (3) the stock market might receive the developments in restructuring favorably. The member, although a little cautious in making such a judgment, stated that the government should shift from policies that merely stimulated aggregate demand to strategic policies promoting reallocation of resources among industries.

Another member claimed that employment policies should be reviewed drastically as part of the measures to reallocate resources. This member pointed out the importance of an "active labor market policy" to support the unemployed in their search for new jobs--a policy advocated by the Organisation for Economic Co-operation and Development (OECD), which included skill development programs. The same member stressed the importance of such a shift in the government policy, referring to the fact that Japan ranked the lowest among the G-7 countries in the ratio of such government expenditure to GDP.

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

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

Some members expressed the view that it was not necessary, at this point, to further ease the Bank's policy stance. This was based on the grounds that (1) the overall economic deterioration was moderating, thanks to the large-scale fiscal expenditure, and (2) conditions for corporate financing for the end of fiscal 1998 (March 1999) were not as tight as they were for the end of the calendar year (December 1998), reflecting progress in preparations for injection of public funds into financial institutions. One pointed out that, while the crisis in Russia in summer 1998 had a substantial impact on financial markets worldwide, the influence of the current developments in Latin America was moderate. Therefore, the risks associated with overseas developments were not as significant as they were when the Bank eased its policy stance in September 1998. A few other members were of the view that, with little room left for additional monetary easing, it was necessary to consider carefully the effect of the slightest policy change.

Many members, however, also shared the view that (1) there was no prospect of economic recovery; (2) financial conditions still contained some elements of instability; and (3) there were risks associated with developments in overseas economies, rising long-term interest rates, and the yen's appreciation. They therefore agreed that it was necessary to maintain the current easy stance on monetary policy and to continue to provide ample liquidity through, for example, the new measures to support firms' financing activities decided on November 13, 1998. One emphasized that the policy stance should be kept at least as easy as it was at present, stating that, since real interest rates were still higher than was consistent with the current economic situation, it might be appropriate to reduce nominal interest rates were there enough room to do so, which was not the case.

Members also discussed the significance of the recent increase in long-term interest rates in managing monetary policy.

One member remarked that Japan had experienced several times during periods of recession a rise in long-term interest rates, which was accompanied by an appreciation of the yen and a fall in stock prices. Therefore, developments in long-term interest rates this time also warranted close attention in the management of monetary policy.

In relation to this point, the argument for the Bank's underwriting of Japanese government bonds (JGBs) and the Bank's basic stance on JGB outright purchasing operations were discussed as critical issues.

Concerning the Bank's underwriting of JGBs, one member pointed out that there were good reasons for this being prohibited by the Public Finance Law. The member expressed clear objection to such activity, claiming that it would undermine the credibility of the central bank and lead to the loss of fiscal discipline. This view was shared by the Board members.

Regarding JGB outright purchasing operations, many members argued against expanding such operations to influence long-term interest rates. Many members claimed unequivocally that, if the Bank actively purchased JGBs, market participants would interpret this as the monetization of the fiscal deficit. This being connected in their minds with loss of fiscal discipline and downgrading of Japan's credit rating, there was the risk that the consequence would be even stronger upward pressure on long-term interest rates.

Based on these considerations, some members expressed reluctance about increasing JGB outright purchasing operations to an extent that would involve the Bank diverging significantly from its basic stance on such operations, which was to carry them out in accordance with the long-term trend in demand for banknotes. These members, however, added that, although growth in banknote issuance was likely to slow in the near future, a reduction in the operations, an immediate reaction to what might be only a short-term fluctuation, could provoke unwelcome speculation in the markets about the Bank's intention. They therefore considered that it was appropriate to maintain the current pace of 400 billion yen worth of such operations per month.

Another member made a general point that it was impossible for a central bank alone to control long-term interest rates. At the conclusion of this discussion on monetary policy management in relation to long-term interest rates, many members shared the view that the Bank should concentrate on stabilizing the money market.

Members also exchanged opinions on monetary policy in relation to the risk of a deflationary spiral. A few members noted that, although the decline in prices was not accelerating, the expected progress in firms' restructuring made it difficult to rule out the possibility that the economy would fall into a deflationary spiral, and the risk warranted more attention than before in the management of monetary policy.

A conclusion was not reached, however, on whether monetary policy could completely contain such deflation risk once it amplified. One member suggested that a policy aiming at monetary expansion might be a conceivable policy option. This same member, however, mentioned that this was subject to a number of difficult questions which could not as yet be answered: (1) whether the bond market would react instantaneously and whether, as a result, nominal long-term interest rates would rise before firms' expected rate of inflation increased; (2) how the Bank could expand money when nominal interest rates were already very close to zero; and (3) whether the effectiveness of various measures--JGB outright purchasing operations and other measures--in expanding money differed.

Another member expressed the view that the recent fall in prices was attributable not only to weak domestic demand, but also to excessive production capacity in Japan and changes in the global supply structure due mainly to growth of the emerging economies. Citing such a background to recent price developments, the member noted that there was naturally a limit to setting a target for price fluctuations and achieving the target solely by means of monetary policy.

Based on the above discussions, the majority of members took the position that, in determining the guideline for money market operations for the immediate future, it was appropriate to maintain the current decisive, easy stance on monetary policy, while staying alert to a possible increase in deflationary pressure.

In contrast to this majority view, one member expressed the opinion that the support from low interest rates was no longer necessary. This member argued that the positive effect of the monetary easing of September 1998 had been limited mainly to supporting financial institutions, but this was no longer necessary as there was now a safety net against possible disruptions in the financial system. The member also claimed that, in the management of monetary policy, weight should be placed on the fact that (1) interest rates influenced not only the business conditions of financial institutions, but also people's everyday lives through pensions, insurance, and other channels, and (2) a recovery in household confidence was a prerequisite to achieving an economic recovery, given the continued weakness in business fixed investment.

Another member proposed a further easing of the monetary policy stance and lowering the target level of the uncollateralized overnight call rate to around 0.10 percent. The proposal was made on the following grounds: (1) the economy was likely to face a critical situation in the January-March quarter or, at the latest, the April-June quarter as the yen's appreciation and higher long-term interest rates worsened economic conditions; (2) the price decline was expected to accelerate in fiscal 1999 against the background of the large domestic output gap and the yen's appreciation; (3) prompt implementation of monetary policy was necessary since the government had very little capacity left to further expand fiscal policy; and (4) it was essential to start an economic recovery while the U.S. economy was still in good shape, considering the significant risk associated with developments in the global economy, including the European and Latin American countries. This member also proposed stating clearly in the directive the Bank's intention to push up in the medium term the annual rate of increase in the consumer price index (CPI) to 1 percent--which was approximately zero when adjusted for the upward bias in the CPI. The member claimed that this was necessary to show the Bank's resolution to prevent deflation.

One member questioned the appropriateness of this proposal, pointing out that (1) many members expressed the view in earlier discussions that long-term interest rates had stabilized somewhat; and (2) the emergency economic package would be implemented fully in the near future, and it was not appropriate to think at this point that no additional fiscal policy support was left. The member who made the proposal, however, argued that (1) long-term interest rates, after reversing its downtrend since April 1997, had been on an increase, and even with some correction they were unlikely to fall below 1.5 percent--rather they were likely to continue rising beyond the peak of a little over 2 percent recorded in December 1998; and (2) the effects of the emergency economic package would be offset by the increase in long-term interest rates.

Another member put forward two arguments concerning the proposal: (1) there might not be a consistent causal relationship between a reduction in the call rate to around 0.10 percent and an increase in the annual rate of change in the CPI to about 1 percent; and (2) if a target were to be set for a price index, it might be necessary to first give careful consideration to which index to target, and in what time span the target should be achieved. The member who made the proposal explained that (1) monetary policy would be implemented in stages, by first lowering the call rate to 0.10 percent and observing its effect on prices, and then additionally taking a different measure to expand money if the outcome was insufficient; (2) the CPI should be targeted because it was the easiest to grasp of all price indexes; and (3) the member was uncertain how long it would take to achieve the target, and therefore suggested maintaining the easy policy stance "in the medium term" or until the target was achieved.

IV. Remarks by Government Representatives

Government representatives also made comments during the meeting. The representative from the Ministry of Finance made the following remarks.

(1) The economy was still in a prolonged slump, and in a very severe situation. Based on this acknowledgment, the government would steadily implement the emergency economic package of November 16, 1998, focusing on the smooth and prompt disbursement of the third supplementary budget for fiscal 1998. The government had also submitted to the Diet that day a proposal for the fiscal 1999 budget, which would form a "15-month budget" together with the third supplementary budget for fiscal 1998 to ensure uninterrupted implementation of measures from the end of fiscal 1998 into fiscal 1999. The budget proposal reflected the government's exertion of maximum effort to bring about an economic recovery, incorporating an appreciably expanded amount of public investment and over 9 trillion yen worth of national and local tax reductions.

(2) As a result, the ratio of new government debt issuance to the fiscal 1999 initial budget would reach 37.9 percent, a level close to the 38.6 percent in fiscal 1998 after the third supplementary budget. In view of the ensuing burden on future generations, fiscal structure reform was essential. The government intended to address this issue comprehensively as a national priority for the early 21st century, after the economy had resumed a recovery path.

The representative from the Economic Planning Agency made the following remarks.

The large-scale fiscal stimulus package had reduced the government's capacity for additional policy measures, and therefore, it was essential to secure the effects of the emergency economic package. To secure the effects, it was important to promote structural reform, particularly disposal of nonperforming assets, without further delay. Therefore, although the situation required careful monitoring, with the economy facing various difficulties including a continued fall in land prices and the persistently stringent lending attitude of financial institutions, it was necessary to form a solid consensus on the importance of promoting the disposal of nonperforming assets and restructuring of financial institutions.

V. Votes

The views of many members were summarized as follows: (1) the pace of economic deterioration had slowed and the tightness of firms' financing conditions had relaxed somewhat; (2) the economic downturn would stop at least temporarily as the effects of fiscal policy materialized; (3) however, the prospect of recovery in private-sector demand was remote; and (4) developments in overseas economies, the appreciation of the yen, and the rise in long-term interest rates in Japan were apparent risks to the economy. Based on this acknowledgment, the majority of members were of the opinion that the Bank should maintain the current decisive, easy stance on monetary policy for the immediate future. In doing so, the Bank should monitor closely the effects of the monetary and fiscal policies already implemented and the progress made in financial system revitalization.

However, one member, placing more weight on the above risk factors, expressed the view that the economic deterioration would not be contained in the first half of 1999, and that the fiscal year-end settlement at the end of March might exert significant downside pressure on the economy. Based on such an outlook, this member claimed that the Bank should further ease the guideline for money market operations, giving expression to the Bank's determination to prevent deflation. Therefore, two policy proposals were put to the vote.

Mr. Nakahara proposed the following as the policy directive in the intermeeting period ahead:

The Bank would encourage the uncollateralized overnight call rate to move on average around 0.10 percent, aiming in the medium term at raising the percentage change from a year earlier in the 12-month backward moving average of the consumer price index (CPI, all items) to 1 percent. Regardless of the above guideline for the call rate, the Bank would provide more ample funds, if judged necessary, to maintain the stability of the financial markets.

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(see attachment).

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

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

Votes for this proposal: Mr. M. Hayami, Mr. S. Fujiwara, Mr. Y. Yamaguchi, Mr. Y. Gotoh, Mr. S. Taketomi, Mr. T. Miki, and Mr. K. Ueda

Votes against the proposal: Mr. N. Nakahara and Ms. E. Shinotsuka

Mr. Nakahara dissented for the following reasons: (1) amid a global trend toward deflation, the negative impact of the increase in long-term interest rates in Japan and the appreciation of the yen should be given more weight; (2) it was important to show more clearly the Bank's determination to prevent deflation rather than continuing to emphasize the stance of aiming at a non-inflationary and non-deflationary situation; and (3) any measure would be too late if it was implemented after the fiscal-year-end settlement at the end of March.

Ms. Shinotsuka dissented, claiming that the policy interest rate was a significant economic indicator affecting people's everyday lives. She pointed out that the current low level of interest rates could be misinterpreted as a source of subsidies to banks, and could therefore undermine the credibility of the policy.

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

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 January 21, 1999 in the Monthly Report of Recent Economic and Financial Developments (the "Ivory Paper," consisting of "The Bank's View" and "The Background"). 6

  1. 6The original full text, written in Japanese, of the Ivory Paper was published on January 21, 1999 together with the English version of "The Bank's View." The English version of "The Background" was published on February 2, 1999.

VII. Approval of the Minutes of the Monetary Policy Meeting Held on November 27, 1998

The Policy Board approved unanimously the minutes of the Monetary Policy Meeting, the "Green Paper," of November 27, 1998, for release on January 22, 1999.


For immediate release

January 19, 1999
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.