Minutes of the Monetary Policy Meeting

on February 25, 1999
(English translation prepared by the Bank staff based on the Japanese original)

March 30, 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 Thursday, February 25, 1999, from 9:02 a.m. to 11:46 a.m., and from 12:33 p.m. to 3:28 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 ²
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. S. Tanigaki, State Secretary for Finance, Ministry of Finance ³
Mr. H. Imai, Parliamentary Vice Minister, Economic Planning Agency ⁴
Mr. T. Komine, Director-General of the Price Bureau, Economic Planning Agency ⁵

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
Mr. T. Kurihara, Manager, Policy Planning Office

The minutes of this meeting were approved by the Policy Board at the Monetary Policy Meeting held on March 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.
Mr. Fujiwara was absent from 9:27 a.m. to 11:46 a.m. to attend a session of the Diet.
Mr. Tanigaki was present from 9:02 a.m. to 11:46 a.m.
Mr. Imai was present from 9:20 a.m. to 10:36 a.m.
Mr. Komine was present from 10:36 a.m. to 11:46 a.m., and from 12:33 p.m. to 3:28 p.m.

I. Approval of the Minutes of the Monetary Policy Meeting Held on January 19, 1999

The Policy Board approved unanimously the minutes of the Monetary Policy Meeting, the"Green Paper," of January 19, 1999 for release on March 2, 1999.

II. Summary of Staff Reports on Economic and Financial Developments ⁶

A. Money Market Operations in the Intermeeting Period

Market operations in the period since the previous meeting on February 12 were conducted in accordance with the guideline determined at that meeting:

The Bank of Japan will provide more ample funds and encourage the uncollateralized overnight call rate to move as low as possible.

To avoid excessive volatility in the short-term financial markets, the Bank of Japan will, by paying due consideration to maintaining market function, initially aim to guide the above call rate to move around 0.15 percent, and subsequently induce further decline in view of the market developments.

As a result, the uncollateralized overnight call rate was around 0.10 percent throughout the intermeeting period.

On February 15, the first business day after the announcement of the change of the guideline for money market operations on February 12, active transactions were made in the overnight call money market, with its rate at 0.15 percent. Later, on the same day, the rate further declined reflecting the ample funds injection by the Bank. As a result, the weighted average of the overnight call rate of the day stood at 0.12 percent (0.28 percent as of one business day before). On February 17, the weighted average of the overnight call rate declined to a record low of 0.08 percent in response to the Governor's statement at a press conference on the previous day that the Bank would allow the overnight call rate to fall to zero percent if possible. Since February 18, however, despite the active funds injection by the Bank, the weighted average of the overnight call rate had not declined, fluctuating at around 0.11-0.13 percent. This was partly because (1) some fund-investors shifted a part of their funds from the call money market to ordinary deposits with an interest rate of 0.10 percent; and (2) some fund-raisers actively procured funds to prepare for the end-of-month settlement.

As for interest rates on term instruments, the rates on one-month Euro-yen TIBOR (Tokyo Inter-Bank Offered Rates) contracts declined by 0.19 of a percentage point, and those on three-month contracts by 0.21 of a percentage point from February 12 (just before the announcement of the policy change) to February 24, the day before the present meeting. These figures revealed that the rates on term instruments had declined by a larger margin than had the uncollateralized overnight call rate.

From the above developments, the changes observed in the money market since February 12 could be summarized in the following three points. First, fund-investors, especially life and nonlife insurance companies, tended to shift their short-term funds from the overnight call money market to ordinary deposits when the uncollateralized overnight call rate fell below the sum of the interest rate on ordinary deposits at 0.10 percent and broker fees. For this reason, the level of the interest rate on ordinary deposits seemed to be the determinant of the floor of the overnight call rate for the time being. Second, fund-investors were increasing their holdings of term funds based on their assumption that the overnight call rate could decline close to zero percent in the future. Thus the recent monetary easing brought about the decline in these rates. Third, the speed of the progress in satisfying the reserve requirement in the reserve maintenance period had varied across financial institutions. This was due to the fact that some banks raised funds at an early stage when the rate recorded the 0.12-0.13 percent level, based on their perception that the overnight call rate would not decline immediately judging from the fund-investors' moves to shift their funds to ordinary deposits. By contrast, others that were late in procuring funds found it difficult to raise funds in the afternoon due to the reduction in trades in the call money market.

In view of the above situation, policy actions would be required in the immediate future, to confirm whether the market could accommodate any further lowering of the uncollateralized overnight call rate, giving due consideration to avoiding disruptions to the financial market. One of the key factors would be whether moves to lower interest rates of ordinary deposits would emerge among banks. As a measure to induce a further decline in the uncollateralized overnight call rate, repo operations would be actively used as agreed at the meeting on February 12, when the guideline for money market operations was changed.

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

1. Developments in foreign exchange markets

The yen depreciated rapidly against the U.S. dollar from around 114 yen, reflecting (1) the additional monetary easing by the Bank on February 12; (2) the decline in long-term interest rates in Japan; (3) the press report that policy makers accepted the depreciation of the yen; and (4) strong economic indicators released in the United States. Furthermore, no specific comment on the exchange rate was included in the communique released after the G-7 meeting of finance ministers and central bank governors on February 20, and market participants interpreted this as acceptance of the depreciation of the yen against the U.S. dollar. As a result, the yen fell to around the middle of the 122-123 yen range against the U.S. dollar on February 22, which was the lowest level since early December 1998. After February 23, the yen moved within a narrow range of 121-122 yen against the U.S. dollar, reflecting profit-taking transactions and the market concern about the sharp fall of the yen.

The euro continued to decline against the U.S. dollar reflecting (1) the difference in the economic developments in the two areas; and (2) a series of remarks suggesting a willingness to accept a depreciation of the euro by officials of the member countries of the European Monetary Union (EMU) and by the European Central Bank (ECB). Thus, the euro declined below $1.10 to the lowest level since the launch of the new currency. Nevertheless, the euro's exchange rate against the U.S. dollar was generally stable compared to the rapid movements of the yen against the U.S. dollar.

Meanwhile, currencies of emerging market economies were weak in general amid the decline in transaction volume due to events such as the Chinese New Year in Asia and carnivals in Latin America. The Brazilian real further declined after the carnivals reflecting the concern in the market that more capital was likely to flow out of the country. Recently, the value of the real was 40 percent lower than before the introduction of the floating exchange rate regime in January.

2. Overseas economic and financial developments

In the United States, the economy continued to expand firmly with stable price developments. The testimony by Mr. Alan Greenspan, Chairman of the Board of Governors of the Federal Reserve System, for the Federal Reserve's semiannual report to the Congress on monetary policy, had attracted much attention.

Mr. Greenspan commented that the fundamental underpinnings of the recent U.S. economic performance were strong, but the economy appeared stretched in a number of dimensions after eight years of economic expansion, implying considerable risks to the economic outlook. In the testimony, he pointed out the following as examples: (1) the robust increase of production had been using up the nation's spare labor resources; (2) equity prices were high enough to raise questions about whether shares were overvalued; and (3) the external debt and the debt of the household and business sectors had mounted. Furthermore, he added that the U.S. economy remained vulnerable to rapidly changing conditions overseas.

After presenting his view that various risks existed as indicated above, Mr. Greenspan remarked:"The Federal Reserve must continue to evaluate, among other issues, whether the full extent of the policy easings undertaken last fall to address the seizing-up of financial markets remains appropriate as those disturbances abate." He also emphasized that,"monetary policy must be ready to move quickly in either direction should we perceive imbalances and distortions developing that could undermine the economic expansion."

C. Economic and Financial Developments in Japan

1. Economic developments

Factors that change the Bank's judgment on the economy were not found in the economic indicators released in the period since the previous meeting.

As for the value of public works contracts, the orders based on the first supplementary budget for fiscal 1998 had peaked out. However, judging from various sources including the Bank's contact with firms, the value was expected to start increasing again in February, reflecting orders based on the third supplementary budget, formulated to implement the emergency economic package. Although real exports increased considerably in January, the underlying trend seemed to remain level as they fluctuated considerably from month to month basis.

As for business fixed investment, leading indicators (machinery orders) continued to be on a downtrend. According to a survey on business fixed investment plans for fiscal 1999 conducted by The Nihon Keizai Shimbun, considerable decreases were planned although figures available at present were provisional. Regarding private consumption, sales of large-scale retail stores in Tokyo recorded a sharp increase in January due to the closing sale at a certain store. However, private consumption had not yet shown distinct signs of a steady recovery. In housing investment, a rising trend in sales of condominiums and a decreasing trend in inventories had become apparent, suggesting a possibility that the decline in construction starts for condominiums for sale would come to a halt.

2. Financial developments

In the financial markets, overall interest rates in the money market declined reflecting the monetary easing decided at the previous meeting. With the planned public funds injection, concern about funds availability at the fiscal year-end had subsided. In these circumstances, interest rates on term instruments in the interbank market declined by approximately 0.15 to 0.20 of a percentage point, reflecting the decline in the uncollateralized overnight call rate.

Long-term interest rates (yields on ten-year JGBs) had temporarily risen slightly after the implementation of the monetary easing, but had declined in the period following. Market sentiment remained nervous.

The growth rate of M2+CDs from a year earlier was 3.6 percent in January 1999, which was lower than the 3.9 percent in December 1998. This was because, in January 1998, there was a large shift of funds from the assets outside M2+CDs (investment trusts, trusts, and bank debentures) to those included in M2+CDs due to the growing concern about financial system stability. The relatively large figure for January 1998 resulting from this shift of funds pushed down the twelve-month growth rate for January 1999. The fact that firms were less eager to increase their on-hand liquidity due to the alleviation of concerns about financial system stability might also become a factor to cause the growth of M2+CDs to slow somewhat in the immediate future.

The growth rate of the monetary base (the sum of currency in circulation and reserves) from a year earlier fell sharply toward the end of 1998, and also declined somewhat in January 1999. The growth in banknotes, which made up most of the monetary base, was recovering slightly in February.

Meanwhile, the number of corporate bankruptcies declined significantly below the previous year's level in January, as was the case in December, falling to the low levels of the early 1990s. This seemed to be a clear reflection of the expansion of the credit guarantee system.

6Reports were made based on information available at the time of the meeting.

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

A. The Current Economic Situation and the Economic Outlook

Members generally agreed that the judgment on the current economic situation confirmed at the last meeting--that although the economic deterioration had moderated, there was not yet a clear prospect of an economic recovery given the continued sluggishness in economic activity in the private sector--was still valid because there had not been any marked changes in the economic indicators released during the intermeeting period.

One member expressed a view on public works orders, which had stopped increasing since the turn of the year 1999. The member commented that this development reflected delay in orders financed by the third supplementary budget while orders financed by the initial budget and the first supplementary budget for fiscal 1998 had peaked out. This member remarked that the delay could be attributed to more time than expected being taken for designing and other preparations, and because of this, the delay was not a matter of concern. This member, however, added that it would temporarily have a negative effect on the prices of construction-related materials and profits of firms involved in construction works.

With regard to the economic outlook, some members expressed the view that developments in financial markets since the monetary easing decided at the last meeting somewhat reduced, at least temporarily, the risks to the economy arising from the rise in long-term interest rates and the appreciation of the yen.

Members, however, generally agreed that they could not be too optimistic about the economic outlook, because of the continued severity of the corporate profits situation and of employment and income conditions. One member, who was particularly pessimistic, claimed that the most notable feature of the current recession was the extreme sluggishness in private consumption, which could decline even further considering the severe employment and income situation. This member projected that, although the economy seemed to be on the verge of recovery, it would actually deteriorate once again for the following reasons: (1) housing investment might somewhat increase but it would only have a limited effect on the economy as a whole; (2) exports would start to decrease; (3) public investment would manage to underpin the economy only until around the middle of the year; and (4) land prices were expected to decline once again.

Some members stressed again the severity of the corporate profits situation and of employment and income conditions. One member pointed out that one after another firms were revising forecasts for their earnings for fiscal 1998 substantially downward and a number of firms were expected to go into the red. The member noted that the deterioration in corporate performance, together with the progress in the disposal of nonperforming assets, would pressure the firms to change their supply-side structure. This member further commented that such developments would entail drastic cuts in bonus payments and could even result in base wage reductions and employment cuts. The member remarked that there still existed a risk of the above developments leading the economy into a deflationary spiral.

Another member pointed out that even the shipbuilding industry, which had been enjoying satisfactory performances, was now preparing for production cuts reflecting the decline in demand associated with the weakness in crude oil prices and the intensified international competition among shipbuilders. A different member referred to the case of a large firm in that industry, where the management proposed a 10 percent wage cut and the labor union had no choice but to accept the cuts in order to secure employment.

A different member expressed strong concern about the influence of the March accounting results on the economy. This member claimed that poor accounting results would (1) force firms to proceed with the disposal of their excess capital stock, which was estimated to be as much as 20 to 30 percent of the total stock in some industries, and (2) strongly affect developments in employment and wages. In relation to the second point, the member stated that laying off all idle workers, estimated at around 4 million, would improve firms' return on equity (ROE) by 8 percent, while it would also exert a negative pressure that would either raise the unemployment rate up to around 10 percent or push down wages by more than 10 percent.

With regard to housing investment, a few members commented on the recent increase in the sales of condominiums as a positive factor. However, these members added that it should be carefully examined whether this increase would push up the number of new construction starts, given the still large condominium inventory.

B. Financial Developments

With regard to developments in the financial markets, the discussion mainly focused on the effects of the monetary easing on February 12 on interest rates and exchange rates.

In the money market, members confirmed that the uncollateralized overnight call rate and interest rates on term instruments were declining across the board.

One member commented on the developments in deposit rates in the above money market situation. The member pointed out that the reduction in the interest rates of notice deposits and time deposits could cause funds in these deposits to shift to ordinary deposits--the rates of which were unchanged--thereby making financial institutions' liabilities highly liquid and forcing their financial position to be vulnerable. Further, the member expressed concern that these reductions in deposit rates might further weaken the attitude of consumers toward spending which had already been defensive.

The same member also commented on lending rates. Specifically, the member remarked that the effects of monetary easing on February 12 had not spread to corporate financing, referring to the fact that long- and short-term prime lending rates had not been changed. Some other members, however, claimed that if the uncollateralized overnight call rate was guided further downward, the effects of monetary easing would spread to lending rates through the following channel: the decline in the overnight call rate would push down interest rates on ordinary deposits and this would influence the short-term prime lending rate and, in turn, lending rates in general.

Members also discussed the factors behind the moderate decline in long-term interest rates (yields on ten-year JGBs) from the period before the monetary easing.

One member referred to the possibility that the decline in interest rates on term instruments induced by the monetary easing had spread to the medium zone of the yield curve. However, the member added that, judging from the time of the decline, the government's announcement on February 16 regarding the government bond issuance--that the government would (1) diversify the maturities; and (2) resume the JGBs purchases by the Trust Fund Bureau--seemed to have contributed more as the factor behind the decline in long-term rates.

In response, another member said that (1) the effects of the decline in short-term interest rates on medium-term ones should be given more credit; and (2) the Bank's announcement that it would maintain the frequency and the volume of outright purchases of JGBs unchanged had not resulted in any negative developments in the market.

Members discussed developments in foreign exchange markets focusing on the implications of the yen's depreciation after the monetary easing for economic activities.

One member stated that, of all the changes that had taken place in the various markets since the monetary easing, the depreciation of the yen would have the largest impact on economic activities. Another member pointed out that there had been a decline of approximately 5 percent in the yen against the U.S. dollar from the time right before the monetary easing when the yen was around 115 yen, and an 8 to 9 percent decline from the period when upward pressure was particularly strong and the yen was around 110 yen. The member commented that if the current level of the yen continued, it could provide a substantial support to export industries.

Although members in general acknowledged that the recent depreciation of the yen would have some positive effects on the economy, there was an opinion that the yen was merely approaching the level that firms had already projected for the second half of fiscal 1998.

Another member commented that the yen was not likely to depreciate further than the 120-125 yen level because Japanese firms were expected to sell the U.S. dollars and buy the yen in order to close their positions before the end of the fiscal year. A different member remarked that the risk of Japan-U.S. trade friction still existed against the background of the expanding trade imbalance between the two countries, and that if the yen should appreciate beyond 110 yen, it would severely damage many firms which had already projected decline in exports for fiscal 1999. These comments confirmed that there was significant uncertainly about the future course of the yen. Members generally shared this view.

One member also raised the issue of what level of the exchange rate could be considered as"neutral" to Japan's economy. This member mentioned that, at present, compared to the early 1990s, more firm managers regarded the level of the yen--which was lower than that in the early 1990s--as"fair." The member pointed out that such assessment was apparently inconsistent with the progress that had been made in firms' cost structure through depreciation of excess capital created during the"bubble" period and also with the convergence of differential between corporate service prices at home and abroad. Regarding this point, the member presented a hypothesis that firms' strategy might have become more exports-oriented against the background of sluggishness in domestic sales in terms of both volume and prices. The member concluded that further analysis would be required of the relation between firms' cost-profits structure and the level of exchange rates.

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

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

On the recent uncollateralized overnight call rate of around 0.10 percent, members shared the view that the Bank was still in the process of encouraging the rate to fall"as low as possible" in conformity with the guideline determined at the previous meeting on February 12. On the downside risks to the economy, there was a view that the risks created by the rise in long-term interest rates and the appreciation of the yen had abated somewhat due to market developments since the previous meeting. At the same time, however, there was a cautious view that these risks might rekindle any time. Consequently, members generally agreed that developments continued to warrant careful monitoring. At the conclusion of various discussions, many members agreed that it was appropriate to maintain the current guideline for money market operations for the immediate future, and encourage a gradual decline in the overnight call rate giving due consideration to market developments.

In the course of the discussions, some members weighed the fact that the uncollateralized overnight call rate remained around the level of interest rates on ordinary deposits (0.10 percent). They suggested that it might be necessary to encourage a further decline in the overnight call rate at an early stage to see whether it caused market disruption. One of these members stressed the need to accelerate the reduction in the interest rate, expressing concern that the current pace of reduction would not be effective.

Regarding a further lowering of the call rate, however, some members stressed that it was important that the Bank pay careful attention to market developments, such as the resulting shift of funds from the call money market to ordinary deposits, as well as developments in interest rates on term instruments, lending rates, and reserves.

Another member opposed inducing a further decline in the overnight call rate for reasons other than its possible influence on the financial markets. This member noted that a further lowering of the overnight call rate would place downward pressure on interest rates on ordinary deposits, and a consequent decrease in deposit interest rates overall could lead to the impairment of the Bank's credibility by, for example, intensifying the already cautious attitude of households.

With regard to long-term interest rates, members discussed their relation with monetary policy.

One member pointed out the following, based on the perception that the government's announcement on February 16 concerning a change of policy on government bond issuance might have had a favorable impact on long-term interest rates. First, it was undeniable that the rise in long-term interest rates until the beginning of February had been attributable not only to concern about an expansion of the budget deficit in the long term, but also to a short-term risk factor, which market participants referred to as the"supply-demand factor" of JGBs. Second, if the government's decision to diversify the maturity of new government bond issues had alleviated to some extent the supply-demand factor,"operation twist" by the Bank might also have some effect, although on condition that the budget deficit did not expand. Third, even if this was the case, however, the operation twist might be effective only when the rise in long-term interest rates was due to a temporary increase in risk premium, and it was therefore questionable whether the measure would be effective when employed repeatedly and whether the effects would endure. Lastly, the member suggested that it might be necessary to deepen further the Board's understanding of how long-term interest rates were determined in the markets before considering possible countermeasures against developments in long-term interest rates.

Another member had a somewhat different opinion. The member pointed out that (1) long-term interest rates were determined in large part by the market's outlook for economic and price developments, but (2) the rates recently also incorporated a risk premium for the uncertainty regarding the prospects for large-scale government bond issuance. The member therefore remarked that it was necessary to keep a close watch on the level at which long-term rates would settle under the influence of these two factors. Taking this position, the member was skeptical about the opinion expressed earlier that it might be possible for the Bank to take measures against the supply-demand factor, on the following grounds: (1) the supply-demand factor was not a major determinant of the underlying trend of long-term interest rates; and (2) even if this factor was sometimes behind fluctuations in long-term rates, it was difficult for the Bank to decompose the changes into the supply-demand factor and the fundamentals factor, and to exert influence solely on the former. On the operation twist, this member noted that, when the uncollateralized overnight call rate was allowed to fall close to zero and there was no need to carry out operations for absorbing funds, it would involve the risk of becoming equivalent to an increase in the outright purchase of JGBs because sales of short-term government securities might not be executed to fully offset purchases of JGBs.

During this discussion, one member expressed the view that it was necessary to make it clearer that it was impossible for the Bank to exercise direct control over long-term interest rates. Another member also stated that any attempt by the central bank to control long-term rates might obscure market signals given through movements in long-term interest rates.

Several opinions were given regarding the extent to which the Bank could implement further monetary easing. The opinions related to issues including quantitative easing, the timing of a further easing, if any, and overall economic policy that would appropriately address the problems facing Japan's economy.

One member expressed the view that monetary policy had already been eased to its limit as shown by the fact that the monetary easing decided at the previous meeting on February 12 had produced little effect on corporate financing--for example, it had not brought about a decline in lending rates.

Another member pointed out that the problems in Japan's economy could be understood as problems in the balance sheet of a firm: (1) there still were excessive assets with low profitability, including impaired assets and those bearing unrealized losses; (2) those assets were financed by matching excessive corporate liabilities, which was connected with the nonperforming-asset problem of financial institutions; and (3) acquisition of new, profitable assets was slow to progress. Raising these points, the member, while acknowledging the positive outcomes of the financial system revitalization measures and macroeconomic policy measures already implemented, claimed that the priority task for Japan's economy continued to be the strengthening of the supply side by replacing excessive obsolete assets with profitable ones. This member considered that any substantial quantitative monetary easing would have very limited effects and would therefore not be a priority unless some positive momentum in economic activity was created first through firms' own efforts and policy measures such as tax system reform.

Another member stated that the stimulative effects of fiscal policy had already come out fully and, as for monetary policy, interest rate reductions had been implemented to their limit. Under these circumstances, it was essential that firms create demand by developing new products or technologies and at the same time carry out restructuring of the supply side. The member claimed that measures effective in promoting such movements, including unemployment policies and tax credit on disposal of capital stock, should be considered.

A different member also pointed out that implementation of both monetary and fiscal policy was approaching its limit. The member cautioned that, given this situation, it was highly likely that there would be persistent requests for the Bank's underwriting of government bonds or expansion of JGBs outright purchase operations. The member stressed that the budget deficit should not exceed a certain point, and whether such fiscal discipline would be maintained depended heavily on the central bank's policy. Based on this perception, the member warned that arguments calling for extraordinary policy measures for reasons of emergency, such as those supporting a quantitative monetary expansion, contained significant risks for the economy.

One member, however, was in favor of quantitative monetary expansion. The member expressed the view that it was time that the Bank seriously considered a quantitative easing. This was based on the following considerations: (1) the annualized three-month growth rate in the monetary base had declined considerably; (2) there appeared to be a correlation between a slowing of growth in the monetary base and a rise in long-term interest rates; and (3) monetary policy should be implemented preemptively considering the lag between the policy action and its effects.

Another member took the view that, although immediate action was not necessary, there would be a need to discuss the possibility and the timing of a quantitative easing that would lead to an increase in private-sector demand. This was based on the thinking that, while it had become impossible to take further monetary policy action through money market interest rates, there was a possibility that the economy would once again face a critical situation.

In relation to these discussions, one member remarked that it was a very difficult phase for implementation of monetary policy. The member pointed out that the Bank had very little leeway: on one hand, the Bank had to counteract the modest deflationary trend using every possible means of monetary policy, which did not seem to be fully effective; on the other, it had to hold in check the risk that the policies adopted would generate inflation in the future.

Separately from the above discussions on what monetary policy could do, one member raised the issue of whether an additional indicator should be used together with the uncollateralized overnight call rate as the target of money market operations after the rate declined close to zero. The member cited a classical argument, which assumed ordinary situations where there was ample room for interest rate reductions: when financial shocks were anticipated, such as a surge in demand for liquidity reflecting heightened financial instability, it was better to target interest rates in the implementation of monetary policy; whereas when shocks to economic activity were anticipated, such as an acceleration of deflation, it was better to target the quantity of money. The member then stated that, from the viewpoint of controllability, possible interest rate targets were money market interest rates, including those on term instruments, and possible quantitative targets were reserves or the monetary base. In the member's opinion, the choice of the target required careful deliberation as it involved various issues, including (1) the feasibility of setting a specific numerical target; (2) the potentially different effects of monetary policy; and (3) the impact on people's expectations and long-term interest rates.

A member agreed with the view that employment of new targets needed careful consideration.

Another member emphasized that the issue regarding operation targets was merely a question of whether the Bank would use interest rates or the quantity of money to give monetary policy signals. The member stressed that room for further monetary easing was similarly limited whichever type of target was adopted, since monetary policy, in any case, had to be managed giving consideration to future inflation risk. This member also expressed concern that people might have come to misunderstand that, even if interest rates were reduced to the utmost, quantitative easing provided many new possibilities. With a view to preventing such misperception, the member's thinking at the moment was that the Bank should target interest rates on term instruments and thereby emphasize the consistency of monetary policy, rather than shifting to quantitative targeting.

A different member also claimed that the Bank's policy stance was easy enough already, and if the Bank hurriedly set a quantitative target, it could provoke undue expectations for monetary policy and cause unnecessary confusion. The member also pointed out that quantitative indicators such as money stock had shown little correlation with economic activity in the latter half of the 1990s, although the two were correlated in the very long term, and that it was therefore difficult to set a reliable quantitative target.

As outlined above, no common understanding was reached on how monetary policy should be implemented in the future. However, on the guideline for money market operations for the immediate future, the majority of members agreed that the current guideline should be retained in order for the Bank to proceed with the implementation of the policy determined on February 12.

Despite this majority view, one member, who made a particularly harsh judgment on the current economic situation, made a proposal to further ease the Bank's policy stance. Specifically, the member proposed (1) deleting the Bank's policy on the uncollateralized overnight call rate from the guideline for money market operations; (2) implementing a quantitative easing by maintaining excess reserves of about 500 billion yen for the immediate future, and by gradually increasing this amount, pushing up the growth in the monetary base from a year earlier to about 10 percent in the October-December quarter of 1999; and (3) stating clearly that the Bank would aim at raising the annual growth rate of the consumer price index (excluding perishables and indirect taxes) to 1 percent in the medium term.

The member explained that the proposal was based on the following grounds. First, according to the Taylor's rule--which calculated the appropriate policy interest rate based on the output gap and inflation rate--the appropriate level of the uncollateralized overnight call rate was below zero. This meant that a lowering of the rate to zero would not produce sufficient monetary easing effects, and therefore, it was essential that the Bank induced quantitative expansion. Second, it was necessary to stop the recent sharp decrease in the monetary base--the annualized three-month growth rate was falling at an unprecedented pace. Third, it was important that the Bank show its resolution to prevent deflation. Fourth, due to the planned injection of public funds into financial institutions, it was more likely than before that provision of liquidity to the banking sector would lead to creation of credit. Lastly, considering the risk that the economy would experience a fairly large shock in the April-June quarter, when firms' financial results for fiscal 1998 would be published, it was necessary to implement at this timing a preemptive easing, especially since measures implemented so far had been criticized as"too little, too late."

Members posed various questions regarding this proposal.

One was whether it was appropriate to adopt a new measure when the Bank was still in the middle of implementing the policy decided at the previous meeting. One member claimed that the Board duly acknowledged that the economic outlook was severe when it decided to lower the target for the uncollateralized overnight call rate at the previous meeting, and therefore, the Bank should first do its utmost under the current policy. Another member expressed the view that, in the absence of any drastic change in the economic situation, adopting a new policy before confirming the effects of the latest action would create an inconsistency in the Board's policy management.

Another issue was the appropriateness of setting a quantitative target. One member expressed the view that the choice between an interest rate target and a quantitative target in the implementation of monetary policy required careful deliberation, including the assessment of the nature of expected shocks. The member stated that it was wrong to think that quantitative targeting was just another means of monetary policy the Bank could employ after having used up all interest rate policy measures.

A third member questioned the basis for targeting an annual 10 percent growth in the monetary base. The member pointed out that, since there was no stable relationship between economic activity and quantitative indicators, estimates of the appropriate growth rate of the monetary base could vary widely with even minor changes in assumptions: at its lowest, 4-5 percent was adequate, but at its highest, 14-15 percent was necessary. With such a wide range, the member criticized that it was imprudent to establish the target at 10 percent without adequate deliberation.

A fourth member pointed out that it had not been thoroughly discussed which quantitative indicator should be targeted and at what level the target should be set based on each indicator's relationship with economic activity or prices. This member remarked that, in view of the unclear prospects for demand for banknotes, it was not certain, at least at this timing, whether carrying out the Bank's operations to create excess reserves of 500 billion yen was consistent with targeting 10 percent growth in the monetary base.

In relation to the above questions, one member expressed strong doubts about the controllability of the monetary base. The member's concern was that, if the Bank attempted to change the amount of reserves to offset fluctuations in banknotes with a view to controlling the monetary base, interest rates might become quite volatile, because banknotes accounted for about 90 percent of the monetary base.

One member expressed general support for the view that providing the banking sector with liquidity would have more effect on the entire economy than before, considering that the intermediary functions of financial institutions were improving somewhat. Another member, however, pointed out that, if quantitative easing meant injection of liquidity into the banking sector and thereby encouraging an increase in bank lending, interest rates would decline along the process, making the policy not any different from an interest rate reduction.

Following these comments, the member who made the proposal reinforced the member's argument.

(1) Regarding the opinion that the Bank should first observe the effects of the monetary easing measure decided at the previous meeting, the member argued that the critical economic situation called for immediate action for a further monetary easing.

(2) In response to the criticism that there was no reliable grounds for the targets proposed for the monetary base and excess reserves, the member gave the following explanation. The average of the annual growth rates of the monetary base in the past ten years was a little over 6 percent, and since it was appropriate to pursue a higher growth rate at times of recession, the target was set at 10 percent. As for excess reserves, an increase of 500 billion yen every month would achieve annual increase of 6 trillion yen, and on condition that the amount of banknotes remained unchanged, this would expand by 10 percent the monetary base, which was currently about 60 trillion yen.

(3) Regarding the view that it was impossible to control the monetary base because most of it was banknotes, the member argued that the composition of the monetary base was similar in the United States, and this proved that the monetary base was sufficiently controllable.

On the third point, the member who doubted the controllability of the monetary base pointed out that, because of the very fact that banknotes comprised a large part of the monetary base also in the United States, the quantitative targeting between 1979 and 1982 targeted non-borrowed reserves rather than the monetary base.

Although active discussions were held as outlined above between the member who made the proposal and other members, a consensus could not be formed.

Regarding the public statement concerning the policy change on February 12, a few members claimed that it might have been unsuccessful in accurately conveying the Bank's intention to the market and the general public. These members therefore suggested that future statements on policy changes should be more concise and focused. This opinion, however, was not shared by other members.

V. 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, although some economic indicators had shown positive developments. In this situation, the government had been doing its utmost to implement the various policy measures including the emergency economic package of November 1998. The budget bill for fiscal 1999, formulated with the aim of doing the best that could be done in the current situation to revive the economy, had passed the House of Representatives.

(2) Given the recent developments in long-term interest rates, on February 16, the Ministry of Finance decided the following: (a) the Ministry of Finance would diversify the maturities of the JGBs planned to be issued in March based on the principle that the Ministry takes into account both the total annual amounts of new issues as well as prevailing market conditions when deciding the amount of monthly issuance of each maturity; and (b) the Trust Fund Bureau would resume its purchases of JGBs as part of its portfolio management strategy while taking into consideration the recent developments in the market and the Bureau's financial position. Specifically, the Bureau was planning to purchase JGBs twice in February and twice in March, with the amount of each purchase being approximately 100 billion yen.

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

(1) The economy was in a prolonged slump and in a very severe situation. Signs of change had been detected, with some developments indicating mild improvement while others implying further deterioration. The budget bill for fiscal 1999, which aimed at coping with this severe economic situation, had passed the House of Representatives and was being deliberated in the House of Councilors. The government was determined to do its utmost to realize a self-sustained recovery of the economy by implementing the various measure included in the emergency economic package of November 1998.

(2) With regard to monetary policy, the government welcomed the monetary easing decided at the last meeting as it would contribute to an economic recovery by enabling firms to secure sufficient funds. The government would like to request the Bank to continue its appropriate monetary policy management.

VI. Votes

The views of many members were summarized as follows: (1) there had not been any marked developments in the economic indicators to change the judgment on the economic situation made at the previous meeting that, although the economic deterioration had moderated, there was not yet a clear prospect of an economic recovery given the continued sluggishness in economic activity in the private sector; (2) there was a slight decrease in the risks coming from the rise in long-term interest rates and the appreciation of the yen, to which the monetary easing decided at the previous meeting contributed among other factors; (3) the development in the uncollateralized overnight call rate was consistent with the fact that the Bank was still in the process of implementing the monetary easing decided at the previous meeting. Based on this understanding, the majority of members were of the opinion that the Bank should maintain the guideline for money market operations decided at the previous meeting for the immediate future, and induce further decline of the uncollateralized overnight call rate giving due consideration to avoiding market disturbances.

One member, who was especially concerned about the current severe economic situation, however, stated that the Bank should immediately conduct a further monetary easing and, in doing so, aim at quantitative monetary expansion, because the effects of decline in the uncollateralized overnight call rate were limited. 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 aim at realizing an approximately 1 percent annual increase in the consumer price index (excluding perishables and indirect taxes) in the medium term. Specifically, the Bank would set the target range of the inflation rate for the year 1999 at 0 to 2 percent (change from the average for the October-December quarter of 1998 to the average for the same quarter of 1999) and for the year 2000 at 0.5 to 2 percent (change from the average for the October-December quarter of 1999 to the average for the same quarter of 2000). In achieving these targets, the Bank would initially set the amount of excess reserves at 500 billion yen, and thereafter increase the amount gradually to induce a 10 percent annual growth of the monetary base (change from the average for the October-December quarter of 1998 to the average for the same quarter of 1999) to realize quantitative easing (expansion of the monetary base). The proposal was defeated with one vote in favor, seven against. One member abstained from voting.

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 statement(see attachment). The Bank of Japan will provide more ample funds and encourage the uncollateralized overnight call rate to move as low as possible.

To avoid excessive volatility in the short-term financial markets, the Bank of Japan will, by paying due consideration to maintaining market function, initially ^(note)aim to guide the above call rate to move around 0.15 percent, and subsequently induce further decline in view of the market developments.

Note:"Initially" means the time of the previous Monetary Policy Meeting, February 12, 1999.

Votes for the 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 on the following grounds: (1) the effects of the policy change decided at the previous meeting were not sufficient, judging from the magnitude and the pace of decline in the uncollateralized overnight call rate; (2) it was urgently needed to take a step to a further monetary easing in light of the severe economic situation, and that there was no time to wait and see whether or not the policy change adopted at the previous meeting was effective; and (3) it was disadvantageous to give the impression that the previous monetary easing was the final one, and therefore, it was important to clearly indicate that various other monetary easing measures could be utilized by the Bank even if interest rates touched zero percent.

Ms. Shinotsuka dissented, claiming that (1) the influence on the economy of an experiment of further bringing down the already extremely low interest rate would be unclear; and (2) household sentiment continued to deteriorate and under such a situation, negative impacts of a further decline in the interest rate might be too enormous.

Attachment

For immediate release

February 25, 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.

The guideline for money market operations in the inter-meeting period ahead is as follows: