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Minutes of the Monetary Policy Meeting

on March 12, 1999
(English translation prepared by the Bank staff based on the Japanese original)

April 14, 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 Friday, March 12, 1999, from 9:01 a.m. to 12:19 p.m., and from 1:11 p.m. to 4:07 p.m. 1

Policy Board Members Present
Mr. M. Hayami, Chairman, Governor of the Bank of Japan
Mr. S. Fujiwara, Deputy Governor of the Bank of Japan
Mr. Y. Yamaguchi, Deputy Governor of the Bank of Japan
Mr. Y. Gotoh
Mr. S. Taketomi
Mr. T. Miki
Mr. N. Nakahara
Ms. E. Shinotsuka
Mr. K. Ueda

Government Representative Present
Mr. S. Tanigaki, State Secretary for Finance, Ministry of Finance 2
Mr. T. Mutoh, Deputy Vice Minister for Policy Coordination, 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. 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

  1. The minutes of this meeting were approved by the Policy Board at the Monetary Policy Meeting held on April 9, 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. Tanigaki was present from 9:01 a.m. to 11:04 a.m.
  3. Mr. Mutoh was present from 1:11 p.m. to 4:07 p.m.
  4. Mr. Imai was present from 9:01 a.m. to 11:14 a.m.
  5. Mr. Komine was present from 11:15 a.m. to 12:19 a.m., and from 1:11 p.m. to 4:07 p.m.

I. Approval of the Minutes of the Monetary Policy Meeting Held on February 12, 1999

The Policy Board approved unanimously the minutes of the Monetary Policy Meeting, the "Green Paper," of February 12, 1999 for release on March 17, 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 25 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 (note) aim to guide the above call rate to move around 0.15%, 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.

The uncollateralized overnight call rate declined to 0.03 percent on March 4 reflecting the Bank's more active injection of funds into the money market after the previous meeting. The weighted average of the uncollateralized overnight call rate in the current reserve maintenance period (from February 16 to March 15) decreased to 0.08 percent as of March 11, one business day before the meeting. During the period from February 26 to March 11, the Bank supplied larger amounts of funds to the market, leading to the weighted average declining further to 0.06 percent.

During the intermeeting period, three phases were observed in the Bank's operations and the market's reaction. In the first phase, during the period from February 26 to March 1, the overnight call rate stayed at the 0.09-0.10 percent level despite the Bank's injection of an increased amount of funds into the market. The rate remained at the same level due to (1) the strong demand for settlement funds at the end of the month and the beginning of the following month; and (2) the fact that fund-investors such as life insurance companies kept the offer rates at 0.1-0.2 percent, comparing them with the interest rate on an alternative means of investment, i.e., that on ordinary deposits (0.10 percent). The second phase was during the period from March 2 to 4 when the tight situation of call money transactions around the turn of the month subsided. During this period, market participants became more certain that the Bank aimed at lowering the overnight call rate further to zero percent, as the Bank provided more ample funds in its money market operations. As a result, the overnight call rate declined to 0.03 percent. This development was followed by a fall in interest rates on term instruments and long-term interest rates and a rise in stock prices. In these circumstances, overnight call money transactions decreased rapidly. In the third phase, the period after March 5, the Bank created less excess reserves than in the second phase giving due consideration to financial market developments. Consequently, the overnight call rate rebounded slightly but the level remained extremely low, below 0.05 percent.

Two points should be kept in mind in conducting market operations following the decline in the overnight call rate to close to zero percent. First, the amount outstanding in the call money market had decreased by almost 20 percent compared to that before February 12, owing to the shift of funds to direct call transactions (transactions in which financial institutions trade directly with each other without going through money market dealers) and ordinary deposits. Fund-raisers had successfully diversified their channels for procuring funds, and no disruption in funds settlement had been observed. However, the level of the overnight call rate and the market's reaction to its development required continued monitoring, given that only a few days had passed since the decline of the overnight call rate to the current low level and that the demand for funds for settlement was likely to increase toward the fiscal year-end amid the contraction of call money transactions. Second, with the overnight call rate declining to close to zero percent, it was becoming difficult to predict how actively market participants would bid for the Bank's operations of funds injection into the market.

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

1. Developments in foreign exchange markets

The yen fluctuated widely against the U.S. dollar throughout the intermeeting period. During the period from late February to early March, the yen depreciated to close to 124 yen against the U.S. dollar, recording the lowest level in three months. This was due to (1) a stronger perception among market participants that the difference in the level of economic activity between Japan and the United States was widening; and (2) the considerable decline in market interest rates in Japan. However, the yen recovered to the 119-120 yen level in the evening of March 11, the day before the meeting, following the increase in anxiety about the weak yen and the surge of the euro against the U.S. dollar in response to news of the resignation of Germany's finance minister, Mr. Oskar Lafontaine.

The euro had continued to be weak against the U.S. dollar reflecting expectations of a possible interest rate cut by the European Central Bank (ECB) and a series of remarks by policy makers in Europe suggesting an acceptance of a depreciation of the euro. However, the euro surged reflecting the market's interpretation that the resignation of Mr. Lafontaine, who had attempted to pressure the ECB to conduct monetary easing, was a factor in favor of the euro. Meanwhile, the euro continued to depreciate against the pound sterling partly due to a series of releases of strong economic indicators in the United Kingdom. Recently, however, the euro was recovering against the pound sterling.

After posting a record low in early March, the Brazilian real surged against the U.S. dollar due partly to the raising of the policy interest rate and the adoption of a revised economic program, which reflected the agreement on fiscal adjustment reached between the Brazilian authorities and the International Monetary Fund (IMF).

2. Overseas economic and financial developments

In the United States, the economy continued to expand. The growth in household spending remained firm against the background of favorable income conditions. New orders received by manufacturers were increasing somewhat. In these circumstances, prices were generally stable.

U.S. stock prices (Dow Jones Industrial Average [DJIA]) surged and neared $10,000 with the release of employment statistics for February on March 5. Technology stocks and internet-related stocks continued to lead price movements in the stock market. There were, however, views in the market that stock prices might plunge due to possible changes in the environment considering the price-earnings ratio of technology stocks reaching 50-70. Regarding the stock price developments, Mr. Alan Greenspan, Chairman of the Board of Governors of the Federal Reserve System, made a cautious remark in the testimony at the Congress.

Although the overall economy in the euro area remained to show gradual expansion, situations varied from country to country. For example, some economies, including those of France and Spain, continued to expand firmly while the slowdown was becoming distinct in Germany and Italy.

In the United Kingdom, external demand and production continued to fall, but recently, new orders received by manufacturers appeared to have stopped declining.

In East Asian countries, production seemed to be recovering in Korea while the economies of other countries remained in an adjustment phase.

C. Economic and Financial Developments in Japan

1. Economic developments

With regard to final demand, business fixed investment was declining significantly. As for household spending, private consumption remained weak on the whole, although housing investment had obviously bottomed out. Net exports were leveling off, and public investment continued to grow. Reflecting this development in final demand and further progress in inventory adjustment, industrial production had stopped decreasing.

In sum, at present, the economy appeared to have stopped deteriorating. Meanwhile, domestic wholesale prices were on a downtrend, and corporate service prices were weakening. Consumer prices basically remained weak but the pace of the decline was not accelerating.

As for the outlook, public investment was expected to increase significantly after April as public works orders seemed to have increased substantially in February and March. Housing investment was expected to start increasing, although it would still be at a low level, in or after March. Provision of "regional promotion coupons" (shopping vouchers) and the reduction in income tax were expected to halt the decline in household income. Although firms had been very reluctant to expand production, the possibility could not be ruled out that production would increase in around April to June with the increase in public investment and housing investment, as inventory adjustment had been progressing significantly.

However, given the severe income conditions, such an increase in final demand would still not induce an increase in business fixed investment. In addition, firms were inclined to reduce expenditures due to an expected significant deterioration in their financial results for the fiscal year ending in March. This would constrain growth in employment and wages, provoke further restructuring, and even cause bankruptcies of large firms that could not withstand the burden of necessary restructuring. These developments could lead to a deterioration in consumer sentiment which might exert downward pressure on private consumption. Under such circumstances, at present, it was still difficult to expect a recovery in private demand.

Prices were expected to remain on a downtrend. In a longer-term perspective, careful attention should be paid to a possible acceleration of the decline in prices taking into account the following: there was no clear prospect of the output gap narrowing and the decline in wages might affect service prices.

With regard to future economic conditions, attention should be paid especially to the following: (1) to what extent the projected restructuring and reduction in basic wages by firms would exert further deflationary pressure on the economy, and whether the capital market would show appreciation of such efforts; and (2) whether injection of public funds into banks at end-March would result in failures of non-viable firms, such failures creating deflationary pressure, and whether it would ease the cautious lending stance of financial institutions.

2. Financial developments

Positive signs were appearing in the recent financial markets although demand for funds for economic activities in the private sector remained sluggish.

In the money market, interest rates both on overnight call money and term instruments declined considerably reflecting the additional monetary easing by the Bank on February 12. A recent highlight was that the uncertainty about financial system stability --the major concern in the market since the failure of large-scale financial institutions in autumn 1997--seemed to be subsiding. As reflected in the rapid contraction in the Japan premium, markets' anxiety about liquidity and credit risks of Japanese banks seemed to be easing gradually due to the Bank's supply of ample liquidity and the progress in preparation for public funds injection.

Meanwhile, the amount outstanding of funds in the call money market decreased by almost 20 percent because some institutional investors shifted a portion of their funds to ordinary deposits. Close attention was required to the considerable changes in the flow of funds, although the shrinkage of the market had not led to any difficulty in funds settlement.

In nervous trades in the bond market, long-term interest rates declined following the fall in short-term interest rates. Stock prices increased and stayed at around the middle of the 15,000-16,000 yen level due partly to purchases by foreign investors. In the stock market, participants regarded the following factors as favorable: (1) the depreciation of the yen; (2) the rise in U.S. stock prices; (3) progress in the preparation for public funds injection into banks; and recently, (4) progress in corporate restructuring.

With regard to corporate financing, demand for funds for economic activities such as business fixed investment remained weak, and firms' moves to increase their on-hand liquidity in the face of the cautious lending attitude of financial institutions were settling down. Meanwhile, private banks were retaining their cautious lending stance in view of the worsening performance of borrower firms. However, banks' concern about procuring funds was subsiding, and their insufficient capital base was about to be restored by the public funds injection. Under these circumstances, private banks were focusing on lending with small credit risks, such as loans utilizing the credit guarantee system and loans to firms with high credit standings.

As a result, the previously tightened credit conditions were easing somewhat. However, the market remained cautious of credit risk, and thus there were still a certain number of firms that continued to have difficulty in fund-raising, such as firms with relatively low credit standings. Therefore, this situation required monitoring especially with regard to developments in corporate financing toward and after the turn of the fiscal year.

  1. 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

Members generally agreed with the staff's report on the current economic situation that, at present, Japan's economy appeared to have stopped deteriorating.

To support the above view, many members pointed out the following factors as evidence: (1) public investment continued to increase; (2) housing investment had bottomed out at a low level and showed signs of a recovery; and (3) inventory adjustment had progressed further and production had stopped decreasing. One of these members added that an indication of a slight improvement had been observed in the business sentiment of small firms.

However, at the same time, these members commented that the vicious circle caused by the deterioration in corporate profits and in employment and income conditions remained as seen in the continued sluggishness in private consumption and the significant decline in business fixed investment. One member stated that business fixed investment was in a very severe situation, pointing out that the "Financial Statements Statistics of Corporations by Industry, Quarterly," released by the Ministry of Finance, had shown an 18.7 percent decrease in business fixed investment in the October-December quarter of 1998 compared to the same quarter of 1997, mainly in small firms, and that this figure indicated that the quarter's GDP might have been pushed down significantly.

In this situation, where there were both positive and negative signs in the economy, many members considered that, in the past month, positive signs were increasing slightly while there were few negative ones indicating a further deterioration in the economy. On these grounds, many members shared the view that the economy on the whole appeared to have stopped deteriorating. Furthermore, one member mentioned that the coincident index of diffusion indexes also suggested that the economy had stopped deteriorating at least temporarily.

B. Financial Developments

With regard to financial developments, members focused their attention on the evaluation of the considerable impact on market interest rates of the Bank's provision of more ample funds to the market. Many members concluded that, while the additional monetary easing on February 12 had had a significant impact on the financial markets, various expectations for future monetary policy had also influenced the market. Furthermore, there were many comments stressing that the previously tightened credit conditions were easing somewhat in the money market and corporate financing, and this was contributing to the stop in the deterioration of the economy.

As for the market's response to the recent monetary easing, some members pointed out the following: (1) interest rates on term instruments had declined by a larger margin than the overnight call rate; (2) long-term interest rates had also fallen; (3) the yen had depreciated; (4) stock prices had risen; and (5) the Japan premium had contracted to close to zero. From these developments, the members concluded that the monetary easing had had a considerable impact on the market. However, one of these members commented that other factors besides the monetary easing had contributed to the above developments in the market, including (1) the progress in preparation for public funds injection; (2) the Ministry of Finance's decision to diversify the maturity of Japanese government bond (JGB) issues; and (3) the rise in U.S. stock prices. Many members also commented that not only the effect of the monetary easing but also the emergence of various expectations for future monetary policy had had an impact on the financial markets as the overnight call rate neared zero percent.

Another member mentioned that the recent monetary easing was effective, because (1) the decision on the monetary easing made on February 12 had not been expected by the market; (2) the overnight call rate had fallen rapidly toward zero percent from the end of February; and (3) reflecting these developments, a view had spread among market participants that the Bank was determined to implement decisively easy monetary policy, and was even considering a quantitative monetary easing to this end.

Based on the above recognition, some members had a cautious view that a reversal might occur in the market to some extent if recent movements in the financial market reflected speculation and excessive expectations for future monetary policy.

One of these members commented on the decline in long-term interest rates from the peak recorded in early February. The member had previously considered that factors affecting the supply-demand balance of JGBs--e.g., the diversification of their maturity at issuance and the resumption of purchases by the Trust Fund Bureau--had had more effect on the decline in long-term rates than had the monetary easing. However, at present, a more appropriate interpretation was that both the supply-demand factor and the monetary easing had contributed to the recent decline in long-term interest rates, since this decline could be seen as a reaction to the monetary easing.

As for stock prices, a few members commented that the recent rise was attributable to the additional monetary easing as well as the increased purchases of Japanese stocks by foreign investors who were motivated by the public funds injection into banks and the progress in corporate restructuring. Based on this view, some of these members expressed the opinion that (1) it was questionable whether these factors alone could continue to underpin stock prices for a long period of time, but (2) the recent rise in stock prices could be regarded as a favorable sign because it reflected some positive factors such as the significant contraction in the risk premium and an expectation of recovery in corporate profits as a result of improvement in cash flow.

Meanwhile, there were cautious views about the sustainability of the current level of stock prices. One member commented that stock prices might be fundamentally vulnerable because it had been realized not only by the monetary easing but also by such exogenous factors as the public funds injection into banks, strong U.S. stock prices, and purchases by foreigners--not by the most fundamental factor, improvement in corporate profits. A different member presented the understanding that recent stock prices had been underpinned partly by expectations of a quantitative easing policy, and there were "quasi-bubble" phenomena in the market. According to this member, there might be a reversal in the development in stock prices in the April-June quarter if policy actions turned out to be not as expected, or if the DJIA turned toward a decline after it reached US$10,000. With regard to corporate financing, each member expressed the view that the tension that had once intensified had abated.

One member commented that, despite the approach of the fiscal year-end, stability had been restored in corporate financing through progress in the preparation for the public funds injection and the expansion of the credit guarantee system. Another member expressed the view that the corporate financing situation toward the fiscal year-end in March had eased substantially as banks and firms had been able to secure sufficient funds as a result of the permeation of the Bank's monetary easing in addition to the above support from the government. Based on this recognition, the same member and another pointed out that there was a sufficient amount of funds available, but the recent problem in corporate financing lay in the fact that these funds were not being used fully due to firms' weak demand for funds.

Related to this point, a few members remarked that it warranted attention whether there was a relationship between the recent rise in prices of over-the-counter stocks and of golf club memberships and the widespread alleviation of firms' financing difficulties.

In conclusion, a few members summarized the discussions on the financial developments as follows. The government's measures to restore the stability of the financial system and the Bank's supply of ample liquidity to the market since last year had been contributing to the easing of credit conditions in the money market and corporate financing. The resultant stable market conditions prevented a further deterioration of the economy, and provided one of the requirements for a recovery in corporate and household confidence.

C. The Economic Outlook

On the economic outlook, while many members admitted that, in the short run, the economy would stop deteriorating and could be expected to bottom out, they generally agreed that the prospect of an economic recovery was still unclear considering the continued weakness in economic activity in the private sector.

One member was of the opinion that, at least in the short run, the economy would move around the bottom, after which it could be expected to recover slightly. This was because (1) the effect of the emergency economic package materialized clearly; (2) housing investment was expected to increase gradually; and (3) the situation in the money market and in corporate financing became stable.

According to another member, evaluation of fiscal and monetary policy measures that had been implemented to date and the recent dynamic changes in the markets would be the key to the economic outlook. This member and another were of the opinion that if the current trend in stock prices continued, downside risk to the economy might become smaller through the following: (1) alleviation of the restraints on banks' activities stemming from their insufficient capital base; and (2) elimination of firms' unrealized capital losses.

Many members including these two, however, took the position that they could not be optimistic about the economic outlook because there were hardly any signs of self-sustained recovery in private-sector demand.

Some members considered that an immediate upturn in private-sector activity was unlikely because weakness persisted in corporate profits, employment and income conditions, business fixed investment, and private consumption.

Another member remarked that (1) the coincident index of business conditions released by the Economic Planning Agency had shown signs of a halt in economic deterioration, but this result was partly due to special factors such as the rise in department store sales that resulted from the closing sale of a department store and the rise in the ratio of job offers to applications that resulted from the decrease in job applicants; and (2) the leading index of business conditions had declined. Given these points, the member still saw no prospect of an economic recovery. This member cited the dominant view among the public that firms' fiscal-year-end settlement in March would record a 20-30 percent decline in current profits and a 50 percent decline in net income due to the poor business performance of firms, as well as firms' moves to write off the balance sheet burden that had accumulated since the bursting of the "bubble" economy, prior to the introduction of consolidated accounting. The member stated that, due to the resulting difficult financial position, firms were very likely to restrict expenditure and carry out even more drastic restructuring.

Another member commented that economic activities would remain at a low level even in the April-June quarter. The member continued that prospects varied by industry, by firm, and even by product, citing the following examples. First, production in the automobile industry would have to be cut drastically in the April-June quarter, given the accumulation of inventory reflecting the slump in sales and the increase in production in the January-March quarter to improve the results of the March settlement. Second, the level of production in the April-June quarter in the raw materials industry would decline further, reflecting the weakness in demand for business fixed investment and private-sector construction. Production in the raw materials industry on the whole was estimated to be lower than in the January-March quarter, the initially estimated bottom, and production of steel in particular was expected to record the lowest level in 30 years. In addition, the member stated that consumer confidence was gradually bottoming out because (1) tax reduction and financial system stabilization measures were bringing about a favorable effect on consumer confidence; and (2) negotiations in the spring labor offensive, in which labor unions had been expected to be forced into either choosing job cuts or wage reduction while increases in basic wages could not be hoped for, had not been as severe as initially predicted. As for the outlook, the member noted that consumers' willingness to spend, which might be encouraged by development of new products and technology, could be discouraged if consumer confidence deteriorated once again against the background of a decrease in income accompanying firms' restructuring.

One member expressed a severe economic outlook, commenting that the prospects for the economy after the October-December quarter of 1999 were completely unclear. This member remarked that, considering the various conditions that affected firms' business, drastic restructuring was expected and there was even concern about the possibility of large-scale corporate bankruptcies. The member also pointed out that (1) employment and income conditions were deteriorating and this could negatively affect consumption expenditure; (2) recovery in business fixed investment as late as fiscal 2000 could be quite difficult unless large-scale scrapping of plants and equipment was carried out, considering the existing excessive capital stock; (3) increase in housing investment might only continue until around the summer and might plunge thereafter considering the restraints that could result from the deterioration in income conditions; (4) the prospect for public investment was unclear for the period after the October-December quarter of 1999; and (5) exports to Europe, which increased last year, were very likely to decline and those to the United States could be hampered by the potential trade friction between the United States and Japan. Furthermore, the member added that this assessment was consistent with the developments in long-term leading indicators, which suggested hardly any prospect of the economy entering a recovery phase in eight to eleven months ahead.

Several members cited developments in financial institutions' lending activities following the injection of public funds as one of the important indicators in forming a view on the future development of the economy. According to these members, the key points would be how willing banks became to extend loans and how they assisted firms' risk-taking. One of these members was doubtful that the injection of public funds would bring immediate changes to the activities of financial institutions. The member was, however, of the view that the injection would at least moderate financial institutions' moves to collect loans.

With regard to prices, one member pointed out that the decline in consumer prices was not as large as had been expected. The member commented that it was difficult at this stage to judge whether the moderate decline (1) represented an underlying trend; (2) was a temporary movement; or (3) merely resulted from bias that could arise when compiling statistics. This member therefore concluded that developments in consumer prices should be monitored carefully from April onward when the declining trend in wages would be reflected.

Many members commented on structural adjustment in relation to future economic developments.

Some members pointed out that almost all possible policy measures had been taken on both the fiscal and the monetary front, and that it was now time for the private sector to seriously carry out structural adjustment. One of these members emphasized the importance of finding the right remedy for an economy in which the overnight call rate had been reduced to close to zero by monetary policy. For this purpose, in this member's view, comprehensive deliberation was required within both the public and private sectors and on various areas, both fiscal and financial. Themes to be discussed included (1) what kind of efforts should be made by the private sector hereafter and (2) how the government would carry out fiscal spending and tax reform focusing not just on increasing demand but rather on promoting structural reform of the economy. Another member commented that measures such as those aimed at creating demand through public investment could not fill the huge output gap, and that adjustment of excessive capital stock and employment was inevitable. This member expressed the view that economic recovery should be realized through a combination of private sector efforts and fiscal and monetary measures, for example through the following steps: efforts by the private sector followed by various policy measures such as unemployment measures, a tax system encouraging scrapping of capital stock, and promotion of land liquidation.

A different member remarked that firms' disposal as special loss of the nonperforming assets and excessive capital stock that had accumulated since the economic "bubble" burst was a resolute move to separate from the past. The member stated that, if this action led to an economic recovery, it would eventually lead to so-called "creative destruction." The same member continued that, in reality, there was a large risk of the negative effects of these balance-sheet adjustments emerging before any positive developments appeared. This member added that in that case, from a macroeconomic perspective, the already somewhat deflationary tone of the economy could easily become stronger.

Another member commented that the structural reform accompanying disposal of excessive capital stock and adjustment of excessive employment would influence the economy negatively and that a policy backup was required as a countermeasure. This member added the judgment that provision of such a backup was not something to be expected of monetary policy.

A few members commented on market reaction to structural adjustment. They pointed out that structural adjustment was recently not necessarily taken as deflationary pressure but was being taken in many cases as a positive factor as shown by the rebound in stock prices. One of these members commented that, since the economic "bubble" burst, deflationary pressure arising from structural adjustment and the overall economic downturn had continued to cancel out all positive outcomes of structural adjustment. The member, however, expressed the hope that the possibility of the above-mentioned favorable outcome of structural adjustment would probably lead to an economic recovery this time, considering the fact that the economy on the whole was on its way to a slight recovery helped by policy support.

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.

The views of many members on the economic and financial conditions were, in sum, as follows. First, the economy appeared to have stopped deteriorating following the full-scale implementation of the emergency economic package, improvement in housing investment, and progress in inventory adjustment. Second, the Bank's monetary easing in February, together with the government's policy measures such as the expansion of the credit guarantee system and the planned injection of public funds into banks, was producing its intended effect as observed in the alleviation of the previously tight conditions in the money market and corporate financing. Third, however, private-sector economic activity was still weak, and there was no clear prospect of economic recovery.

On the guideline for money market operations for the immediate future, accordingly, the majority opinion was that the Bank should maintain the current guideline and retain its decisive, easy stance on monetary policy.

As the grounds for this judgment, some members noted that it had only been a few days since the overnight call rate had declined to close to zero, and the Bank now needed to closely monitor resultant market developments. Therefore, it was appropriate to continue to carry out money market operations in accordance with the current policy directive. More specifically, they pointed out that the Bank had yet to stabilize the overnight rate at close to zero and, in adequately providing the necessary funds to keep the rate near zero, had to observe carefully the consequences: for example, (1) the extent to which call money transactions would shrink reflecting, for example, shifts of funds to ordinary deposits; and (2) whether funds settlements for money market transactions would occur smoothly despite such developments.

One of these members pointed out that, even though the Bank was injecting an increasing amount of funds into the interbank market, many of the financial institutions subject to reserve requirements were averse to holding excess reserves. Instead, the funds were flowing into financial institutions that were not subject to reserve requirements, such as tanshi companies (money market broker-cum-dealers). The member stated that it was necessary to consider carefully what this development implied and whether this trend would continue.

Another member expressed an intention to monitor the permeation of the effects of the monetary easing by watching closely how an overnight rate of almost zero, with ample funds being provided, would influence interest rates on ordinary deposits and short-term prime lending rates.

As outlined above, the majority of members expressed the view that, given the recent economic and financial situation, the current guideline for money market operations should be maintained and market developments warranted close monitoring. Following this discussion, some of them expressed concern that undue expectations of further monetary policy measures seemed to have emerged in the financial markets.

One member mentioned that a view seemed to prevail in the markets that, as there was little scope left for the use of fiscal policy, the only means remaining was monetary policy. The member, however, was of the opinion that almost every possible monetary policy measure had already been taken. This member stated that, with monetary and fiscal policies having been implemented close to their limit, the most significant measure for Japan's economy now would be to provide an environment that facilitated the structural adjustment of the private sector. On this premise, the member expressed concern that the recent tendency to rely excessively on monetary policy might obscure the true remedy for Japan's problems. Many of the other members agreed with this view. One of them stated that the emergence of various opinions and speculations was inevitable considering that monetary policy was being managed in an unprecedented situation where interest rates were close to zero. The member continued that the Bank had done its best in implementing policy measures, and should continue to focus on fulfilling its responsibility to make accurate judgment of the economic and financial situation and appropriately manage monetary policy without being easily swayed by these voices.

Two members presented views different from the majority opinion.

One member, having a particularly severe view of the economic outlook, claimed as in the previous meeting that an additional monetary policy measure was needed. The member weighed the possibility that a significant deterioration in business results in the fiscal year ending March 1999 would motivate firms to carry out intensive corporate restructuring involving a cutback on spending in the new fiscal year, and might cause even bankruptcies of large firms. The member claimed that, in the presence of such a risk, the monetary easing of February 12 was no longer sufficient, and emphasized the need to promptly implement additional measures that would fundamentally address the economic situation. This member also noted that there was virtually no room for further interest rate reduction and Japan's economy was caught in a so-called "liquidity trap." In light of this situation, the member specifically suggested that the regime of monetary policy be changed to quantitative easing with a specific price target. This was based on the consideration that (1) the change would clarify the guideline for money market operations, which was currently ambiguous, and increase the transparency of monetary policy, and (2) declaring an explicit aim to bring about growth in the monetary base (the sum of currency in circulation and reserves) would show more clearly the Bank's easy stance on monetary policy. The member further stated that the Bank had defined price stability, which was the objective of monetary policy, as an achievement of a noninflationary and nondeflationary situation, but had never set a specific target for the inflation rate. The member claimed that it would be important from now on to set a target for the inflation rate to convey more clearly to the public the Bank's resolution to maintain price stability and thereby increase the Bank's accountability.

This member also expressed disagreement with the view of some members that almost every effective monetary policy measure had already been taken.

Another member objected to keeping the overnight call rate at close to zero under the current guideline for money market operations. This member acknowledged that the effects of the monetary easing was gradually appearing in various developments, such as the rise in stock prices, the depreciation of the yen, and the stabilization of the financial markets. The member, however, expressed the view that evaluation of the policy was not easy because these positive developments were also attributable to factors other than monetary policy, such as the rise in U.S. stock prices and purchase of Japanese stocks by foreign investors. Further, the member mentioned that the present monetary easing had brought about a contraction of the call money market. Noting the significance of the market's function, which allows swift adjustments by market participants of shortages and surpluses of funds, the member claimed that it was necessary to avert a further shrinkage of the call money market, which might result from the current extremely low level of the overnight call rate.

As outlined above, various opinions were expressed on the guideline for money market operations for the immediate future: one that supported maintaining the current guideline; one that called for a change toward an additional easing; and one that objected to the extremely low interest rate level. Separately from this issue, one member pointed out that, although the zero-percent overnight call rate could be considered the "anchor" of money market operations under the current guideline, it also seemed that this anchor was not firm enough. Based on this consideration, members discussed whether an additional target for money market operations should be used together with the overnight call rate.

One member remarked that, theoretically, it was possible to adopt a target for interest rates on term instruments or quantitative indicators such as excess reserves in addition to the overnight call rate. The member then referred to the issues related to each target. Targeting of interest rates on term instruments posed the following questions: (1) whether it was appropriate to target the interest rate on three-month Treasury bills (TBs), which were safe assets, although the rates were already close to zero; (2) whether it was acceptable to target interest rates on euro-yen deposits, such as three-month deposits, even though the rates incorporated a large risk premium compared to the overnight call rate; and (3) whether it was appropriate to target interest rates on term instruments and gradually shift the target from short-term to longer-term instruments, although this might lead to the misapprehension that long-term interest rates could also be controlled. On the targeting of quantitative indicators, the member cited the experience of the United States between 1979 and 1982, when an attempt to control reserves created huge interest rate volatility and failed in achieving money stock targets. The member then introduced the results of the member's own estimation of targets for the monetary base (the sum of currency in circulation and reserves) and excess reserves consistent with inflation rates, potential medium- to long-term economic growth rates, and a few other variables. Estimation results showed that the targets would vary widely depending on the assumptions. Therefore, the member remarked that the use of such targets required further studies on the technical details. The member also raised a question about the feasibility of creating huge excess reserves. The member stated that, in order to bring about higher growth in the monetary base, the Bank would have to create a sizable amount of excess reserves unless currency in circulation increased significantly. However, the feasibility of market operations to create such massive excess reserves was questionable.

The member who called for additional monetary easing through the introduction of a quantitative target stated that, if the overnight call rate was maintained at close to zero, interest rates on short-term instruments would also naturally come down and this move would spread gradually to longer-term instruments. Therefore, it was meaningless for the Bank to control interest rates on term instruments. On these grounds, the member again stressed the need to adopt a quantitative target. Further, the member took the position that there should not be any problems with the feasibility of the Bank's market operations, which a member had questioned earlier.

Another member expressed the view that a new target, whether it was interest rates on term instruments or quantitative indicators, would not be as easily controllable as the overnight call rate. The member then argued against controlling quantitative indicators. First, analysis of the relationship between quantitative indicators (such as money stock and the monetary base) and economic indicators (such as short- and long-term interest rates, stock prices, prices, and GDP) based on a time-series model showed that the relationship had been unstable since the October-December quarter of 1997. Second, if there was a binding target for quantitative indicators such as the monetary base when large shocks occurred in the financial market, such as the one experienced recently, the target might hinder flexible policy responses and consequently amplify fluctuations in economic activity. Third, the relationship between quantitative and economic indicators was likely to continue to be affected by various factors such as the Year 2000 problem and the start of payoffs in April 2001. With regard to the controlling of interest rates on term instruments, the member noted the risk that the Bank's operations would adversely affect the respective markets by undermining their proper functioning or distorting the determination of interest rates. Nevertheless, the member's conclusion at the time was that, compared with controlling quantitative indicators, this measure would be more consistent with the previous policy of controlling the overnight call rate and more easily understandable.

Some of the other members also expressed cautious views about targeting quantitative indicators in the management of monetary policy.

One member expressed the acknowledgment that interest rates were still at the core of the transmission mechanism of monetary policy effects. On this premise, the member stated that, however hard the Bank tried to expand the quantity of money when interest rates on term instruments were close to zero, the magnitude of the outcome would be limited by the small decline in the rates on term instruments. This member also noted that, if it was assumed that quantitative expansion under zero interest rates could produce certain effects, one option would be to inject an infinite amount of money into the market. The member expressed concern that this, however, involved the possibility of amplifying future inflation risk. The expected outcome was that the quantitative expansion would be continued until prices actually started to increase, accelerating inflation.

In response this argument, the member who called for a quantitative easing claimed that there would be no risk either of injecting an infinite amount of funds or of accelerating inflation if the Bank set a specific target for the inflation rate or the growth rate of the monetary base.

Another member also claimed that it was by no means allowable for the Bank to implement policies that could lead to future inflation. The member warned that arguments highlighting the possibility of quantitative expansion would create undue expectations that monetary policy could be eased much further, and they also involved the danger of leading to policies for financing the fiscal deficit, such as the Bank's underwriting of JGBs or increasing of outright JGB purchases.

A different member expressed a concern that, once the Bank abandoned its interest rate policy for quantitative control, it would not be able to return to the former. The member therefore suggested that, if the interest rate anchor could not be clearly read from the current policy directive--which stated that the Bank would "encourage the uncollateralized overnight call rate to move as low as possible"--the Bank could specifically set a target for the overnight rate at 0.03-0.05 percent, the current level, and thereby emphasize the maintenance of interest rate targeting.

Another member pointed out that, even if the Bank continued managing policy based on interest rates, it might be useful to consider the following points, taking account of the Bank's experience: (1) how much reserves would be required under the normal circumstances in order to stabilize the overnight call rate near zero; and (2) whether it would be possible to use some quantitative indicator as a reference for policy management without causing the misunderstanding that the Bank had switched to quantitative control. A few members shared this view.

As outlined above, various opinions were expressed regarding whether some other monetary operation target should be employed in addition to the target for the overnight call rate, but no firm conclusion was reached.

Some members, however, pointed out that the current directive clearly stated the Bank's stance of paying due attention so that the market's functioning would not be impeded by a considerable decrease in transactions. They explained that the implication in this statement was that the Bank would adequately provide the necessary funds to maintain the overnight call rate at close to zero. They also stressed that this understanding was shared by market participants. One of these members noted that, if the guideline were meant to allow the Bank to provide any vast amount of funds as long as the overnight rate was near zero, the Bank's operations could cause interest rates on term instruments to fall to close to zero, creating a situation where very few transactions would be made. The member was of the opinion that this, however, was not in line with the directive since it would impede the market's smooth functioning. The member further remarked that, with the overnight rate at an unprecedented level of near zero, it was true that the Bank was cautiously implementing monetary policy, but this by no means meant that the current directive was left ambiguous.

V. Remarks by Government Representatives

Government representatives also made comments during the meeting. A representative from the Ministry of Finance made the following remark.

Japan's economy, on the whole, was still judged to be in a prolonged slump and in a severe situation, although some economic indicators had shown positive developments. In this situation, the budget bill for fiscal 1999, which had been formulated with the aim of doing the best that could be done in the current situation to revive the economy, was presently under deliberation at the House of Councilors. The government was determined to continue doing its utmost to implement the various policy measures including the emergency economic package of November 1998.

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

The overall economy was still in a very severe situation due to sluggish private demand. However, the deterioration was coming to a halt underpinned by the effects of various policy measures. The government was determined to do its utmost, to break the vicious cycle of economic deterioration and realize a self-sustained recovery of the economy by implementing the various measures included in the emergency economic package of November 1998. The government would like to request the Bank to continue its appropriate monetary policy management, such as supplying ample liquidity to the market.

VI. Votes

The views of many members were summarized as follows: (1) the economy appeared to have stopped deteriorating, and it seemed that the alleviation of the tight conditions in the money market and corporate financing had contributed significantly to this development; (2) however, economic activity in the private sector remained sluggish, and there was no clear prospect of economic recovery; and (3) it had only been a few days since the overnight call rate had declined to close to zero, and the Bank now needed to observe consequent market developments.

Based on this understanding, the majority of members were of the opinion that the Bank should maintain for the immediate future the guideline for money market operations decided at the previous meeting--which stated that the Bank would "provide more ample funds and encourage the uncollateralized overnight call rate to move as low as possible" and would do so "by paying due consideration to maintaining market function."

In formulating the policy proposal, members discussed whether to change a part of the directive that had become out of date--the statement that the Bank would "initially aim to guide the above call rate to move around 0.15%, and subsequently induce further decline in view of the market developments." At the end of the discussion, it was decided to leave the statement unchanged for the following reasons: (1) a notable change in the wording when there was no change in monetary policy could provoke unnecessary confusion in the markets; and (2) it was unlikely that this part being unchanged would cause the market to misunderstand the guideline for money market operations.

Meanwhile, one member, who had an especially harsh view about the economic condition, claimed as in the previous meeting that, with the prospect of economic recovery remote, it was necessary to adopt an additional monetary policy measure to fundamentally address the difficult situation before the various downside risks materialized and added to the downward momentum in the economy. In this context, the member suggested that the Bank implement a quantitative easing.

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 0.5 to 1.5 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 increase the amount of excess reserves by about 500 billion yen in the intermeeting period ahead, and by continuing to increase the amount thereafter, 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, 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 ahead 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%, and subsequently induce further decline in view of the market developments.

  • Note: "Initially" means the time of the 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) if firms once again strengthened their restrictive stance on spending in and after April reflecting poor business results for fiscal 1998, this would significantly increase the downside risk to the economy; (2) it was therefore necessary to promptly implement a quantitative easing; and (3) the proposed directive did not make clear the target of money market operations.

Ms. Shinotsuka dissented, claiming that the current economic situation called for measures to narrow the large output gap such as industrial restructuring, deregulation, and tax and pension system reforms. She noted the risk that undue expectations for monetary easing under these circumstances would distort the interest rate formulation mechanism.

VII. 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 March 16, 1999 in the Monthly Report of Recent Economic and Financial Developments (the "Ivory Paper," consisting of "The Bank's View" and "The Background"). 7

  1. 7The original full text, written in Japanese, of the Ivory Paper was published on March 16, 1999 together with the English version of "The Bank's View." The English version of "The Background" was published on March 29, 1999.

Attachment

For immediate release

March 12, 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:

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%, and subsequently induce further decline in view of the market developments.

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