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Minutes of the Monetary Policy Meeting

on May 18, 1999
(English translation prepared by the Bank staff based on the Japanese original)

July 1, 1999
Bank of Japan

A Monetary Policy Meeting of the Bank of Japan Policy Board was held in the Head Office of the Bank of Japan in Tokyo on Tuesday, May 18, 1999, from 9:00 a.m. to 12:14 p.m., and from 1:01 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
Mr. Y. Yamaguchi, Deputy Governor of the Bank of Japan
Mr. Y. Gotoh
Mr. S. Taketomi
Mr. T. Miki
Mr. N. Nakahara
Ms. E. Shinotsuka
Mr. K. Ueda

Government Representative Present
Mr. T. Mutoh, Deputy Vice Minister for Policy Coordination, Ministry of Finance 2
Mr. E. Kawade, Director-General of the Coordination Bureau, Economic Plannin Agency

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. E. Hirano, Director, International Department
Mr. T. Oyama, Adviser, International Department
Mr. S. Murayama, Director, Research and Statistics Department
Mr. H. Hayakawa, Adviser, 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 June 28, 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. Mutoh was present from 9:00 a.m. to 12:14 p.m., and from 2:11 p.m. to 3:28 p.m.

I. Approval of the Minutes of the Monetary Policy Meeting Held on April 9, 1999

The Policy Board approved unanimously the minutes of the Monetary Policy Meeting, the "Green Paper," of April 9, 1999 for release on May 21, 1999.

II. Summary of Staff Reports on Economic and Financial Developments 3

A. Money Market Operations in the Intermeeting Period

Market operations in the period since the previous meeting on April 22 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 Monetary Policy Meeting, February 12, 1999.

As a result, in the intermeeting period--including the period from the end of April through early May when major banks increased their fund-raising--the overnight call rate was steady at 0.03 percent, which was virtually zero percent taking account of brokerage fees.

In these circumstances, interest rates on term instruments declined further after Golden Week (the period from late April to early May that includes four national holidays). In particular, interest rates on relatively long-term funds, such as those with six-month and one-year maturities, had marked conspicuous declines. As a result, the yield curve had become even flatter up to the one-year zone. The recent additional declines in term interest rates were attributable to the following developments: (1) the fund positions of major banks had improved due to an inflow of funds to deposits and the sluggish growth in lending; (2) market participants' expectations of a further lowering of interest rates on deposits, including ordinary deposits, had strengthened; and (3) the Governor's statement at a press conference on April 13--that the Bank would maintain its easy stance on monetary policy until deflationary concern was dispelled--had had a significant impact on the awareness of market participants, further alleviating their concern about liquidity and interest rate risks.

The above situation in the interbank market had influenced the entire money market, causing several developments that deserved attention. First, bidding for treasury bills (TBs) and financing bills (FBs) was becoming extremely competitive, and as a result, bids for one-year bills were being accepted at a very low level of around 0.05 percent. Second, fund-investors were recently increasing their lending of term instruments maturing beyond the fiscal year-end. Previously, interest rates on these instruments had been relatively high reflecting the liquidity risk arising from the Year 2000 problem. Due to the increased lending, the interest rates were declining and, consequently, banks were increasing their issuance of eight-month certificates of deposit (CDs), which mature in January 2000. Third, due to investors' active purchases of commercial paper (CP), interest rates on CP at issuance were declining significantly even though the amount outstanding of the Bank's CP operations had recently fallen to around 2 trillion yen from around 8 trillion yen at the end of 1998. As these developments showed, at least fund-investors in the money market appeared to have become somewhat more willing than before to take not only interest rate risks but also credit risks.

For the immediate future, four points required attention in the money market. First, the bid rates on the Bank's various market operations had been extremely low, and the bid amount had also been declining. For example, the lowest accepted bid for the most recent bill purchasing operation was 0.01 percent. Second, the amount outstanding of funds in the call money market, both collateralized and uncollateralized, had contracted by 34 percent since the monetary easing of February 12. So far, this had not led to any difficulty in funds settlement, but close attention should be paid to developments in the call money market considering that this was where the supply and demand of short-term funds were ultimately adjusted. Third, excess reserves and the amount of funds in Bank of Japan current accounts held by financial institutions not subject to reserve requirements continued to be substantial, and this trend required careful monitoring. Fourth, although the money market conditions were extremely easy at present, future developments required attentive monitoring, as they could be affected by U.S. stock prices and financial institutions' Year 2000 preparedness.

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

1. Developments in foreign exchange markets

The yen had generally stood at around 120 yen against the U.S. dollar, but had been depreciating since the previous week. The yen's depreciation was attributable to the following two factors. First, reflecting the difference in the economic situation between Japan and the United States, the interest rate differential between the two countries was expanding--i.e., short- and long-term interest rates in Japan were declining further while long-term interest rates in the United States were rising reflecting strong economic and price indicators. Second, statements by the monetary authorities of Japan and the United States, such as the remark made by a high-rank U.S. government official that a strong dollar was very much in America's national interest, had been taken by market participants as a sign of acceptance of the U.S. dollar's appreciation, and this seemed to have contributed to the rise of the U.S. dollar.

Meanwhile, the euro was stable against the U.S. dollar. Asian currencies had weakened somewhat against the U.S. dollar, influenced partly by the depreciation of the yen against the U.S. dollar.

There were two conspicuous developments in the global financial markets. First, international fund managers had been adjusting their portfolios. They were slightly increasing their investments in the assets of Japan and emerging economies based on a recognition that the weight of these countries' assets in their total portfolio had become too small. This was one of the factors that gave a boost to these countries' stock markets. Second, such countries as Brazil were resuming their bond issuance in international financial markets given the improvement in market conditions for emerging economies, as seen in the contraction in the yield spread between U.S. dollar-denominated bonds of emerging economies and U.S. Treasury securities.

2. Overseas economic and financial developments

The U.S. economy continued to expand. Although prices remained stable, some influence of the rise in crude oil prices was observed. The labor market continued to be tight.

Meanwhile, the growth of European economies had slowed somewhat. East Asian economies were showing stronger indications of a bottoming out. Nevertheless, given that the recent economic recovery had been fueled in large part by progress in inventory adjustment, close attention should be paid to whether final demand would continue to improve and whether the strength in stock prices would be sustained.

C. Economic and Financial Developments in Japan

1. Economic developments

In final demand, net exports were level, and private consumption was showing mixed developments at a low level. Business fixed investment was basically on a downward trend although some leading indicators were showing signs of improvement. Meanwhile, public investment was increasing, and housing investment was recovering.

Reflecting these developments in final demand and continued progress in inventory adjustment, production had stopped decreasing.

In sum, Japan's economy had stopped deteriorating.

With regard to prices, consumer prices remained weak, but there were no signs of the decline accelerating.

On the outlook, it was likely that the economy would remain stable, underpinned by the progress in public works and the recovery in housing investment.

For the economy to move on to a clear recovery, there must be some factor that could trigger a recovery in private demand. In this regard, the rise in stock prices was one favorable factor, as it could be considered to have a positive effect on the sentiment of corporate managers and households. In reality, however, firms remained cautious about increasing production, and private consumption was still unlikely to recover for the time being.

Another positive factor was that business fixed investment at small firms, previously deferred due to financial constraints, was being commenced reflecting the easing of corporate financing conditions. However, the overall trend in business fixed investment would be weak given the fact that firms, especially large ones, were implementing full-scale restructuring, including the reduction of interest-bearing liabilities.

In light of the above conditions, a self-sustained recovery in private demand still seemed unlikely.

In these circumstances, prices were expected to remain weak. In view of the recent developments, however, the pace of decline in consumer prices would probably remain moderate. Still, there remained a risk that the decline in prices would accelerate gradually if the economy could not start a recovery but showed a double dip, and this risk needed to be watched closely.

2. Financial developments

In the money market, with the overnight call rate near zero percent, confidence about the availability of funds was growing among many financial institutions. Interest rates on term instruments had declined further, reflecting the market's expectation of prolonged monetary easing. In addition, the Japan premium had almost disappeared.

Given the decline in term interest rates, market participants were becoming more willing than before to take interest rate risks and credit risks. Therefore, long-term interest rates, not only yields on Japanese government bonds (JGBs), but also those on corporate bonds and bank debentures, were declining. Stock prices were generally firm partly reflecting the continued rise in U.S. stock prices.

The amount outstanding of funds in the call money market was decreasing slowly as institutional investors continued to shift funds to ordinary deposits and longer-term instruments.

In relation to the monetary aggregates, firms' demand for funds for economic activities such as fixed investment remained sluggish, and their moves to increase on-hand liquidity in the face of severe fund-raising conditions had clearly settled down. As a result, private-sector demand for funds had weakened further.

Meanwhile, private banks basically retained their cautious lending stance with a view to ensuring sound management. However, the constraints arising from severe fund-raising conditions and insufficient capital base had been eased. Under these circumstances, major banks had gradually become more willing to lend, particularly when the credit risk involved was relatively small.

Reflecting these developments, corporate financing conditions were easing. As for the future, the situation warranted careful monitoring of the extent to which private banks would ease their lending stance and how the change would stimulate firms' investment.

With regard to developments in money stock from a somewhat long-term perspective, M2+CDs in recent years had grown by a constant rate of 3-4 percent while nominal GDP had not increased. As a result, the Marshallian k (money stock divided by nominal GDP) was rising quite rapidly. This could be interpreted as the cumulative effect of monetary easing.

  1. 3Reports 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

On the current economic situation, members agreed that Japan's economy had stopped deteriorating but clear signs of recovery had not been observed yet. A member described this situation as the economy plodding along at the bottom with positive and negative factors intertwined.

As factors behind the halt in economic deterioration, many members noted the recovery in demand stimulated by policy measures, such as the increase in public investment and the improvement in housing investment. A few members pointed out that, given the progress in inventory adjustment, production could start to increase depending on developments in final demand. Furthermore, many members shared the understanding that the improvement in financial market conditions, such as the contraction of the risk premium and the strength in stock prices, was contributing to the recent stability of the economy.

One member elaborated on the recovery of East Asian economies as a favorable external factor. The member commented that economic recovery was becoming apparent especially in Korea, Taiwan, and Thailand, and the positive effects were gradually spreading to Japan's manufacturing industry. As examples of the positive effects, the member cited the following: (1) knockdown exports of cars and exports of plant and equipment had started to increase; (2) this increase in demand was in turn favorably affecting domestic and external demand for materials; (3) with the prices of iron and steel and of petrochemical products recovering in Asia and domestic inventory adjustment almost completed, these sectors were in a better position than before to raise product prices in Japan; and (4) these three developments, along with the recovery in public and housing investments, were pushing up the monthly earnings of materials manufacturers.

Despite the positive developments mentioned above, members judged that clear signs of a recovery had not been observed yet. This was because there was question about the sustainability of the factors currently underpinning the economy such as public investment and housing investment, and a cyclical upturn was still not observed in private demand, which was persistently sluggish.

Specifically, the majority of members considered that, under the severe employment and income conditions, private consumption would remain basically flat although both positive and negative factors were currently observed. One member even expressed the opinion that the weakness in private demand had recently become slightly more conspicuous, citing figures from the Family Income and Expenditure Survey and those for sales at department stores.

With regard to business fixed investment, members generally shared the view that positive signs had appeared reflecting the alleviation of concern about small firms' financing conditions. They also agreed, however, that various surveys still did not show any changes to the downward trend in business fixed investment, particularly at large firms.

One member noted that some business leaders had begun to say that the economy might be at a turning point. However, the member remarked that, taking into account the above developments underlining the weakness of the economy, it was necessary to examine very closely whether the somewhat positive developments recently observed were widespread and sustainable enough to lead to a fundamental change in the overall economic conditions.

B. Financial Developments

Regarding financial developments, most members pointed out that risk premiums overall, including some credit risk premiums, had contracted further. This was clear from the fact that both short- and long-term interest rates, including interest rates on the liabilities of firms and financial institutions, were declining substantially, and that stock prices generally remained firm. Members basically agreed that the improvement in the financial market conditions was mainly due to the maintenance of the zero interest rate policy, which the Bank had explicitly announced, and the establishment of a framework to ensure financial system stability, which included a scheme to inject public funds into banks. Referring to the above, many members considered that the conditions necessary for the positive effects of financial developments to spread to economic activity had now been provided.

Specifically, on the recent decline in long-term interest rates (the rise in bond prices), a member pointed out that this decline could not be a reflection of a pessimistic economic outlook, considering the strength in stock prices, but it was a so-called "liquidity-driven rally." Here, the member did not mean that the decline in long-term interest rates had already gone too far. Rather, the member was of the opinion that this decline was consistent with the intention behind the Bank's money market operations, which were conducted in accordance with the prevailing economic situation. The member furthermore noted that the important point was whether the effects of the monetary easing would spread to economic activity, for example through an increase in bank lending, while such favorable financial market conditions were maintained.

A different member expressed concern that, if the bond market was driven by financial professionals, without relevance to the level of economic activity, there was a possibility that long-term interest rates would decline too far, subsequently causing a significant rebound.

Another member commented that it is a natural outcome of monetary easing that stock prices increase and long-term interest rates decline before economic activity moves on to a recovery path. The member added that it is not a problem if long-term interest rates rise when signs of an economic recovery are apparent. A few other members remarked that the recent declines in various interest rates, including long-term interest rates, that reflected the ample supply of liquidity in the market were consistent with the Bank's intention behind the decision in February to further ease monetary policy. They also recognized that the declines were a prerequisite for an economic recovery. Many other members shared this view.

As a possible explanation of the overall strength in stock prices despite the persistent weakness in private-sector activity, a member stated that market participants attached more importance to expected improvements in the structural and nonperforming-asset problems, rather than to the burdens placed by these "negative legacies" of Japan's economic "bubble." The member expressed high hopes that the positive expectations reflected in the current stock prices would also translate into firms' real investment. However, the member also mentioned the risk that, if corporate profits did not recover as expected, disappointment would hit the stock market, causing a drop in stock prices. In light of this risk, the member emphasized that developments continued to require close attention.

A different member noted that the rise in stock prices since the beginning of 1999 had pushed up the total market value of listed stocks by approximately 80 trillion yen. This member mentioned the possibility that this wealth effect might restore the confidence of corporate managers and eventually contribute to an increase in business fixed investment. At the same time, the member called attention to the possibility that the financial results of firms, to be released from the end of May, would trigger an adjustment in stock prices.

With regard to bank lending, many members commented that banks appeared to have become somewhat more willing than before to take credit risks given that a framework for ensuring financial system stability had been established, and as a result, corporate financing conditions had ameliorated. However, most of the members considered that banks' risk-taking activity alone was still not strong enough to favorably influence economic activity, and an increase in firms' demand for funds was necessary for an increase in bank lending.

On this issue, one member asserted that the injection of public funds into banks and the maintenance of the zero interest rate policy, which the Bank had explicitly announced, had eased the constraint on banks' lending. The member pointed out, however, that banks had basically retained a cautious lending stance with the aim of improving profitability and thereby securing sound management. The member noted that the current financial intermediary functions of banks were hardly sufficient compared to the monetary easing phases before the 1990s, when banks used to actively stimulate demand for loans through such actions as lowering lending rates, although at that time they had gone too far. The member added that, to boost business fixed investment from the financial side, it was necessary to either further strengthen banks' intermediary functions or improve other channels of financial intermediation.

A different member remarked that it was quite unlikely that the supply side would be the driving force for credit expansion because banks had to put emphasis on strengthening their profitability to return the public funds injected into their capital base.

Another member commented that the recent change in the banks' lending stance was a mere precondition for an increase in bank lending, and the important issue was whether firms with adequate credit ratings would expand their demand for funds.

A different member shared the view that banks would not increase their loans unless firms' demand for funds increased. At the same time, however, the member pointed out that major banks had become sufficiently active in extending loans, and some of them were even willing to lend to large firms with low credit ratings whose business performance had deteriorated. The member emphasized that, in light of this trend, developments in the loan market required full attention.

Taking the above arguments into consideration, one member presented the view that, on the one hand, banks had still not come to the point where they were aggressively taking risks. On the other, such indicators as the Marshallian k suggested that the pace of increase in the monetary aggregates was fast compared to the growth in economic activity. The member thus concluded that both the risk of under- and over-supply in financial intermediation needed to be watched closely.

A few members also referred to the credit guarantee system as one of the factors that had supported banks' lending since autumn 1998. The members pointed out that, since many small firms were currently surviving on account of this system, there was the risk that the number of bankruptcies would surge when its effects tapered off.

C. The Economic Outlook

On the economic outlook, members generally agreed that the economy was very likely to remain stable in the immediate future, but with the persistent pressure for structural adjustment in the medium term, the prospect of an economic recovery driven by private demand remained unclear. They therefore acknowledged the risk that the economy would show a double dip in or after the second half of fiscal 1999, when public investment was expected to decrease.

Specifically, members shared the view that the increase in public investment and housing investment, which were stimulated by various policy measures, was currently contributing to economic stability, but this effect would probably subside in the second half of fiscal 1999 if no additional measures were taken.

According to one member's projection, construction works related to public investment were likely to continue at a high level until the end of 1999 but were likely to decline in the January-March quarter of 2000. This projection was based on factors such as the government's budget execution plan, the amount of prepayment surety, and the time lag between contract and actual implementation. Another member presented a gloomier view that public investment, on the basis of national accounts, would start declining in the July-September quarter of 1999. The member also mentioned that a significant fall was observed in the accomplishment rate of public works financed independently by local governments (the ratio of local governments' actual public works expenditures during a fiscal year to the amount planned) from the peak in the early 1990s, and expressed concern that this suggested a deterioration in the fiscal conditions of local governments. Although opinions varied on the exact timing of the decline, all members agreed that there would be less public investment in the second half of fiscal 1999 than in the first half.

With public investment expected to decline, members' focus was on the extent to which private demand, such as private consumption and business fixed investment, would increase toward the second half of fiscal 1999. In consideration of the corporate profit situation and employment and income conditions, however, members were still, as in previous meetings, anxious about the outlook for private demand.

One member presented the opinion that any recovery in private demand would have to start from firms' activities. This was based on the view that private consumption could not be expected to lead a recovery given the high probability that employment and income conditions would deteriorate further. Another member commented that a composite leading indicator constructed from various economic indicators could be interpreted as suggesting an economic upturn approximately eight months ahead. The member stated that nevertheless, since recent movements in the leading indicator had been extremely unstable, no definite conclusion could be drawn.

Many members referred to the persistent structural problems of the economy, or in other words, the medium-term structural adjustment pressure, as factors clouding the prospect of a recovery in private demand.

One member stressed firms' low profitability and excessive capital stock, citing the following two points: (1) firms' breakeven point ratio was worsening despite cutbacks in depreciation and personnel expenses, reflecting factors such as sluggish sales; and (2) substantial adjustment pressure on capital stock persisted, judging from the ratio of capital stock to GDP, which was far above its medium-term trend, and from capacity utilization, which had fallen below the bottom marked in 1993. This member stated that, judging from the severe situation of the corporate sector, business fixed investment could continue to be restrained for some time. On this basis, the member pointed out the need to be alert to the risk that sluggish shipments of capital goods might delay overall inventory adjustment.

Another member expressed concern about the prolonged hollowing-out of Japanese industry. The member made the observation that, even if business fixed investment recovered, manufacturing industry might put all its investment in the expansion of overseas facilities unless Japan's industrial structure was drastically reformed.

A different member claimed that wages in nonmanufacturing industry were too high compared to those in manufacturing industry, referring to the situation in the United States. The member expressed the opinion that either improvement in the productivity of nonmanufacturing industry or correction of the wage differential between the two industries was necessary for Japan to achieve economic growth.

There was also a member who mentioned that firms, already encumbered with excess labor, production capacity, and liabilities, were coming under strong pressure for enhanced disclosure and improved return on equity (ROE). Given this situation, the member judged that potential deflationary pressure would remain for a few more years.

In relation to the impact of corporate restructuring on employment, one member expressed concern that it had been taking longer time for the unemployed to find new jobs. Another member explained that, in the United Stated during the 1990s, sectoral employment shares had changed significantly, with health- and medical-related industries absorbing a substantial amount of labor. The member noted that, in Japan, nursing-service industry was one of the new industries expected to absorb the excess labor from other sectors. In this respect, it was important that an appropriate institutional framework be established to facilitate the shift of labor by 2000, when long-term cure insurance would be introduced.

While such pessimistic remarks on the influence of structural adjustment pressure on the economic outlook were prevalent, one member made a positive comment. The member was of the opinion that the deflationary pressure would be alleviated if the markets, for example the stock market, reacted positively to progress in structural reform. On this basis, the member pointed out the importance of setting out at an early stage realistic and effective measures for structural reform that would induce favorable market reaction.

A few members also commented on the external factors and other developments that could affect the economy in and after the second half of fiscal 1999. One member, although acknowledging the risk of the economy deteriorating again in or after the second half of the fiscal year, commented that the significant improvement in financial market conditions from those in 1998 should be given due credit.

This member remarked that Japan's economy in and after the second half of fiscal 1999 would also be substantially influenced by economic developments overseas, such as those in the United States and in Asian countries.

In relation to developments in the U.S. economy, a different member pointed out that, considering the potential trade friction, growth in Japan's exports to the United States could not be expected even if the U.S. economy maintained its current momentum. Another member stated that current U.S. stock prices (Standard & Poor's 500 Index) were approximately 4.4 times higher than the bottom in 1990 and that this was close to the magnitude of the increase observed in the 1920s, when stock prices in 1929 became 4.85 times higher than those in 1921.

In relation to Asian economies, one member, while noting the recoveries being observed in economic activity, called attention to the persistent fragility in the financial sector. A different member commented that it was not clear whether the recoveries now starting in East Asian economies were sustainable, and whether the currently robust U.S. economy would continue to enjoy high growth without inflation.

On price developments, members generally agreed that there was little risk of the fall in prices accelerating in the immediate future. Deflationary concern, however, would remain since the possibility could not be precluded that the economy would deteriorate once again in or after the second half of fiscal 1999.

Although members were of the opinion that the risk was tilted toward deflation, a few considered that attention should be paid also to inflationary factors. One member attached importance to the April surge in the United States' consumer price index, even if this did not continue in the following months, and expressed concern over its possible influence on Japan's economy. The member warned that a possible expansion of the interest rate differential between the United States and Japan might bring about a depreciation of the yen, and this in turn would increase Japan's import prices. Another member expressed concern about the possibility of a further rise in crude oil prices toward the summer. This member elaborated that, since antagonistic relations between some members of the Organization of Petroleum Exporting Countries (OPEC) were improving, their agreement to cut production would most likely be observed.

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 situation could be summarized as follows. First, Japan's economy had stopped deteriorating, supported by public investment and housing investment. Second, the monetary easing to date had produced appreciable effects in the financial markets. Third, however, the prospect of an economic recovery remained unclear, given the continued weakness in private-sector activity and the persistent medium- to long-term structural adjustment pressure. Fourth, the third point suggested that there existed the risk of the economy showing a double dip in or after the second half of fiscal 1999, when public investment was expected to dwindle, and therefore deflationary concern remained.

In light of the above-mentioned judgment on economic and financial conditions, the majority of members agreed that the obvious conclusion was to maintain the current, decisive easy monetary policy in line with the Bank's commitment to maintaining the current policy until deflationary concern was dispelled.

One member commented that the monetary easing to date was possibly giving some degree of support to corporate profits and prices. The member, however, pointed out that it should be carefully monitored whether the effects of the monetary easing would reach the next stage where effective demand was stimulated.

Another member remarked that there had been a growing sense of relief as the effects of the zero interest rate policy permeated the financial markets. However, considering that the important task in the immediate future was to lay the foundations for an economic recovery, the member was of the view that the Bank should keep firmly to the current monetary policy and that such a clear policy stance would help maintain the Bank's credibility.

During the discussion, some members commented on the risk that the current zero interest rate policy was encouraging financial institutions to take excessive risks.

One member, while basically welcoming the decline in various risk premiums, commented that, in managing monetary policy, attention should be paid to whether investors' and financial institutions' discipline in relation to credit and interest rate risks was falling off.

Another member remarked that the decline in short- and long-term interest rates since the monetary easing on February 12 had been far greater than what the member had expected. In view of the magnitude of interest rate declines, the member acknowledged a possible impairment of a normal sense of risk, a phenomenon that could be taken as a side effect of monetary easing. Having said so, however, the member clearly expressed the view that, taking into account the current economic situation and the outlook, the Bank had no option but to maintain the current easy policy stance even if some kind of excessive risk-taking might be emerging.

A different member also commented that there was no other choice than to maintain the current decisive stance on easy monetary policy. This was based on the consideration that (1) the possibly excessive risk-taking might be a reflection of the seasonally large surplus of funds in the market following the turn of the fiscal year, and (2) the deterioration in the economy had only recently come to a halt and deflationary concern persisted. Another member mentioned that, if the Board considered the current policy to have produced more-than-intended monetary easing effects in the financial markets, one logical policy option might be to slightly raise the overnight call rate to keep market developments in check. The member, however, pointed out that such action by the Bank could harm the prevailing market confidence and the Bank's credibility. The member therefore stated that the Bank should be very cautious in employing such a policy.

One member commented that it was inappropriate even to deliberate the possibility of raising the overnight call rate, and that further monetary easing should be adopted instead.

Members also discussed the necessity and the feasibility of an additional monetary easing, bearing in mind the policy environment ahead. Regarding this issue, many members shared the view that the Bank had already done all it could.

Specifically, one member noted that interest rates on term instruments had already declined to the lowest possible level partly due to the Bank's announcement of its intention to maintain the current monetary policy until deflationary concern was dispelled. The member considered that, under this situation, no effective policy could be thought of except extreme actions no central bank would ordinary take.

A different member remarked that, in order to revitalize Japan's economy, it would be necessary to promote the restructuring of corporate management and the reform of fiscal spending. This was based on the consideration that almost every possible fiscal and monetary policy measures had been implemented to date and that financial system reconstruction measures had been put into effect.

One member claimed that, given the current financial situation where monetary easing effects had materialized sufficiently, as observed in the sizable drop in the risk premium, the criticism that the current monetary policy was not easy enough was wide of the mark. The member also criticized the argument put forward by some economists and scholars that the Bank should influence the expected inflation by, for example, setting a quantitative target, saying that such an argument was based on an inverted logic. The member argued that only a rise in expected economic growth could bring about a rise in expected inflation consistent with the former. As measures needed to boost expected economic growth, the member cited the following supply-side measures: (1) establishment of a taxation system that would not hamper firms' risk-taking activity, such as creation of new demand; and (2) reform of pension and employment systems to alleviate households' concern about the future.

This member also commented that, considering that prices are affected by developments worldwide, the recent economic and price developments in the United States and in Asian countries should reduce the deflationary risk in Japan. The member remarked that this was lessening the need for an additional monetary easing. The member also added that price declines reflecting the correction of the price differential between Japan and abroad were a welcome development accompanying structural adjustment, and should be distinguished from deflation.

One member wrapped up the above discussions by citing the important points to be noted about the current monetary policy management: (1) the Bank had taken every possible measure; (2) the Bank would maintain the current policy until deflationary concern was dispelled; (3) the Bank had no intention of employing measures that would lead to the loss of fiscal discipline and, as a result, burden future generations; and (4) the Bank held high hopes for progress in structural adjustment. The member added that it was important for the Bank to be fully committed to explaining these points to the public.

At the end of the entire discussion above, the majority of members were of the opinion that, in the management of monetary policy in the immediate future, it was appropriate to maintain the current guideline for money market operations.

One member, however, took the stance that the Bank should not prolong the zero interest rate policy as it had serious side effects, and therefore the Bank should raise the overnight call rate under the currently stable financial market conditions. The member specified the following as side effects of the zero interest rate policy: (1) institutional investors such as life insurance companies, in their struggle to secure investment returns, might engage in transactions with excessive risk; and (2) the newly launched public offerings system for FBs was not promoting the "internationalization of the yen," an expected by-product, since FBs were not appealing to foreign investors under the current extremely low interest rate environment. This member, while acknowledging the existence of positive outcomes, claimed that the side effects might gradually outweigh the favorable impact if this extraordinary interest rate level was sustained over a long period. The member therefore advocated guiding the overnight call rate up to the level before the monetary easing on February 12, that is, around 0.25 percent on average.

With regard to the above argument, one member questioned whether any consideration was given to the risk of the financial markets reacting negatively, adversely affecting economic activity. In response, the member who claimed raising the interest rate argued that (1) the condition of the financial system was different from that before February 12 as a result of the injection of public funds into banks in late March, and (2) the Marshallian k (money stock divided by nominal GDP) was rising at a faster pace than during the "bubble" period, suggesting that there was even a possibility that a "quasi-bubble" was being created.

One member expressed the opposite opinion that the current monetary easing was insufficient and the Bank should therefore shift to full-scale quantitative easing by, among other things, increasing the amount of excess reserves by 500 billion yen every month. The suggestion was based on the following views: (1) in consideration of the fact that Japan's economy was at a critical juncture, the member was more apprehensive than the others about a possible economic downturn in or after the second half of fiscal 1999; (2) it was necessary to maintain the current momentum of monetary easing effects by preserving the market's expectation of an additional monetary easing; (3) it was appropriate to implement further monetary easing at an early stage considering the great impact that would be exerted on Japan's economy should U.S. stock prices drop; and (4) with nominal interest rates at the lowest possible level and the growth rate of the monetary base lower than the previous year, it was appropriate to influence stock prices, exchange rates, and expected inflation through monetary expansion.

On this point, one member suspected that, given the staff's report on the extremely low bid rates and the decreasing amount of bids in the Bank's money market operations, it would be technically difficult to increase the amount of excess reserves by 500 billion yen in the current reserve maintenance period. In view of this difficulty in achieving the target, the member expressed doubts as to whether the Bank would be able to maintain its credibility should it adopt this policy. In response, the member advocating a quantitative easing explained that the Bank would be able to provide excess reserves considering that potential bidders held eligible collateral worth approximately 20 trillion yen.

V. Remarks by Government Representatives

The representative from the Ministry of Finance made the following remarks.

(1) The economy was still in a very severe situation, with private demand remaining sluggish. The economic deterioration, however, was coming to a halt with intensive public investment and various policy measures such as the expansion of the credit guarantee system and the implementation of financial system stabilization measures.

(2) The Prime Minister had ordered the task force in charge of strengthening industrial competitiveness and addressing unemployment problems to work out specific measures by around mid-June.

At a meeting between Finance Minister Kiichi Miyazawa and U.S. Treasury Deputy Secretary Lawrence Summers held during the finance ministers' meeting of the Asia-Pacific Economic Cooperation (APEC) forum last weekend, Mr. Miyazawa explained that the Japanese government was determined to strengthen its economy and financial system and to proceed with structural adjustment.

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

(1) The economy was still in a very severe situation, with private demand remaining sluggish. However, the economic deterioration was coming to a halt with the various policy measures supporting the economy. By mid-June, the government would draw up measures to deal with the unemployment problem and to strengthen industrial competitiveness.

(2) The government would like to request the Bank to continue to closely examine the effects of the current monetary policy, and to provide ample funds in the market through appropriate money market operations until self-sustained economic growth became apparent, and thereby contribute to realizing an economic recovery.

(3) There had been some misleading news reports concerning comments made by the Minister of State for Economic Planning of the Economic Planning Agency at the Monetary Policy Meeting on February 12 regarding the policy change. However, the government would like to stress that the opinion of the Minister of State was exactly as he stated at the Meeting. The government had clarified this point at an official press conference that followed the above-mentioned news reports.

VI. Votes

The views of many members were summarized as follows. First, the economy had stopped deteriorating, but the prospect of an economic recovery remained unclear given the weakness in private-sector activity. Therefore, the possibility could not be ruled out that the economy would show a double dip in or after the second half of fiscal 1999. Second, deflationary concern over the coming periods had not been dispelled. Third, the effects of monetary easing had sufficiently permeated at least the financial markets, and the Bank was now at the stage of observing whether the favorable developments in the financial markets would in turn positively influence economic activity. And fourth, although some market developments suggested that financial institutions were engaged in excessive risk-taking under the current easy monetary conditions, the most important task given the current economic and price situation was to give maximum support to the economy on the monetary front.

Based on this understanding, the majority of members considered that it was appropriate to maintain the current guideline for money market operations for the immediate future, continuing to give due consideration to maintaining the market function.

One member, however, presented the opinion that it was appropriate to raise the interest rate. Another member claimed that it was appropriate to adopt a full-scale quantitative easing.

On the basis of these arguments, three policy proposals were put to the vote.

Ms. Shinotsuka proposed changing the monetary policy guideline back to the one that had been employed before the monetary easing on February 12. Specifically, she proposed the following as the guideline for money market operations for the intermeeting period ahead:

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

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

The proposal was defeated with one vote in favor, eight against.

Mr. Nakahara proposed the following as the guideline for money market operations for the intermeeting period ahead:

The Bank of Japan will aim at realizing an approximately 1 percent annual increase in the consumer price index (excluding perishables) in the medium term. Specifically, the Bank will set the target range of the inflation rate 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 this target, the Bank will increase the amount of excess reserves by about 500 billion yen in the current reserve maintenance period from May 16 through June 15 (change in the average amount outstanding from the previous reserve maintenance period to the current maintenance period), and by continuing to increase the amount thereafter, induce an approximately 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.

Ms. Shinotsuka gave the following reasons for voting against the proposal. First, a zero-percent interest rate was extremely abnormal and should be corrected as soon as possible. Second, if the zero interest rate policy was maintained until deflationary concern was dispelled, households would further lose the interest income they would otherwise have earned. Third, it was not clear how the current monetary easing was expected to lead to an economic recovery. And fourth, the current stable economic situation, including the pleasant Japan-U.S. relation concerning economic policy, offered a good opportunity for the Bank to raise the interest rate.

Mr. Nakahara dissented for four reasons. First, it was necessary to conduct an additional monetary easing at an early stage considering the high probability that the economy would make a downturn and the time lag between implementation of policy and permeation of its effects. Second, given that there was no room left for a further decline in nominal interest rates, the Bank should shift to full-scale quantitative monetary easing in order to avoid running the risk of giving the impression that there was no measure left for monetary policy. Third, the growth in the monetary base was insufficient. And fourth, it was advisable to be prepared for a possible drop in U.S. stock prices.

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 May 20, 1999 in the Monthly Report of Recent Economic and Financial Developments (the "Ivory Paper," consisting of "The Bank's View" and "The Background"). 4

  1. 4The original full text, written in Japanese, of the "Ivory Paper" was published on May 20, 1999 together with the English version of "The Bank's View." The English version of "The Background" was published on June 1, 1999.

Attachment

For immediate release

May 18, 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.