Minutes of the Monetary Policy Meeting

on July 16, 1999
(English translation prepared by the Bank staff based on the Japanese original)

September 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, July 16, 1999, from 9:00 a.m. to 10:54 a.m., and from 12:30 p.m. to 4:22 p.m. ¹

Policy Board Members Present
Mr. M. Hayami, Chairman, Governor of the Bank of Japan ²
Mr. S. Fujiwara, Deputy Governor of the Bank of Japan
Mr. Y. Yamaguchi, Deputy Governor of the Bank of Japan
Mr. Y. Gotoh
Mr. S. Taketomi
Mr. T. Miki
Mr. N. Nakahara
Ms. E. Shinotsuka
Mr. K. Ueda

Government Representative Present
Mr. T. Haraguchi, Deputy Vice Minister for Policy Coordination, Ministry of Finance
Mr. T. Komine, Director-General of the Price Bureau, Economic Planning 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. S. Murayama, Director, Research and Statistics Department
Mr. E. Hirano, Director, International Department
Mr. M. Amamiya, Chief Manager, Planning Division 1, Policy Planning Office
Mr. T. Yoshida, Research and Statistics Department

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. T. Kurihara, Manager, Policy Planning Office
Mr. H. Yamaoka, Manager, Policy Planning Office

The minutes of this meeting were approved by the Policy Board at the Monetary Policy Meeting held on September 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.
Mr. Hayami was absent from 9:42 a.m. to 10:54 a.m. to attend a session of the Diet. During his absence, Mr. Fujiwara performed the duties of chairman pursuant to Article 16, Paragraph 5 of the Bank of Japan Law of 1997.

I. Approval of the Minutes of the Monetary Policy Meeting Held on June 14, 1999

The Policy Board approved unanimously the minutes of the Monetary Policy Meeting, the "Green Paper," of June 14, 1999 for release on July 22, 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 June 28 were conducted in accordance with the guideline determined at that meeting. ⁴

As a result, the overnight call rate was steady at 0.03 percent throughout the intermeeting period. Interest rates on term instruments increased slightly toward the end of June due to a strengthening of market expectations that the Bank would before long end its zero interest rate policy. However, such expectations subsequently weakened due to the fact that (1) some Policy Board members affirmed again at the Diet and elsewhere that the Bank would maintain the zero interest rate policy until deflationary concern was dispelled, and (2) the results of the June Tankan--Short-Term Economic Survey of Enterprises in Japan--were within the market's projection. Consequently, Euro-yen interest rates declined somewhat.

Two conspicuous developments were observed in this situation.

First, reflecting the abatement of market expectations of an early termination of the zero interest rate policy, fund-investors increased their once-reduced investments in term instruments, such as those maturing beyond the end of September, the semi-annual settlement. As a result, overnight call transactions decreased once again, and the total amount of funds outstanding in the collateralized and uncollateralized call money market fell to approximately 20 trillion yen. However, this had not impeded the market's functioning.

Second, various developments related to the Year 2000 problem were observed. For example, although the Japan premium had been close to zero, that on six-month U.S. dollar funds rose to around 0.15-0.25 percent as some banks started to raise foreign-currency funds maturing beyond the year-end. In addition, the "Year 2000 premium" on Euro-yen interest rate futures was rising. ⁵

3Reports were made based on information available at the time of the meeting.
4The guideline was 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 ("initially" means the time of the Monetary Policy Meeting, February 12, 1999) aim to guide the above call rate to move around 0.15%, and subsequently induce further decline in view of the market developments."
5The "Year 2000 premium" is calculated by subtracting the average of interest rates on contracts to be delivered in September 1999 and in March 2000 from the rate on contracts to be delivered in December 1999.

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

1. Developments in foreign exchange markets

In the intermeeting period, the yen moved within an extremely narrow range of 120-122 yen against the U.S. dollar. In the foreign exchange markets, Japanese exporters and foreign investors were eager to increase their purchase of the yen against the U.S. dollar, but the upward pressure on the yen was offset by participants' anticipation of a possible intervention. Foreign investors' purchases of Japanese stocks had been at a high level since March, and this trend continued in July.

The euro continued to be weak against the U.S. dollar. At one time, the euro stood at the 1.01-1.02 level, the lowest since the introduction of the currency in January. This was attributable to (1) the marked difference in the level of economic activity between the United States and Europe--i.e., the U.S. economy and stock prices were firm while many economic indicators in the European economies were weak as seen in Germany's industrial production for May, and (2) a series of remarks made by policy makers in Europe suggesting an acceptance of the depreciation of the euro and also casting doubt on the fiscal soundness of the member countries of the European Monetary Union.

2. Overseas economic and financial developments

The economic expansion in the United States remained robust due to strong domestic demand led by private consumption and improvement in the environment surrounding exports. In these circumstances, the Federal Open Market Committee (FOMC) decided on June 30 to increase the target for the federal funds rate by 0.25 percentage point to 5 percent. Labor markets were tightening, as reflected in the gradual uptrend in wages. However, in the financial markets, long-term interest rates were declining reflecting (1) the small increase in the target for the federal funds rate, and (2) the ebbing of market expectation of another rate increase at the next FOMC meeting on August 24 given the stability in the consumer price index in May and June. U.S. stock prices continued to record historic highs reflecting the decline in long-term interest rates and the favorable performance of firms during the April-June quarter. More recently, however, the stock market was leveling off.

The Asian NIEs and the ASEAN countries were achieving an economic recovery due to the positive effects of previously implemented monetary and fiscal policy measures and the strength in exports of information-related goods to the United States and Japan. In Korea, the economic growth forecast had been revised upward. In Thailand and the Philippines, indications of a bottoming out of the economy were appearing. Meanwhile, the economic slowdown in China was becoming conspicuous, as uncertainty about the future grew given the increase in lay-offs due to restructuring of state-owned enterprises.

In Latin America, political instability was emerging in Argentina ahead of the presidential election in October, and candidates had repeatedly promised drastic actions on the economic front. At present, there was little possibility that the instability in Argentina would spread to other countries since the Brazilian economy was recovering and hedge funds had not shown disturbing movements so far. Nevertheless, attention should be paid to future developments.

C. Economic and Financial Developments in Japan

1. Economic developments

Business fixed investment had generally been on a downtrend, and net exports were decreasing slightly due to an increase in imports. Private consumption showed mixed developments. Meanwhile, public investment continued to increase, and housing investment was recovering. With such developments in final demand and progress in inventory adjustment, production had basically stopped declining although there were some fluctuations. In addition, business sentiment was improving.

Overall, Japan's economy had stopped deteriorating.

The pace of improvement in business sentiment in the past six months had been comparable to that in previous recovery phases. The improvement seemed to be closely related to the recovery in stock prices, while it had little to do with other economic indicators such as production indices. In consideration of this, it could be concluded that the upturn in business sentiment strongly reflected firms' confidence in the stability of the financial system and their expectation of continued implementation of economic measures by the government.

As for the outlook, it was highly probable that the economy would remain stable given (1) the "multiplier" effects of the growth in the January-March quarter of 1999, (2) continued progress in public works, and (3) sustained recovery in housing investment. However, for the economy to return to a self-sustained recovery path, it was necessary that corporate profits recover and business fixed investment start to increase while the improved consumer confidence was underpinning private consumption despite the decline in income. In relation to this point, so far, while private consumption had shown mixed developments, plans for business fixed investment in fiscal 1999 had been extremely limited. Thus, there had been no clear signs of an immediate self-sustained recovery in private demand.

With regard to prices, corporate service prices continued to follow a downward trend, but domestic wholesale prices were leveling off reflecting a rise in import prices, such as those of crude oil, as well as the progress in inventory adjustment. Consumer prices were close to the previous year's level. In the immediate future, prices were expected to be generally flat. However, the situation continued to warrant attention because, if a self-sustained economic recovery was delayed and therefore further inventory adjustment became necessary, there was the risk that prices would show a double dip reflecting the expansion of the output gap.

2. Financial developments

In the financial markets, the overnight call rate remained close to zero, and many financial institutions became increasingly confident about the availability of liquidity. Interest rates on term instruments increased slightly reflecting (1) some market participants' expectation that the Bank would before long end its zero interest rate policy, and (2) financial institutions' moves to procure funds maturing beyond the year-end reflecting concerns about the Year 2000 problem.

Yields on long-term government bonds rose to the 1.8-1.9 percent level due to expectations of an early termination of the Bank's zero interest rate policy, but subsequently fell back. Stock prices increased by about 2,000 yen in the past month reflecting the market's improved view of the prospects for Japan's economy and the strength of U.S. stock prices, and were recently moving at around 18,000 yen.

Meanwhile, the Japan premium on most contracts remained close to zero, although that on some maturing beyond the year-end strengthened slightly. The yield spread between government bonds and private bonds (bank debentures and corporate bonds) continued to narrow, and market participants were gradually becoming more willing to take credit risks.

With regard to the monetary aggregates, the cautious lending stance of private banks remained basically unchanged. However, the constraint on bank lending caused by the severe fund-raising conditions for banks and their insufficient capital base had been alleviated. Under these circumstances, major banks were gradually becoming more active than before in extending loans, carefully evaluating the credit risks involved. This trend was confirmed by the June Tankan results.

However, credit demand for economic activities such as business fixed investment remained weak. In addition, firms were not increasing their on-hand liquidity. As a result, credit demand in the private sector weakened further.

Private bank lending was sluggish, and the year-to-year decline accelerated slightly in May and June. The pace of issuance of corporate bonds and commercial paper had generally been slowing moderately.

As shown above, fund-raising in the private sector was decreasing overall. However, the year-to-year growth in money stock (M2+CDs) had been rising slightly due partly to an increase in fiscal expenditure.

In sum, the financial environment continued to improve, and the previously tight credit conditions had eased. As for the future, it warranted careful monitoring how these favorable changes in the financial market would affect economic activity, such as firms' investment.

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

A. The Current Economic Situation

On the current economic situation, members generally agreed that Japan's economy had stopped deteriorating and business sentiment had improved slightly, but clear signs of a self-sustained recovery in private demand had not been observed yet. One of the members described this situation as "the economy plodding along at the bottom with positive and negative factors intertwined."

As grounds for judging that economic deterioration had stopped, the members pointed out, as in the previous meeting, that public investment remained at a high level and housing investment was firm. One member also referred to the progress in firms' inventory adjustment and the halt in the decline in production, which reflected the positive effects of demand stimulated by policy measures and the recovery in exports to Asia.

In addition, many members expressed the view that the improvement in firms' perception of business conditions, supply and demand conditions for products, and their financial position, revealed in the June Tankan survey, confirmed that the economy was no longer deteriorating.

With regard to private consumption, some members were impressed that further deterioration had been avoided despite the severe employment and income conditions, and they judged that this had contributed to the halt in economic deterioration. However, many members added that private consumption was still showing mixed developments and not strong enough to lead a full-scale economic recovery.

Specifically, a few members pointed out that sales at the bonus season maintained the previous year's level although summer bonus payments had fallen below the previous year's level, and that private consumption-related indicators were showing signs of improvement. As the background to these developments, many members cited the following: (1) the improvement in consumer sentiment due to the rise in stock prices; (2) the positive impact of income tax reduction; and (3) the stability of prices. Further, one member expressed the view that income from part time jobs undertaken by spouses to compensate for the fall in the principal income earner's wages had underpinned the recent level of consumption.

However, most members considered that a recovery in private consumption would be limited since employment and wages were both basically declining due to corporate restructuring. One of the members commented that (1) consumers felt a strong anxiety about the prospects for social security and pensions, and were therefore restricting their spending to save for the future, and (2) in these circumstances, consumption was undergoing structural changes, with consumers becoming more selective about what they purchased. As a result, the present circumstances allowed the survival only of businesses and products that successfully grasped the needs of consumers.

As regards business fixed investment, many members took a gloomy view on the grounds that the improvement in business sentiment had not led to a rise in spending activities. A few of these members noted that the increase in business fixed investment in the January-March quarter was only temporary, and that the general trend remained weak. This view was based on the following factors: (1) according to the June Tankan survey, excess production capacity remained at virtually the same level, and business fixed investment plans for fiscal 1999 had turned out to be persistently cautious; and (2) hardly any signs of recovery had been observed in leading indicators such as machinery orders and construction starts. In addition, another member remarked that corporate management was presently focusing on restoring firms' financial condition, and with excess production capacity remaining, the prospect of a recovery in business fixed investment was remote.

With regard to price developments, many members shared the understanding that there was still a large output gap in the economy and that downward pressure on prices persisted. However, prices overall were more or less flat reflecting the recovery in international commodity prices and the progress in inventory adjustment in Japan. One of the members further noted that a deflationary spiral had so far been avoided.

One member commented that there were both positive and negative factors in the current economy, and the contrast between them was becoming conspicuous. In this situation, the overall economic trend could be misjudged if only macroeconomic indicators were followed. Therefore, attention also needed to be paid to developments at the microeconomic level.

A different member presented a gloomier view of the economy compared to other members. The member cited the following as the basis for this view. First, the coincident diffusion index for business conditions had been below 50 for two consecutive months, and the composite index--which indicates the level of economic activity--had stopped suggesting that the economy was at the bottom. Second, the June Tankan survey indicated that employment adjustment had been deferred and that firms were unduly optimistic about their profit forecast, and thus offered no bright prospects for the economy. Third, the sentiment of small firms was poor according to surveys released by other institutions. And fourth, the positive outcome of public investment would most likely subside in the future, given that public investment on a GDP basis had recorded unprecedented, double-digit quarter-to-quarter growth for two consecutive quarters.

B. Financial Developments

On the financial front, many members agreed that the financial environment was improving. Some of these members expressed the view that the positive effects of policy measures, such as the zero interest rate policy and injection of public funds into banks, were expected to become increasingly evident, considering the time lag between the implementation of policy and the materialization of its effects.

In relation to stock prices, many members pointed out that the recent rise was contributing to an improvement in corporate and consumer confidence. One of these members explained how the firmness in stock prices can positively influence economic activities. The member stated that, if stock prices increase, the balance sheets of firms and financial institutions ameliorate accordingly, allowing them to become more positive about spending and lending. The member also pointed out that, in addition to the strengthening of corporate activities, the wealth effect is realized for the household sector. Based on simple calculation--considering that recent stock prices were about 40 percent higher than in autumn 1998, when the latest bottom was marked, and about 30 percent higher than before the monetary easing in February, and that stocks held by the household sector were worth 60 trillion yen--the capital gain would amount to about 20 trillion yen. If this was included in income, it would more than make up for the decline in wages.

A few members noted that long-term interest rates were generally stable, albeit with some fluctuation, and this was contributing to the improvement in the financial environment. On this point, a different member expressed concern that there was a possibility that long-term interest rates would rise further toward the autumn reflecting a deterioration in the supply and demand balance of Japanese government bonds (JGBs).

Some members commented that there was ample liquidity in the money market, but attention should be paid to developments in interest rates maturing beyond the year-end because market participants were becoming anxious about the Year 2000 problem.

Members also commented on the lending stance of financial institutions in the improving financial environment. A few members noted that lending to small firms, which are sensitive to movements in interest rates, had usually increased swiftly in previous monetary easing phases. However, this trend could not be observed this time because banks were in the process of disposing of their nonperforming assets and were working to improve their financial soundness and profitability. Further, one of the members cited the experience of the United States in the early 1990s, when bank lending did not increase even when the economy had started to recover after resolving the balance-sheet problem, and the capital market replaced the function of lending. Meanwhile, a different member presented the view that the major factor behind the sluggish lending was weak credit demand due to firms' reduction of interest-bearing liabilities.

C. The Economic Outlook

With regard to the economic outlook, many members considered that the economy would remain stable in the immediate future but the risk of the economy deteriorating again in or after the second half of fiscal 1999 persisted, and therefore deflationary concern had not been dispelled.

In view of this downside risk, discussion was focused on the mechanisms through which private demand might attain a self-sustained recovery. Specifically, members discussed how private consumption and business fixed investment might recover while firms carried on with their restructuring and households continued to face severe employment and income conditions.

A few members noted that firms' restructuring creates expectations of a recovery in corporate profits, thereby pushing up stock prices and improving household confidence, and that such effects were gradually being observed in the economy. One of these members expressed the opinion that restructuring did not merely mean disposal of excess plants and equipment and reduction of employees, but was a way of achieving efficient utilization of capital and human resources. This member mentioned that, if employment cuts and wage reductions led to an expansion in corporate profits and consequently a rise in stock prices, capital gains on households' holding of stocks would compensate for a part of the fall in employees' income. The member also commented that a recovery in corporate profits would encourage firms to gradually become more active. This member concluded that the deflationary impact of corporate restructuring should not be overly stressed.

Many members held the view that a recovery in corporate profits had not yet been confirmed. A few were optimistic about the prospects for the following reasons. First, firms were determined to carry out restructuring as shown in the June Tankan survey, where they forecasted growth in profits in fiscal 1999 while projecting sales to remain more or less unchanged. And second, production was expected to increase in the July-September quarter of 1999 reflecting a recovery in exports to Asia and completion of inventory adjustment. Some members, however, expressed the view that developments in corporate profits required careful monitoring. They gave the following as grounds for this view: (1) the profits projection for the second half of fiscal 1999 was high in the June Tankan survey merely because firms calculated this projection so that the target set on the annual business plan would be met, that is to say, the shortfall in actual performance in the first half of fiscal 1999 was added in the projection for the second half; (2) the forecast for the current profit-to-sales ratio in the second half of fiscal 1999 was very high reflecting the strong profits projection, and it was doubtful whether this ratio could actually be attained.

On private consumption, members shared the understanding that its future course under the severe employment and income conditions depended on whether or not the current level of consumer confidence was maintained. One member commented that, while employment and income conditions were the basic determinants of private consumption, the consumption behavior of households with abundant financial assets also warranted careful attention. Specifically, this member focused on whether the prospects for interest rates and asset prices would motivate wealthy households to start using a portion of their savings.

Members also discussed developments in business fixed investment. There was one member who considered that the worst stage was over. As the grounds for this judgment, the member stated that the ratio of business fixed investment to nominal GDP was close to its historic low and that corporate financing conditions and business sentiment were improving. The majority of members, however, remained cautious about the outlook on the grounds that firms were still burdened with excess plants and equipment, and profits had not yet recovered.

With respect to an upturn in business fixed investment, a few members projected that it would start from small firms. They remarked that, if financial institutions became more willing to lend as the overall financial environment improved, small firms, which are sensitive to interest rate developments, would start to increase their investment. A different member, however, commented that recovery would rather start from large firms that have completed capital-stock adjustment and balance-sheet restructuring. This was based on the consideration that (1) the fund-raising conditions for small firms were not yet very accommodative, and (2) large firms had drastically reduced their business fixed investment in fiscal 1998.

In relation to confidence of economic entities, there was active discussion on the recent trend in stock prices.

A few members pointed out that the rise in stock prices simply reflected the prospect of a recovery in corporate profits. One of these members added that the current level of stock prices was not necessarily too high, considering the yield spread--i.e., the spread between government bond yields and expected earnings on stocks.

In response to the above comments, several members presented a cautious view that the recent increase in stock prices and improvement in business sentiment stemmed mainly from expectations. These members pointed out that (1) recent developments in the economy were not as strong as the market's expectations, (2) a recovery in corporate profits was not yet confirmed, and (3) some foreign investors' improved view of Japan's economy could not be regarded as evidence of an economic recovery because the assessment had been revised based only on comparison with other countries. They noted the risk that, once the market became aware of the above three points, stock prices might fall. A different member expressed an even more cautious view that a further rise in stock prices was very unlikely, since they seemed to be already at their highest possible level.

One member focused on the role of exports in economic recovery. This member expressed hopes that an increase in exports might add to the positive momentum produced through demand stimulated by policy measures, thereby inducing a recovery in private demand, on the following grounds: (1) exports of information-related goods to the United States were expected to remain firm given the robust U.S. economy; (2) trade between Japan and other Asian countries was expected to expand reflecting the recovery in the Asian economies; and (3) a profit margin would be secured as long as the current exchange rate level remained more or less unchanged.

Another member argued that exports would not play such a role. As reasons for this, the member cited the following risk factors abroad: (1) the current U.S. stock market was significantly overheated and therefore the outlook for the U.S. economy was unclear; (2) the structural problems in the Asian economies remained unsolved and there was a possibility of an economic slowdown in or after the autumn of 1999; (3) in China, it especially required attention whether or not the current exchange rate level of the renminbi would be maintained and the current path of reform would be continued; and (4) crude oil prices could rise above US$20 per barrel considering the forecast by the International Energy Agency (IEA) that world oil stocks would decrease in the third quarter of 1999.

In relation to the above argument, a different member remarked on the identification of risk factors abroad. This member commented that it was not appropriate to treat all the various overseas risks the same. The member explained that, for example, the slowdown in China's economy was a development actually reflected in statistics whereas a fall in U.S. stock prices was a mere possibility.

Members also commented on the outlook for prices and deflationary concern. Many members judged that downward pressure on prices remained given the persistent risk of the economy showing a double dip in or after the second half of fiscal 1999 and the downward trend in wages.

Some members, however, raised the question of why prices had remained almost unchanged despite the large output gap. Specifically, the members focused on the issue of how to evaluate the contribution of the high growth in money stock compared to that in nominal GDP, in other words, the rise in the Marshallian k (money stock divided by nominal GDP) among other contributing factors--the progress in inventory adjustment and the rise in crude oil prices. One of these members remarked that firms' holding of ample funds could positively affect the supply and demand conditions in the economy by, for example, discouraging firms from selling off inventories. However, some members, including these members, shared the understanding that it required careful consideration whether the usual relationship between money stock and prices would apply in the current situation.

A different member pointed out that the methodology of measurement of the output gap was controversial and, given the current stable price developments, expressed an opinion different from the majority that deflationary concern was subsiding. This member also referred to (1) the improvements in business and consumer sentiment, and (2) the continued inflow of foreign capital through such channels as securities investment and tie-ups with Japanese firms, which was evidence of a positive appraisal of Japan's economy. On these bases, the member judged that incipient signs of a self-sustained recovery were present and that this development was contributing to the current stability of prices.

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.

Many members' view of the economic and financial situation remained basically unchanged from the previous meeting. First, although Japan's economy had stopped deteriorating and business and consumer sentiment had improved somewhat, clear signs of a self-sustained recovery in private demand had not been observed yet. Second, although prices remained level, downward pressure on prices persisted. And third, the improved financial environment had exerted positive effects on economic activity and was expected to continue to do so.

Based on this assessment, these members judged that the risk of the economy showing a double dip in or after the second half of fiscal 1999 persisted strongly, and that deflationary concern had not yet been dispelled.

In the management of monetary policy in the immediate future, the majority of members considered that it was necessary to focus on eliminating the downside risk to the economy, and in this sense, it was appropriate to maintain the current guideline for money market operations in line with the Bank's stance to keep the policy unchanged until deflationary concern was dispelled.

Two members expressed opinions different from the above.

One of the members suggested that the Bank guide the overnight call rate up to the level before the monetary easing in February--that is, around 0.25 percent on average --saying that, although deflationary concern remained, the downside risk to the economy had been reduced. More specifically, the member mentioned the following four points as grounds for this view. First, the financial environment on the whole was improving, as seen in the rise in stock prices and the easing of corporate financing conditions reflecting the implementation of financial system reconstruction measures since mid-1998 and the zero interest rate policy. The improved financial environment was expected to invite positive developments in economic activity. Second, recent price indicators showed that the downward pressure on prices had lessened. Third, it had become less justifiable to continue the zero interest rate policy despite its negative outcomes--including declines in the interest income of households, delay in structural adjustment, emergence of moral hazard, and malfunctioning of the price mechanism of interest rates--which would be aggravated should the policy be prolonged. And fourth, an interest rate level of 0.25 percent would still be extremely low.

Regarding the above argument, one member remarked that raising the interest rate could harm the financial market conditions, which had improved partly as a result of the zero interest rate policy. Another member made the following comments regarding the "negative outcomes" of the zero interest rate policy. First, the zero interest rate policy could in fact be accompanied by distortion in income distribution and delay in structural adjustment. However, the Bank had adhered to the policy judging that it was most important at present to support economic activity through low interest rates, and the effects were clearly materializing. Second, the decline in the risk premium related to credit and liquidity risks should not be regarded as a purely negative development, but as one indicating the revitalization of the financial intermediary function, one of the intended effects of the zero interest rate policy.

Given the above comments, the member advocating a raising of the interest rate defended the member's judgment. The member remarked that, although raising the interest rate would have some impact on the market, if it was conducted at this time, the impact would not be detrimental. This member further expressed concern that, if this opportunity was missed, the zero interest rate policy would be prolonged, consequently bringing about greater negative effects. The member therefore judged that it was appropriate to raise interest rates slightly at this particular time when the economy was stable.

A different member advocated further monetary easing in consideration of the persistent risk of the economy falling into deflation and the need to counter potential upward pressure on long-term interest rates. Specifically, this member proposed the adoption of monetary base targeting accompanied by inflation targeting, giving the following five reasons. First, the Bank's clear indication of monetary policy targets and tools would be the best way to secure the independence of the Bank in the medium to long term. Second, given that an economic recovery in or after the second half of 1999 was not foreseeable and that there was a high probability of deflation occurring, it was necessary to shift immediately from interest rate targeting to quantitative targeting. Third, quantitative targeting would give the Bank more flexibility in the implementation of market operations, which had been confined to "1 trillion yen morning projection for reserves." ⁶ Fourth, the ratio of gross general-government debt to nominal GDP was at a critical level, close to that of Italy. The consequent deterioration in the supply and demand conditions in the bond market was likely to place upward pressure on long-term interest rates. This policy, however, could prevent both a rise in long-term interest rates as well as an appreciation of the yen. And fifth, a probable rise in long-term expected inflation could positively affect the economy.

Various arguments were put forward regarding the above opinion.

First, a few members noted inconsistency in the argument that further monetary easing would restrain a rise in long-term interest rates while at the same time inducing a rise in expected inflation, which would in turn push up nominal interest rates. In response to this comment, the member who advocated a further monetary easing explained that effective monetary easing through quantitative targeting would constrain a climb in long-term interest rates in the short run, and then gradually increase expected inflation in the long run.

Second, one member commented on the relationship between fiscal deficit and long-term interest rates. The member doubted the accuracy of the argument that a large fiscal deficit would push up long-term interest rates, and that the increase could be restrained by providing liquidity. This member expressed the understanding that developments in long-term interest rates depended on (1) the outlook for the economy and prices, (2) the prospect of contraction in the fiscal deficit, and (3) the smooth flow of funds from the financial-surplus sectors into the government. Given these comments, the member advocating a further monetary easing repeated that long-term interest rates, in fact, were most likely to increase due to an expansion of the fiscal deficit and concern about a deterioration in the supply and demand balance of bonds, whether or not the investment-savings balance was later adjusted among sectors.

Third, on the argument that adoption of quantitative targeting would give the Bank more flexibility in monetary policy implementation, some members claimed that both interest rate targeting and monetary base targeting ensured flexibility of more or less the same degree, as far as its economic significance was concerned. One of these members expressed concern that, if the Bank were to inject more funds into the market when funds were so abundant that, in some cases, bids in money market operations fell short of the amount the Bank intended to offer, the argument might emerge that an increase in the Bank's outright purchase of JGBs was inevitable. On this point, the member advocating a further monetary easing explained as follows: (1) interest rates and quantity of money are not "two sides of the same coin" when the overnight rate is virtually zero, and therefore, the extent of monetary easing should be clearly indicated by the "morning projection for reserves" and the amount of the monetary base; and (2) the Bank would be able to supply such funds sufficiently considering the market participants' holdings of approximately 20 trillion yen worth of short-term financial assets that could be used in the Bank's market operations.

On the timing of the termination of the zero interest rate policy, an issue that had attracted the market's attention since the end of June, many members reconfirmed that the Bank would maintain the zero interest rate policy until deflationary concern was dispelled.

Specifically, a few members commented that it was meaningful to communicate to the market the Bank's intention to keep firmly to the current policy, especially given the recent sway in market expectations. One of these members made remarks in relation to a rise in long-term interest rates. If there was a clear prospect of a sustainable economic expansion, a consequent increase in long-term interest rates should be accepted. However, if the market's misinterpretation of the Bank's messages and reaction to a temporary upturn in economic indicators were behind the rise, the Bank needed to convey its policy judgment to the market through its money market operations. This was the most effective way of stabilizing the market. Further, if the media and the market apparently misunderstood the Bank's intentions, the Bank should try to give appropriate explanation to clarify their understanding. A different member stressed the importance of the timing of monetary policy decisions. This member remarked that, given the current economic and financial situation, it was important "not to change" policy.

Another member, although admitting that the current situation was anomalous in that substantial amounts of uncollateralized overnight call money were made available at zero interest, judged that it was appropriate to maintain the current zero interest rate policy for a while, and gave the reasons by summarizing the majority view expressed in the above discussions. First, the effects of the zero interest rate policy were definitely materializing as seen in the improvement of the corporate financing situation, and this favorable effect was expected to continue to permeate the economy. Second, deflationary concern remained. And third, no detrimental negative outcome had been confirmed.

6The "morning projection for reserves" is the projection announced each morning of the amount by which reserves will exceed/fall short of "remaining required reserves"--the daily average of reserves that should be deposited in the remaining days of the reserve maintenance period--at 5:00 p.m., when reserves are officially calculated.

V. Remarks by Government Representatives

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

(1) Japan's current economic situation was severe as reflected in the weak recovery in private demand. Recently, however, the situation was improving slightly due to the materialization of the effects of various policy measures, such as the supplementary budgets for fiscal 1998, the expansion of the credit guarantee system, and implementation of financial system stabilization measures. As for the future, the effects of the fiscal 1999 budget were also expected to become evident.
(2) On June 11, the government set out a comprehensive plan to improve employment conditions and strengthen industrial competitiveness. A supplementary budget appropriating over 500 billion yen for improving employment conditions had been drawn up and was currently being discussed by the Diet. Further, the government intended to submit a bill concerning measures to strengthen industrial competitiveness and also implement necessary tax measures.

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

(1) Japan's current economic situation was severe as reflected in the weak recovery in private demand, but was recently improving slightly due to the permeation of the effects of various policy measures. In other words, the economy had managed to show some improvement supported by the positive effect of policy measures. The economy therefore still could not be judged to be on a self-sustained recovery path.
(2) It was necessary that the government continue to proceed strongly with the implementation of various measures, such as the emergency economic package. Recently, the government had decided a comprehensive plan to improve employment conditions and strengthen industrial competitiveness. The government would like to request the Bank 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.

VI. Votes

The views of many members of the economic and financial situation were summarized as follows. First, Japan's economy had stopped deteriorating and business sentiment and consumer confidence had improved slightly. Second, the improved financial environment had exerted positive effects on economic activity and was expected to continue to do so. Third, despite the above points, clear signs of a self-sustained recovery in private demand had not been observed yet. Fourth, downward pressure on prices remained although prices had recently been flat. And fifth, given the above four points, it could be judged that deflationary concern had not yet been dispelled.

Based on this understanding of the economic and financial situation, 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 overnight call rate. A different member claimed that it was appropriate to implement further monetary easing by setting a target for the growth rate of the consumer price index (CPI) and adopting an apparent quantitative targeting.

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

Ms. Shinotsuka 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 a 0.5 to 2.0 percent annual increase in the consumer price index (excluding perishables) in the October-December quarter of 2001 as a medium-term target. 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 July 16 through August 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 January-March quarter of 1999 to the average for the same quarter of 2000) to realize quantitative easing (expansion of the monetary base). ^(note) Regardless of the above target for the monetary base, the Bank will expand money further should the financial markets destabilize, for example, should the uncollateralized overnight call rate rise substantially.

Note:To realize approximately 10 percent annual growth of the monetary base (change from the average for the January-March quarter of 1999 to the average for the same quarter of 2000), the Bank would need to increase reserves by about 3 trillion yen by the end of March 2000 through market operations if it was assumed that the current annual growth in banknotes, which was about 6 percent, would continue.

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: Ms. E. Shinotsuka and Mr. N. Nakahara.

Ms. Shinotsuka, while considering that deflationary concern had not been completely dispelled, dissented on the grounds that the downside risk to the economy had lessened. This judgment was based on the following five points. First, the effects of financial system reconstruction measures and the zero interest rate policy had permeated the market. As a result, corporate financing conditions had improved and stock prices had firmed. Second, given these developments, business and household confidence had improved. Third, price indexes showed stable developments. Fourth, it was questionable whether the Bank should continue the zero interest rate policy when it was apparently producing negative effects. And fifth, as observed in interest rate developments, some market participants were expecting a change in the zero interest rate policy.

Mr. Nakahara, claiming that it was appropriate to implement further monetary easing through monetary base targeting accompanied by inflation targeting, dissented from the chairman's proposal for the following three reasons. First, the Bank had been confined to "1 trillion yen morning projection for reserves," and was therefore unable to give additional signals to the market. Second, if the Bank persisted in continuing the zero interest rate policy, the negative impact of the termination of this policy could become substantial. And third, there were no prospective countermeasures should the economic situation worsen further in or after the autumn.

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

The Policy Board discussed "The Bank's View" of recent economic and financial developments, and put it to the vote. The Board unanimously determined "The Bank's View," for publication on July 21, 1999 in the Monthly Report of Recent Economic and Financial Developments (the "Ivory Paper," consisting of "The Bank's View" and "The Background").⁷

7The original full text, written in Japanese, of the "Ivory Paper" was published on July 21, 1999 together with the English version of "The Bank's View." The English version of "The Background" was published on August 2, 1999.

Attachment

For immediate release

July 16, 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: