Minutes of the Monetary Policy Meeting

on August 13, 1999
(English translation prepared by the Bank staff based on the Japanese original)

September 27, 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, August 13, 1999, from 9:00 a.m. to 12:23 p.m., and from 1:16 p.m. to 3:51 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. Haraguchi, Deputy Vice Minister for Policy Coordination, Ministry of Finance
Mr. E. Kawade, Director-General of the Coordination 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 21, 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.

I. Approval of the Minutes of the Monetary Policy Meeting Held on June 28, 1999

The Policy Board approved unanimously the minutes of the Monetary Policy Meeting, the"Green Paper," of June 28, 1999 for release on August 18, 1999.

II. Summary of Staff Reports on Economic and Financial Developments ²

A. Money Market Operations in the Intermeeting Period

Market operations in the period since the previous meeting on July 16 were conducted in accordance with the guideline determined at that meeting.³ Throughout the intermeeting period, money market operations were conducted in line with a positive"morning projection for reserves" of 1 trillion yen, and the weighted average of the overnight call rate remained generally stable at 0.03 percent. ⁴Recently, there were situations where overnight transactions were contracted at 0.02 percent. This was because city banks' demand for call money had decreased due partly to sluggish lending.

Three conspicuous developments were observed during the intermeeting period.

First, interest rates on term instruments, which had increased since mid-June, started to weaken again. For example, interest rates on short-term CDs declined to 0.03 percent, the same level as the overnight call rate, or even lower.

The rise in interest rates on term instruments maturing beyond end-September, the end of the semi-annual accounting period, was extremely small compared to that observed in the same period of the previous year. This suggested that market participants were not anticipating difficulty in raising funds maturing beyond end-September. Meanwhile, interest rates on those maturing beyond the year-end--that is, term instruments of six months or longer--were high. This seemed to reflect the market's anxiety about the Year 2000 problem and expectation of a termination of the zero interest rate policy in the near future.

Second, interest rates on futures contracts started to rise moderately following the release of strong economic indicators, such as industrial production for June. The recent level of interest rate futures seemed to reflect the market's expectation of a possible 0.25 percent increase in the overnight call rate in or after early 2000.

Third, developments related to the Year 2000 problem were observed. The"Year 2000 premium" on Euro-yen interest rate futures remained level, reflecting little change in the market's perspective on funding risks arising from the Year 2000 problem. ⁵In Japanese government bond (JGB) transactions, however, borrowing fees of particular issues had surged more recently. This suggested that anxiety was intensifying among some market participants that large investors would reduce securities lending transactions of JGBs over the year-end.

2Reports were made based on information available at the time of the meeting.
3The 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."
4The"morning projection for reserves" is defined as a projection of the"daily excess/shortfall of reserves" announced by the Bank each morning. The"daily excess/shortfall of reserves"--which is affected by the Bank's market operations of the day--is the amount by which reserves exceed/fall short of the"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.
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

From mid-July to early August, the U.S. dollar depreciated against the yen and the euro.

The weakness in the U.S. dollar reflected the following: (1) concern about possible inflation was expressed by Mr. Greenspan, chairman of the Board of Governors of the Federal Reserve System, in the testimony on the Federal Reserve's semiannual report on monetary policy; and (2) economic indicators released after the testimony were stronger than had been forecasted, corroborating the testimony.

Recently, there had been a pause in the yen's rise against the U.S. dollar. This was attributable to anticipation of possible intervention as well as several Asian factors giving rise to concern: for example, (1) growing tension between China and Taiwan; and (2) possible devaluation of the Chinese renminbi.

Nevertheless, appreciation of the yen against the U.S. dollar seemed to be a persistent underlying trend in the foreign exchange markets. This was because market participants considered that (1) with the economic recovery in East Asia, the perspective of the world economy was changing from"a robust U.S. economy with other economies sluggish" to"an uncertain outlook for the U.S. economy with prospects of recovery in other economies," and (2) structural reform was finally starting in Japan.

2. Overseas economic and financial developments

In the United States, economic expansion continued to be robust. However, reflecting concerns about inflation, developments in the U.S. financial markets were changing as observed in the fall in the currency, stock prices, and bond prices. With the release of indicators hinting at a buildup of inflationary pressure, such as the labor cost index and average hourly earnings, long-term interest rates rose to the highest level since October 1997 and stock prices declined by about 4 percent from their peak.

In Europe, underpinned by the strength in private consumption, the pace of economic expansion was accelerating moderately.

The Asian NIEs and the ASEAN countries were showing clearer signs of an economic recovery. However, stock prices in these economies had fallen back since mid-July, declining in general by about 10-20 percent from their recent peak. While this fall reflected the uncertainty in the economic outlook for the United States and the growing tension between China and Taiwan, it basically represented an adjustment phase of stock prices, which had risen considerably since early January.

As regards the international flow of funds, funds were flowing from U.S. dollar-denominated assets to yen-denominated assets. Yen funds seemed to be widely invested in not only stocks but also medium- and long-term bonds, and treasury bills (TBs).

C. Economic and Financial Developments in Japan

1. Economic developments

Business fixed investment continued to decline, and net exports decreased slightly due to an increase in imports. Public works remained high reflecting large amount of orders placed in February and March 1999, and housing investment was recovering. Underpinned by favorable consumer sentiment, private consumption showed mixed developments despite the increasing severity in employment and income conditions, as observed in the drop in summer bonus payments. Reflecting such developments in final demand and the progress in inventory adjustment, production had stopped declining although there were some fluctuations.

Overall, Japan's economy had stopped deteriorating. In addition, business sentiment had improved somewhat recently.

As for the outlook, shipment of public works-related goods was expected to increase toward early autumn since public works were progressing slower than usual. Accordingly, it was also projected that a substantial drop in shipment could be avoided in the October-December quarter. In addition, it was likely that the recovery in housing investment would be sustained and exports would increase given the recovery in overseas economies, especially in Asia. Under these circumstances, production, which had decreased slightly in the April-June quarter, was expected to turn upward in the July-September quarter. The economic stability was therefore likely to continue for some time.

However, firms were still restraining their business fixed investment due to restructuring, and it was not very likely that investment would show a clear recovery within fiscal 1999. Further, a slight increase was expected in exports in the near future, however the sustainability of the uptrend was uncertain. As regards summer bonus payments, they seemed to have declined sizably from the previous year's level, and the possibility could not be precluded that this might negatively affect private consumption through the resulting deterioration in consumer sentiment and income. Therefore, the probability that private demand would achieve a smooth self-sustained recovery was still considered to be low. The recent appreciation of the yen was not likely to have a considerable impact on corporate profits as the yen's current level did not differ greatly from the exchange rate level of 116-117 yen projected by large manufacturers in the June Tankan--Short-Term Economic Survey of Enterprises in Japan.

As regards prices, corporate service prices continued to follow a downward trend, but domestic wholesale prices were flat 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. As for the outlook, it was expected that domestic wholesale prices and consumer prices would remain generally flat in the immediate future. However, in the medium term, downward pressure on prices was considered to remain since contraction of the large output gap resulting from a self-sustained recovery in private demand was still not foreseeable.

2. Financial developments

In the money market, the overnight call rate remained close to zero, and anxiety about the procurement of overnight call money continued to be absent. Interest rates on term instruments had increased slightly from mid-June but subsequently declined, recently showing stable developments. However, interest rates on term instruments maturing beyond the year-end were relatively high reflecting concerns about the Year 2000 problem.

Yields on JGBs fell temporarily to around 1.6 percent in mid-July, but rose slightly afterwards reflecting the strengthening of market expectations of an economic recovery. Recently, they were moving at 1.8-1.9 percent. Stock prices had generally been above the 18,000 yen level, recently declining to 17,000-17,500 yen.

Meanwhile, the Japan premium had remained close to zero since March. The yield spread between JGBs and private bonds (bank debentures and corporate bonds) narrowed further--especially that between JGBs and corporate bonds with low credit ratings--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 eased. Under these circumstances, major banks were gradually becoming more willing than before to extend loans, carefully evaluating the creditworthiness of borrowers.

However, credit demand for economic activities such as business fixed investment remained weak. In addition, firms did not increase their on-hand liquidity. As a result, credit demand in the private sector continued to weaken, and sluggishness in private bank lending persisted. The pace of issuance of corporate bonds and commercial paper continued to slow.

The year-to-year growth in money stock (M2+CDs) continued to be slightly above 4 percent, reflecting the permeation of the effects of monetary easing and an increase in fiscal expenditure.

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 recently improved slightly, but clear signs of a self-sustained recovery in private demand had not been observed yet. One of the members described this economic situation as"positive and negative factors still being intertwined."

As grounds for judging that economic deterioration had stopped, many members pointed out that (1) construction related to public investment was progressing at a high level, (2) housing investment was recovering, and (3) reflecting these developments in demand, production had stopped declining.

In addition, one member commented that corporate sentiment had continued to improve according to the Business and Investment Survey of Incorporated Enterprises conducted by the Economic Planning Agency. A few other members pointed out that demand for information-related goods was strong in various areas, such as consumption, investment, and exports. One of them remarked that fields of information technology often described by terms such as"digital" and"mobile" were showing strong growth, as observed in the increase in orders for telecommunications equipment, firm sales of household electric appliances, and the particularly high growth in communications expenses in total household expenditure. As another positive factor, a different member cited the concentration of new venture businesses in central Tokyo.

However, members also generally agreed that there were still no clear signs of an economic recovery. This judgment was based on the following: (1) the economy still relied heavily on demand stimulated by policy measures, such as expanded public investment and housing investment; and (2) there was no evidence of private consumption and business fixed investment--the main components of private demand--recovering as a whole, although there were some positive indicators. One member stated that, even an in-depth analysis of each component of the diffusion indexes released by the Economic Planning Agency did not provide evidence of a bottoming out of the economy. Another member commented that, because the economy was in a delicate stage and macroeconomic statistics might not fully reflect the movements in new industries, attention should be paid not only to macroeconomic figures but also to developments of each industry.

With regard to private consumption, many members noted that there were some positive indicators, such as sales of personal computers and air conditioners, as well as department store sales in Tokyo. At the same time, however, they pointed out that (1) there were also negative factors, such as a decline in sales of automobiles in July, and (2) it was most likely that the increase in sales at department stores in Tokyo and sales of air conditioners was due to temporary factors, such as a closing sale at a department store and the extremely hot summer. Thus, the members concluded that consumption overall continued to exhibit mixed developments.

As regards business fixed investment, one member pointed out as a favorable factor that machinery orders (from the private sector, excluding shipbuilding and electric power) were projected to increase in the July-September quarter. However, a different member expressed the view that the trend of orders were, in fact, not strong considering that (1) the increase in orders was mainly due to a rise in semiconductor-manufacturing devices, and at the same time, (2) orders from agencies, consisting mainly of orders of small firms, were expected to drop significantly in the July-September quarter. In the end, the majority of members, including the above members, shared the view that there was still no clear indication of a recovery in business fixed investment. This was based on the following factors: (1) according to the Tankan and other surveys, business fixed investment for fiscal 1999 was expected to fall below the previous year's level; and (2) firms' credit demand remained weak as reflected in the sluggish private bank lending and capital market financing.

As for production, one member presented the view that an upturn in firms' plans for production and profits was becoming highly probable due to growth in exports to other Asian countries, which had shown an economic recovery. Another member commented that firms planned to increase production in the July-September quarter, which was a favorable factor, but they also remained very cautious about increasing inventories.

B. Financial Developments

On the financial front, members generally agreed that the effects of monetary easing had permeated further and concerns about the availability of liquidity had subsided considerably. In these circumstances, members focused their attention on the following two developments. First, there had been some changes in the trends in the financial markets, which had previously featured a combination of a depreciation of the yen, a decline in long-term interest rates, and a rise in stock prices. Specifically, the yen appreciated against the U.S. dollar, long-term interest rates rose to the 1.8-1.9 percent level, and stock prices declined somewhat. Second, money stock (M2+CDs) was growing steadily while bank lending remained sluggish.

First, members discussed developments in the financial markets.

Regarding the yen's appreciation, many members expressed the view that it was unlikely to have a significant impact on the economy. As grounds for this view, they pointed out that (1) the rise this time, unlike that observed in and after autumn 1998, reflected an assessment that Japan's economy had improved, and (2) so far, the extent of the rise had been limited and therefore was unlikely to affect firms' business plans. Further, the members considered that the recent fall in stock prices and the rise in long-term interest rates posed little downside risk to economic activity.

One member presented the following theory to support the above views. When monetary easing is implemented, the first reactions are a depreciation of the yen, a decline in long-term interest rates, and a rise in stock prices. Subsequently, the yen appreciates and long-term interest rates increase as market participants' confidence in the economic outlook improves. As for stock prices, they may show various developments influenced by expectations of an increase in profits, the strengthening of the yen, and the increase in interest rates. On these grounds, the member commented that the financial market developments so far could mostly be explained as the initial effects of monetary easing and the subsequent changes accompanying growth in expectation of an economic recovery. A different member expressed the view that the level of ongoing adjustment in stock prices was not particularly problematic, noting that foreign investors, whose active purchasing had contributed to the previous advance in the stock market, were not making massive sales but were merely taking a wait-and-see stance.

However, a few other members warned that, if the yen's appreciation were to accelerate abruptly, the impact on firms' profits could not be ignored. One of these members stated that another surge of the yen would impede an economic recovery since exports were currently underpinning the economy. In relation to this, a different member remarked that increasing the weight of yen-denominated transactions was one effective way to reduce the impact of exchange rate fluctuations on corporate management, and it was hoped that firms would make efforts in this area.

In addition, a few members pointed out that uncertainty regarding the outlook for the U.S. economy was one of the factors behind the recent appreciation of the yen against the U.S. dollar, and in this sense, developments in the U.S. economy in the immediate future were an important risk factor to consider. Further, one of these members commented that the yen's uptrend could gain unexpected momentum if the market's perception of the global economic situation changed dramatically. Members agreed that the yen's exchange rate and its effects on the economy should be monitored carefully.

With regard to the monetary aggregates, members discussed the situation where money stock (M2+CDs) was growing steadily while bank lending remained sluggish.

One member commented that, although private banks were gradually becoming more willing to take risks, the credit intermediary function had not fully recovered. On this point, the majority of members, including this member, considered that in view of (1) the alleviation of the constraint on bank lending caused by the severe fund-raising conditions for banks and their insufficient capital base, and (2) the results of various surveys of corporations, it was unlikely that banks had become cautious in their lending stance. They judged that the sluggishness in bank lending basically reflected the persistently weak credit demand of the private sector.

One member stated that, in an economic recovery phase, a rise in business fixed investment by small firms normally occurred at the outset. However, the current sluggish lending suggested that the prospect of an economic recovery gathering momentum through this mechanism was extremely remote.

Another member elaborated on the coincidence of the steady growth in money stock (M2+CDs) and the sluggish bank lending: (1) the government was issuing JGBs and paying out money to firms; (2) firms, on receiving these funds, were depositing them at financial institutions; and (3) financial institutions were using them to purchase JGBs. On this basis, the member noted the possibility that, even if investment started to increase as the economy recovered, the monetary aggregates, such as money stock and lending, might hardly increase at all if internal reserves were used to finance the investment.

A different member cited the following as factors causing the sluggishness in lending: (1) demand for on-hand liquidity was declining reflecting the market's increasing confidence in the availability of liquidity as the effects of monetary easing permeated; and (2) improvement in firms' cash flow was contributing to their balance-sheet restructuring--that is, repayment of loans. On this point, the member presented the view that lending and money stock (M2+CDs) might not rise at the current stage of economic recovery where firms' cash flow improved but this was not leading to an increase in business fixed investment.

Taking the above discussion into account, many members agreed that the recent developments in lending were influenced by various factors, such as firms' moves to reduce excess liabilities that had accumulated during the economic"bubble" and the abatement of anxiety about the availability of liquidity. Based on this view, a few members added that the relationship between economic activity and the monetary aggregates was expected to become more unstable than before, and therefore it was quite possible that the monetary aggregates would remain sluggish for some time even if the effects of monetary easing permeated further.

C. The Economic Outlook

With regard to the economic outlook, the majority of members considered that the economy was most likely to remain stable in the immediate future, partly due to the continuation of public works that reflected the delay in their implementation, and that the risk of the economy deteriorating once again in 1999 had lessened. Members, however, also generally shared the view that the prospect of a recovery in private demand remained unclear and that the risk remained of the economy showing a double dip in or after the turn of the year, when public investment was expected to decrease.

Many members referred to the delay in the implementation of public works, saying that, given the delay, public investment was likely to remain at a high level until early next year although it had initially been expected to decrease by the end of this year. These members shared the view that, as a result, the risk of another economic downturn in 1999 had lessened and the economy was likely to remain stable longer than previously expected. A few of these members remarked that the delay had turned out to be a positive factor since it secured more time for private demand to gather momentum while the economy was underpinned by policy measures.

Meanwhile, another member pointed out the possibility that the economy had been stable despite the delay in the implementation of public works because private demand had been unexpectedly firm.

Members also discussed the outlook for private demand.

Many members pointed out that exports, which were projected to increase in view of the apparent recovery in the East Asian economies, were one of the positive factors for the economic outlook. One of the members, however, commented that, growth in exports would be limited considering the already large current account surplus of Japan.

Many members shared the view that an increase in private consumption was unlikely, on the grounds that it was difficult for households' propensity to consume to rise further to compensate for the severe employment and income conditions.

A few members remarked on the severe employment and income conditions.

One member presented the opinion that the decrease in income was attributable to a negative momentum in the business cycle as well as firms' restructuring, which was strongly reflected in wage reductions due to the difficulty in laying off workers. Another member remarked that the actual employment situation was harsher than what could be expected from the unemployment rate. The member commented that unemployment statistics showed that it was taking people more time than before to find jobs and that the number of people who had given up job hunting seemed to have increased.

One member expressed the opinion that the upward trend in households' propensity to consume, which had prevented a fall in private consumption despite declining employee income, could not be expected to continue. Other members generally agreed with this opinion.

In relation to private consumption, one member presented the example of the United States where, during its"jobless recovery," the economy was underpinned by wealthy households' spending on education, housing, and leisure activities. This member pointed out that the situation was somewhat different in Japan. According to this member, the annual growth of real consumption expenditure (three-month moving average) in the Family Income and Expenditure Survey showed that spending cuts had been most notable among employees of large firms--who are assumed to have a relatively high income.

Another member presented a different interpretation of the above survey results. This member commented that nominal consumption expenditure by size of household's annual income showed that it was households with annual income of 6-8 million yen--those in the middle income bracket--that had significantly restrained their spending. This member added that those in the middle income bracket, which were burdened with housing loans, had been hit by the deterioration in income conditions more seriously than others.

Given the above comments, one member pointed out that the results of the Family Income and Expenditure Survey are easily affected by sample revisions, and therefore, analyses should be interpreted carefully.

On business fixed investment, many members considered that it would take some time for it to fully recover, in view of the negative momentum in the business cycle, structural adjustment pressure, and firms' restructuring.

One member stated that a recovery in business fixed investment was not foreseeable in the near future, because (1) large firms were resolved to restrain their investment in fiscal 1999, (2) firms' restructuring would hamper investment, and (3) structural adjustment pressure was especially notable among small firms.

A few other members commented that, even if firms' cash flow improved, firms implementing restructuring of the balance sheet would first pay off debts, and therefore, it would take longer time for business fixed investment to recover than in past economic recovery phases. One of these members, however, remarked that the risk of a further economic deterioration being produced through a negative chain reaction triggered by firms' balance-sheet restructuring had decreased considerably, and that the balance-sheet restructuring could be a step toward generating a positive momentum in the economy.

One member expressed a more cautious view of the economic outlook than the others.

This member expressed concern about the effects of the recent decline in stock prices and also stated that the negative impact of the appreciation of the yen on exports would largely offset the positive effect produced by the recovery in the Asian economies. The member also commented that, since the emergence of new industries that would create jobs was not yet in prospect amid the ongoing corporate restructuring, a further rise in the unemployment rate was inevitable. The member also projected that the price of West Texas Intermediate (WTI), a benchmark price of crude oil, would rise as high as US$23-25 per barrel by the end of 1999.

The same member also made remarks on developments overseas. With regard to the Asian countries, the member expressed concern about the recent decline in stock prices as well as the risks associated with the disposal of nonperforming assets and the political situation. On the U.S. economy, the member stated that the outlook was very unclear, referring to the bottleneck in the supply side of the economy.

With regard to the outlook for price developments, the majority of members were of the view that prices were very likely to remain level in the immediate future, but with the prospect of a self-sustained recovery in private demand still unclear, downward pressure on prices remained. They therefore judged that concern about deflation had not been dispelled yet.

A few members commented that the recent halt in price declines was partly attributable to supply-side factors, such as the rise in crude oil prices, and pointed out that prices of consumption goods were softening while those of raw materials and intermediate goods were firm. They also remarked that price increases originating from the supply-side of the economy, such as the rise in crude oil prices, had the positive effect of dampening deflationary expectations but could also have the negative effect of squeezing corporate profits.

Another member commented that downward pressure on consumer prices would persist given the pressure of international competition on the distribution industry although expectations of a price recovery were mounting in, for example, the raw materials industry.

One member remarked that it also required careful attention whether or not the current halt in the decline in prices would affect future price developments by discouraging deflationary expectations in the private sector.

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 could be summarized as follows. First, Japan's economy had stopped deteriorating supported by public investment and housing investment. Second, the effects of monetary easing by the Bank had further permeated the financial markets, and market participants had become more active in taking risks. Third, some positive changes had been observed in private consumption, business fixed investment, and the export environment. Fourth, despite these points, the prospect of a self-sustained economic recovery remained unclear. And fifth, therefore, the risk remained of the economy showing a double dip after the turn of the year, when public investment was expected to decrease, and concern about deflation was not yet dispelled.

Based on this assessment, the majority of members considered that the Bank should maintain its extremely easy monetary policy in line with its stance to keep policy unchanged until deflationary concern was dispelled.

In relation to this, one member claimed that the Bank should give adequate explanation on the following points. First, price stability, which central banks pursue, could not be monitored solely through a specific indicator. This was because there are various price indicators as well as numerous price-affecting factors such as technological innovation, developments in demand, and supply shocks. And second, it was the outlook for prices and not the current price level that was important to economic entities.

Members also exchanged opinions on the negative effects of the zero interest rate policy.

A few members cited the following as the negative effects of the zero interest rate policy: (1) distortion in income distribution; (2) possible delay in structural adjustment resulting from preservation of declining industries and excess production capacities; (3) an increasing insensibility of market participants to risks; and (4) malfunctioning of the market mechanism. One of these members emphasized the notable decline in the risk-awareness of market participants. Specifically, the member pointed out that the issuance rate differential by rating was narrowing, and some banks were trying to increase lending by casting high-risk borrowers low credit-risk premiums. However, given the current economic condition and the risks ahead, many members held the view that it was not appropriate to change the zero interest rate policy at this time.

Another member stressed that it was inappropriate to focus only on the negative aspects in assessing the zero interest rate policy. The member commented that whether to interpret the consequent active risk-taking by economic entities as a"positive development" or as a"decline in risk-awareness" should be considered in relation to the prevailing economic conditions. Further, this member noted that, while the low interest rate environment would support declining industries, it would also help the development of growth industries. The member expressed the view that, in promoting structural adjustment, fostering of new industries that would be the driving force of Japan's economy in the future was more important than weeding out of feeble sectors, and in this respect, low interest rates would be a positive factor.

On the other hand, one member remarked that the prolongation of the zero interest rate policy was intensifying its negative effects, referring to the widening income gap between households in the high income brackets and others. The member concluded that it was not appropriate to continue the zero interest rate policy any further.

In relation to the technical aspects of money market operations, members discussed the recent continuation of a positive"morning projection for reserves"of 1 trillion yen.

One member raised the question of whether the continued"morning projection for reserves" of 1 trillion yen was appropriate given the fact that (1) demand for excess reserves seemed to have decreased further reflecting the permeation of the effects of monetary easing, and this was consequently increasing the amount of funds in the current accounts at the Bank held by institutions not subject to reserve requirements, such as tanshi companies (money market broker-cum-dealers), and that (2) the"morning projection for reserves" itself was in no way an indication of the Bank's policy stance.

Another member expressed the view that the market took the"morning projection for reserves" of 1 trillion yen as a"quasi-target" of money market operations. Based on this view, this member remarked that the Bank should explicitly state the"morning projection for reserves" in the guideline for money market operations to make monetary policy more transparent. The member also noted that the gap between the amount of projected and actual"daily excess of reserves" had widened since the introduction of the zero interest rate policy. The member warned that such a situation, if it continued, could impair the credibility of the Bank. Further, this member expressed the opinion that the gap had originated from a framework of projection that could not exclude the effects of current accounts at the Bank held by tanshi companies, and that the framework did not suit the current financial environment and market operations. The member advocated a revision of such a framework as a whole, including how to project the"daily excess of reserves" and supply and demand of funds in the money market.

At the request of another Board member, the Bank's staff gave the following explanation in response to the above comments.

The staff explained that the Bank did not regard the"morning projection for reserves" of 1 trillion yen as the aim of money market operations, but it was the result of funds provision in line with the guideline for money market operations, that is,"to encourage the uncollateralized overnight call rate to move as low as possible."

The staff also explained that (1) the"morning projection for reserves" indicated the projected amount of reserves that would be supplied by the Bank in excess/falling short of"remaining required reserves" when reserves are officially calculated, and that the Bank was providing funds in line with its projection, and (2) the disparity between the amount of projected and actual"daily excess of reserves" was mainly attributable to the accumulation of funds in the current accounts at the Bank held by tanshi companies and other institutions not subject to reserve requirements, as a result of abundant supply of funds by the Bank. The staff concluded that they would continue to improve its transparency and accountability by taking necessary measures, as demonstrated by the start of the release in April 1999 of daily amounts of current accounts at the Bank held by institutions not subject to reserve requirements.

Given the above explanation, many members expressed the opinion that there was no need to change the current target of monetary policy, that is, the overnight call rate. Specifically, one member expressed the view that there was no need to add the"morning projection for reserves" to the guideline for money market operations, which already indicated an interest rate target. Another member agreed with this opinion, stating that it was impossible to achieve the two targets of interest rate and quantity of reserves simultaneously, and therefore there was no use in including them both in the guideline.

Members also discussed the opinion outside the Bank that it should conduct unsterilized yen-selling intervention.

One member explained that unsterilized yen-selling intervention under the zero interest rate policy simply meant that the supply of excessive funds would increase by the amount of the intervention only on the day of the settlement. This member stated that such kind of operation could hardly be considered to have an effect. This member further commented that various empirical analyses generally showed that the effectiveness of foreign exchange intervention did not depend on whether or not the intervention was sterilized, but on the explicitness with which the policy makers' intentions were expressed and subsequent policy changes were signaled.

Further, the member mentioned that, in order for unsterilized intervention to have some effect, if any, it would have to accompany a reduction in interest rates. However, with no room for a further reduction in interest rates, the member concluded that unsterilized intervention could not affect the foreign exchange market any more than sterilized intervention could. Several members agreed with this opinion.

A different member, although holding the view that monetary policy should not be appropriated directly to influence the exchange rate, suggested that, if market participants truly believed that unsterilized intervention would have some effect, it might be worth considering measures that took advantage of this view. This member also stated that the ratio of the amount of monetary base in Japan to that in the United States seemed to be affecting the foreign exchange market. The member continued that unsterilized intervention could be considered as a way to increase the monetary base, and that the increase in the monetary base itself would positively affect Japan's economy.

Regarding the above argument, the member who denied the effectiveness of unsterilized intervention mentioned that the correlation between the yen-dollar exchange rate and the growth differential between the monetary base in Japan and the United States was very weak and unstable in the long run, although some economists attached importance to such correlation. A few members including this member asserted that the Bank should not take measures that it did not consider to be effective theoretically, just to take advantage of the market's perception. They continued that, even if such a measure had some effect in the short term, it would only be very temporary.

A few other members, referring to the views expressed in the above discussion, stated that the Bank had already been supplying more funds through its daily market operations than what would be expected through unsterilized intervention under the current zero interest rate policy.

At the end of the above discussions, the majority of members considered 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, suggested that the Bank should, at this time, guide the overnight call rate up to the level before the monetary easing on February 12--that is, around 0.25 percent on average--considering the decreasing risk of an economic slowdown and the increasing negative effects of the continued zero interest rate policy. The member continued that, even if the Bank raised the interest rate, it would still be extremely low, and that the Bank should fine-tune its monetary policy under this new framework.

A different member advocated that the Bank should make a drastic decision to adopt quantitative easing. The member gave the following four reasons. First, the recent appreciation of the yen, the decline in stock prices, and the rise in long-term interest rates indicated that the effects of the monetary easing in February on the financial markets had played themselves out. Considering that developments at this stage were very important to an economic recovery, an additional monetary easing was needed at this point. Second, the momentum for a self-sustained recovery in private demand was not strong enough, and there was still a risk of the economy deteriorating in the second half of fiscal 1999. Third, the introduction of monetary base targeting accompanied by inflation targeting would enhance the transparency of monetary policy. This would also be an effective way of showing the Bank's determination to support the economy. And fourth, with no more room for a reduction in the nominal interest rate, making the"morning projection for reserves" a policy target would give the Bank more flexibility in its market operations.

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 had improved slightly due to the materialization of the effects of various policy measures.

(2) In June, in light of the above situation, the government set out a comprehensive plan to improve employment conditions and strengthen industrial competitiveness. On July 21, the Diet adopted a supplementary budget for fiscal 1999. On August 6, the Diet passed bills concerning special measures for the revitalization of Japanese industries and related bills concerning special tax measures.

On fiscal policy management in the immediate future, the government would, in view of developments in Japan's economy, take necessary measures expeditiously and flexibly, including the utilization of reserve funds for public investment and the formulation of a second supplementary budget for fiscal 1999 to construct a so-called 15-month budget. The government hoped that the Bank would be in sympathy with the thinking behind its economic and fiscal policy management.

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

(1) On the current economic situation, the Agency shared the view of the Ministry of Finance. As for economic policy, the government would effectively utilize the framework established by the new law concerning special measures for the revitalization of Japanese industries in addition to the emergency economic package and a comprehensive plan to improve employment conditions. The government was determined to strongly promote implementation of these measures.

(2) The government would like to request the Bank to contribute to realizing an economic recovery by providing ample funds in the market through appropriate money market operations until self-sustained economic recovery became apparent.

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 had improved slightly, but clear signs of a self-sustained recovery in private demand had not been observed yet. Second, given the above, deflationary concern had not yet been dispelled. Third, the effects of monetary easing had further permeated the financial markets, and market participants had become more active in taking risks. And fourth, given the current economic situation, it was necessary to continue to give maximum support to the economy from the monetary front, although the continuation of the zero interest rate policy was possibly producing some negative effects.

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.

One member, however, presented the opinion that it was appropriate to raise the interest rate. Another member claimed that it was appropriate to adopt an apparent quantitative easing and also set a target for the inflation rate.

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

Ms. Shinotsuka proposed changing the guideline for money market operations back to the one that had been employed before the monetary easing on February 12. Specifically, she proposed the following as the guideline 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 August 16 through September 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: Mr. N. Nakahara and Ms. E. Shinotsuka.

Ms. Shinotsuka dissented for the following three reasons. First, the risk of the economy showing a double dip had lessened. Second, the zero interest rate policy was producing negative effects, such as distortion of income distribution in the household sector, possible delay in structural adjustment, and moral hazard among market participants. And third, such negative effects would increase with the continuation of the zero interest rate policy.

Mr. Nakahara voted against the chairman's proposal for the following three reasons. First, the current zero interest rate policy was causing a large disparity between the amount of projected and actual"daily excess of reserves." Continuation of the current policy would only increase this disparity. Second, while the effects of the current monetary easing were starting to run out as seen in the appreciation of the yen and the falling back of stock prices, a self-sustained recovery in private demand was still not in prospect. This proved that the monetary easing to date had not been sufficient. And third, the policy framework, which was currently described in ambiguous language such as"to dispel deflationary concern" and"provision of more ample funds," should be changed to a more transparent one.

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 August 17, 1999 in the Monthly Report of Recent Economic and Financial Developments (the"Ivory Paper," consisting of"The Bank's View" and"The Background"). ⁶

6The original full text, written in Japanese, of the"Ivory Paper" was published on August 17, 1999 together with the English version of"The Bank's View." The English version of"The Background" was published on August 27, 1999.

Attachment

For immediate release

August 13, 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.

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