Minutes of the Monetary Policy Meeting

on September 21, 1999
(English translation prepared by the Bank staff based on the Japanese original)

November 1, 1999
Bank of Japan

A Monetary Policy Meeting of the Bank of Japan Policy Board was held in the Head Office of the Bank of Japan in Tokyo on Tuesday, September 21, 1999, from 9:00 a.m. to 12:21 p.m., and from 1:11 p.m. to 4:15 p.m.¹

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

Government Representative Present
Mr. S. Tanigaki, State Secretary for Finance, Ministry of Finance²
Mr. T. Haraguchi, Deputy Vice Minister for Policy Coordination, Ministry of Finance³
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. N. Inaba, Advisor, Policy Planning Office
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. H. Tanaka, Chief Manager, Planning Division 2, Policy Planning Office
Mr. T. Kurihara, Manager, Policy Planning Office
Mr. H. Yamaoka, Manager, Policy Planning Office
Mr. K. Araki, Manager, Financial Markets Department⁴

1. The minutes of this meeting were approved by the Policy Board at the Monetary Policy Meeting held on October 27, 1999, as "a document which contains an outline of the discussion at the meeting" stipulated in Article 20, Paragraph 1 of the Bank of Japan Law of 1997. Those present are referred to by their titles at the time of the meeting.
2. Mr. Tanigaki was present from 9:00 a.m. to 10:48 a.m.
3. Mr. Haraguchi was present from 10:59 a.m. to 12:21 p.m., and from 1:11 p.m. to 4:15 p.m.
4. Mr. Araki was present from 9:00 a.m. to 9:43 a.m.

I. Approval of the Minutes of the Monetary Policy Meeting Held on August 13, 1999

The Policy Board approved unanimously the minutes of the Monetary Policy Meeting, the "Green Paper," of August 13, 1999 for release on September 27, 1999.

II. Discussions and Decisions concerning the Basic Policy on the Eligibility as Collateral of Asset-Backed Securities and Debt Obligations Issued by Financial Institutions that Maintain Current Accounts with the Bank of Japan

A. Staff Proposal

1. Asset-backed securities

To date, the Bank had not accepted asset-backed securities (ABSs) as eligible collateral.

It would, however, be appropriate for the Bank to accept ABSs as collateral for extension of credit by the Bank if they were deemed eligible in terms of credit risk after thorough examination from the viewpoint of ensuring the soundness of the Bank's assets. This was based on the following considerations: (1) issuance of ABSs was likely to increase in the future; and (2) central banks of some major industrialized countries accepted ABSs as eligible collateral.

For the time being, however, ABSs should be accepted only as collateral for bill purchasing operations utilizing corporate bonds and loans on deeds. The Bank should, following decisions by the Policy Board, announce further details of conditions for acceptance.

2. Debt obligations issued by financial institutions that have current accounts with the Bank of Japan

As for debt obligations issued by financial institutions that held current accounts with the Bank (hereafter, "counterpart financial institutions"), the Bank had been accepting the following as eligible collateral and market operations instruments: bank debentures issued by long-term credit banks and commercial paper (CP) issued by securities companies and securities finance companies.

The Bank should, however, reconsider whether it should accept debt obligations issued by counterpart financial institutions given the expected commencement in October 1999 of banks' issuance of straight bonds and the diversification of the fund-raising means of financial institutions.

Considering the following, it was inappropriate for the Bank to accept debt obligations issued by counterpart financial institutions as eligible collateral:

(1) the Bank's acceptance/non-acceptance of debt obligations would constitute disclosure of its judgment on a particular financial institution's creditworthiness--if the Bank were to decide to no longer accept the debt obligations of a financial institution whose creditworthiness had declined, the financial institution's fund-raising conditions might deteriorate, and this could give rise to uncertainty about the stability of the financial system--if, on the other hand, the Bank continued to treat them as eligible with a view to avoiding this risk, the soundness of the Bank's assets would be threatened;

(2) if the Bank took as collateral or obtained through money market operations debt obligations that might be redeemed by proceeds from the Bank's credit, the Bank might in fact be extending credit without sufficient collateral; and

(3) the central banks of major industrialized countries did not accept such debt obligations as collateral.

However, bank debentures and CP issued by securities companies and securities finance companies were widely accepted by the Bank as eligible collateral. Therefore, these financial instruments should remain eligible for a while: bank debentures until the end of March 2001, and the CP purchased by the Bank by the end of March 2000.

B. Members' Discussion and Votes

A few members revealed their stance in favor of the staff's proposal. The proposal was then put to the vote. Members unanimously approved the proposal and decided that the decision should be publicized immediately after the meeting.

III. Summary of Staff Reports on Economic and Financial Developments⁵

A. Money Market Operations in the Intermeeting Period

Market operations in the period since the previous meeting on September 9 were conducted in accordance with the guideline determined at that meeting.⁶ Throughout the intermeeting period, the Bank generally maintained a "morning projection for reserves" of an excess of 1 trillion yen.⁷ When demand for funds in the call market increased due to concerns that computer systems might not function properly on September 9 and due to the approach of the last day of the reserve maintenance period on September 14, the Bank flexibly made a larger "morning projection for reserves" and supplied more ample funds than usual to stabilize the market in accordance with the guideline to "encourage the uncollateralized overnight call rate to move as low as possible."

The overnight call rate temporarily increased to 0.06 percent on September 8 and 9 reflecting concerns about the possible malfunctioning of computer systems on September 9. But as the Bank provided ample funds in the market, the overnight call rate generally stabilized again at 0.03 percent from September 10. Following the reduction of brokerage fees by tanshi companies (money market broker-cum-dealers), the majority of call transactions had been contracted at 0.02 percent, and on September 17, the weighted average of the overnight call rate marked 0.02 percent for the first time.

Interest rates on term instruments generally declined as expectation that the zero interest rate policy might be terminated in the near future waned further given the recent appreciation of the yen. Interest rates on three-month and six-month treasury bills (TBs) fell below the overnight call rate, and recently, rates on one-year TBs declined to 0.04 percent, close to the level of the overnight call rate. It seemed that the effects of the zero interest rate policy had permeated to interest rates on even longer-term instruments.

With the continued zero interest rate policy, market participants had become more confident than before that they could raise funds whenever they wished at almost no cost. As a result, foreign banks, in addition to city banks, had recently adopted the stance of not holding unnecessary excess reserves. Against this background, the funds provided by the Bank were accumulating even more conspicuously than before in the current accounts held by institutions not subject to reserve requirements such as tanshi companies. Thus, it could be said that the abundance of funds in the market had become more and more pronounced.

1. 5Reports were made based on information available at the time of the meeting.
2. 6The 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."
3. 7The "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.

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

1. Developments in foreign exchange markets

From the time of the previous meeting on September 9 through mid-September, the yen appreciated considerably against the U.S. dollar and the euro, surging to the 103 yen level against the former on the London market. However, the yen fell back thereafter to the 106 yen level reflecting market expectations of further policy action by the Bank and coordinated foreign exchange intervention by Japan and the United States. Such expectations emerged following a meeting on September 16 between Mr. Miyazawa, Minister of Finance, and Mr. Hayami, Governor of the Bank of Japan. Under these circumstances, the market was paying great attention to this Monetary Policy Meeting.

The dominant view in the market was that the recent appreciation of the yen was fueled basically by expectations of a recovery in Japan's economy and that the trend in the foreign exchange market would not change unless these expectations altered.

2. Overseas economic and financial developments

There were no notable changes to the general trend in overseas economies and financial markets in the intermeeting period. However, the following points deserved attention.

First, the U.S. external deficit seemed to be expanding as a result of an increase in imports. According to the U.S. Balance of Payments released on September 14, the current account deficit for the April-June quarter of 1999 expanded from the January-March quarter. As a result, the ratio of the current account deficit to GDP marked 3.6 percent, exceeding the previous record high of 3.5 percent in October-December 1986. The view prevailed in the market that the U.S. economy was very likely to continue to expand beyond its potential growth rate in 2000, although the pace might slow somewhat, and that therefore the external deficit would expand further.

Second, in China, exports were robust, and the trade surplus was expanding. Foreign reserves reached over US$ 150 billion at the end of August. In these circumstances, it seemed that there was little pressure at this point to devalue the Chinese renminbi.

C. Economic and Financial Developments in Japan

1. Economic developments

Not many economic indicators were released in the intermeeting period since there were only six business days. Those indicators did not offer any grounds for changing the Bank's judgment at the previous meeting that the economy had stopped deteriorating and there were some activities improving such as exports and production, but clear signs of a self-sustained recovery in private demand had not been observed yet.

With regard to public investment, the value of public works contracted was level in August.

As for business fixed investment and private consumption, no clear sign of a recovery was observed. Indicators related to business fixed investment suggested that it continued to be on a downward trend. Machinery orders in July remained at more or less the same level as in the April-June quarter. A survey on business fixed investment plans for fiscal 1999 as of August conducted by the Japan Development Bank (JDB) showed that firms with capital of 1 billion yen or more planned to decrease investment by 3.7 percent as compared with fiscal 1998, when they had also reduced investment by 8.0 percent from the previous year. Indicators related to private consumption generally remained flat.

Meanwhile, the yen continued to surge against the U.S. dollar in the intermeeting period. This did not necessitate any significant change in the Bank's view of the outlook for the economy and prices at this point. However, developments in the foreign exchange rate and their impact on exports and corporate profits needed to be closely monitored.

2. Financial developments

In the financial markets, two conspicuous developments were observed in the intermeeting period: (1) a downtrend of interest rates on term instruments and long-term interest rates; and (2) sluggishness in the growth of money stock.

Interest rates on term instruments and long-term interest rates declined against the following background. First, the positive growth in Japan's GDP in the April-June quarter, which was released on September 9, and reports on September 13 that the Trust Fund Bureau would continue to purchase Japanese government bonds (JGBs) in and after October alleviated concerns about a deterioration in the supply and demand conditions for JGBs. And second, the recent surge in the yen engendered market expectations that the zero interest rate policy would likely be extended.

The year-to-year growth in money stock (M2+CDs) in August was 3.5 percent, slowing further from the 3.9 percent in July. This was attributable to the following factors: (1) credit demand for economic activities such as business fixed investment remained weak; (2) firms had begun to reduce their on-hand liquidity recently, reflecting the abatement of anxiety about their fund-raising; and (3) the improved cash flow of firms due to the bottoming-out of production was being used to repay loans. It could be said that the permeation of the effects of monetary easing and the halt in the economic deterioration had facilitated firms' balance-sheet restructuring, such as reduction of liabilities, and this was damping the growth of money stock.

Money stock was expected to grow when the economy started a full-scale recovery and when real investment increased. Until then, it was quite possible that growth in the monetary aggregates, such as money stock, would remain sluggish.

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

A. The Current Economic Situation and the Economic Outlook

The discussion at this meeting focused mainly on economic indicators released after the previous meeting on September 9 as well as the rapid strengthening of the yen toward mid-September and its effects on the economy and prices.

1. Analyses of economic indicators

Members generally agreed that economic indicators released in the intermeeting period did not offer any grounds for changing the Bank's judgment on the economic situation made at the last meeting.

The majority of members commented that, although construction starts remained flat in August, public investment was very likely to continue to support demand for the rest of 1999 given the high level of ongoing public works.

As regards business fixed investment and private consumption, the main components of private demand, members generally shared the view that clear signs of a self-sustained recovery had not been observed yet.

On business fixed investment, some members remarked that clear indications of a recovery were not seen, pointing out that machinery orders in July remained almost unchanged from the April-June quarter and that business fixed investment plans for fiscal 1999 surveyed by the JDB projected a year-to-year decrease, as observed in fiscal 1998. With regard to private consumption, members generally agreed that it continued to show mixed developments, judging from newly released indicators such as outlays for travel and sales of department stores in Tokyo.

One member expressed a slightly more cautious view of the outlook for the economy than the others.

With regard to two consecutive quarters of GDP growth, this member commented that, while spring 1999 could have been the trough of the business cycle, the growth in the January-March quarter was mainly attributable to public investment and that in the April-June quarter to housing investment and tax cuts. The member remarked that, therefore, GDP growth might fall back to negative in the July-September and October-December quarters, when support from the above-mentioned factors could no longer be expected. This member also expressed the view that crude oil prices could become a risk to the world economy, given the prospective further rise due to the seasonal increase in demand in winter and to the projected continuation of production cuts by OPEC until the end of March 2000. This member further pointed out that the continued downtrend in land prices, which was currently one of the factors fettering the disposal of nonperforming loans by financial institutions while also serving to hamper firms' restructuring, would continue to be a drag on the economy for some time.

A different member, referring to the Report on Current Survey of Selected Service Industries released by the Ministry of International Trade and Industry (MITI), remarked that activities in the service industry were showing signs of a recovery, as observed in the rise in sales of the information service industry. On this basis, the member noted that the economy seemed to be becoming more stable. As for prices, the same member commented that prices of international commodities, such as petrochemical products and semiconductors, were rising notably reflecting the recovery in Asian economies, and its effects on Japan's domestic prices required attention.

2. Analyses of developments in foreign exchange markets

Members discussed the surge in the yen toward mid-September and its effects on the economy and prices.

First, members discussed the background of the recent rise in the yen. Many members pointed out that expectations of an economic recovery inevitably put upward pressure on the country's currency, but the recent pace of the yen's rise was too fast and required careful attention.

A few members remarked that the recent appreciation of the yen was largely attributable to the market's anticipation of a recovery in Japan's economy and corporate profits.

One member pointed out that foreign investors' recent active investment in Japan's securities markets was one factor. A different member referred to the current account surplus, which remained large, and the capital account balance, which had recently turned positive. The member remarked that these developments in the external balance seemed to be exerting upward pressure on the yen.

Many members, basically sharing the above views, commented that, if the yen appreciated excessively, concern about the resulting negative impact on corporate profits and economic activities might lead to a halt in the capital inflow, and this might in turn put a brake on the strengthening of the yen. In relation to this, one of these members pointed out that this stabilization mechanism would come into play in the stock and foreign exchange markets unless exchange rates were strongly influenced by the market's perception that they might be used politically in order to solve trade friction or other problems.

Members also shared the understanding that the recent rise in the yen was too rapid, and developments in the yen required careful attention considering that exchange rates often overshoot, diverging significantly from economic fundamentals. One of these members focused on the extent and the pace of the appreciation of the yen, and pointed out that a "further," "rapid" rise would be a problem for the economy.

3. Impact of the appreciation of the yen

Members also discussed from various perspectives the effects of the recent appreciation of the yen on economic and price developments.

A few members, while expressing concern about the impact of the surge of the yen on the economy, for example the effect on corporate profits, pointed out that it would be precipitate to change the Bank's view of the economy and prices based merely on exchange rate developments: the Bank should judge the prospects based on developments in the economy and prices as a whole. Many members shared this thinking.

As a basis for making a comprehensive judgment, one member requested the Bank's staff to explain the estimated impact of the rise in the yen using a macro-econometric model. In response to this, the Bank's staff reported as follows.

(1) A simulation using a macro-econometric model showed that a rise in the yen to 105 yen from 120 yen, an assumption based on the yen's level of slightly weaker than 120 yen against the U.S. dollar until mid-July, had the cumulative effect of pushing down real GDP growth by 0.1 percentage point in the first year and by 0.8 percentage point in the second year from the level that would have otherwise been attained.

(2) The results of the simulation, however, should be considered with some allowance for error, since econometric models do not fully incorporate changes in the economic structure, and since the volume of exports could be influenced greatly by developments in the world economy. The results of a simulation by the econometric model also showed that the negative impact of the rise in the yen from 120 yen to 105 yen against the U.S. dollar on the volume of exports would be more or less cancelled out if the growth rate of the world economy rose by approximately 1 percentage point.

Given the above report, each member expressed their opinion on the impact of the rise in the yen on the economy and prices.

Many members pointed out that a rapid strengthening of the yen could negatively affect the economy and prices.

A few members remarked that the negative impact of the current level of around 110 yen against the U.S. dollar was not so strong as to lead to an economic downturn. However, considering that firms were in the process of restructuring and exports were supporting production in the absence of an upturn in domestic private demand, a further surge in the yen could very likely jeopardize the recovery in corporate profits and the economy.

Another member noted that stock prices were falling concurrently with the rise in the yen, and commented that a further surge of the yen could impair the market's confidence in Japan's economy.

A different member commented that an appreciation of the yen from 108 yen against the U.S. dollar would have a different degree of impact on firms from that from around 120 yen, being detrimental to Japan's economy, particularly manufacturing industry.

Many members, including those who made the above comments, referred to other factors that should also be taken into account to comprehensively analyze the impact of the yen's appreciation.

One member expressed the view that the recovery in the Asian economies would offset to some extent the downside impact of the rise of the yen on export volume. Another member remarked that a climb in prices of international commodities reflecting the recovery in the Asian economies would allow firms to raise export prices. These members noted that developments in the exchange rate and overseas economies involved considerable uncertainty, and therefore, the magnitude of the various effects of the strengthening of the yen on the economy, among other factors, required further careful monitoring.

A few members also commented that Japanese firms were becoming increasingly resistant to an appreciation of the yen due to their measures against exchange rate fluctuations, such as relocating factories overseas and giving greater value-added to their export products, and their efforts to strengthen profitability, such as restructuring. One member expressed the view that, this time, the downward impact of the rise in the yen on business fixed investment would be slightly less than in past phases, since business fixed investment of manufacturing industry had already slipped to as low as below the depreciation expense according to the results of various surveys. Another member noted that it was necessary to pay attention to the positive aspect of the rise in the yen, specifically a resulting increase in Japan's real purchasing power, not being concerned only about the negative aspects, and to make sure that such positive effects would permeate to the household sector and stimulate private consumption.

Based on the above discussions, members generally shared the following views: (1) a little more time was needed to judge the degree of the downside risk to the economy arising from the recent appreciation of the yen; (2) considering that overseas economies were on a recovery path and production and exports in Japan were showing some positive developments, it was not necessary to change the basic judgment on the economy at this time; and (3) if the yen surged further, however, the risk that it might have a serious impact on the economy warranted attention.

Members also agreed that developments in the yen and their impact on the economy and prices continued to require close monitoring.

4. Conclusion

Based on the above discussions on the effects of the rise in the yen, the majority of members shared the view that it was not necessary to change the judgment made at the previous meeting on the current economic situation and the outlook. They judged that Japan's economy had stopped deteriorating, and some activities such as exports and production were showing improvement, but clear signs of a self-sustained recovery in private demand had not been observed yet. One of these members described this economic situation as "positive and negative factors still being intertwined" but "being slowly headed toward a recovery."

B. Financial Developments

With regard to financial developments in the intermeeting period, members were in general agreement with the analysis presented by the Bank's staff.

Some members expressed the view that financial market conditions had eased further. Specifically, they pointed out that flexible provision of ample funds by the Bank had further alleviated concern about the availability of liquidity, and in this situation, banks were reducing their excess reserves, which was leading to further accumulation of excess funds in the accounts held by tanshi companies.

A few members referred to the recent decline in interest rates on term instruments, saying that this also suggested the further permeation of monetary easing effects in the markets. One noted that interest rates on a wide range of term instruments were approaching zero and long-term interest rates had fallen to the 1.6-1.7 percent level. The member commented that these interest rate developments, together with the accumulation of funds in the current accounts held by tanshi companies, indicated that the effects of monetary easing were coming close to their limits.

Further, one member commented that the monetary easing had substantially relaxed corporate financing conditions as a whole. Another member expressed the opinion that financial institutions were becoming gradually active in risk-taking.

Another member, while noting that the financial markets had been stable, pointed out the following risks: (1) a rise in long-term interest rates related to the second supplementary budget; (2) the Year 2000 problem; and (3) a further rise in the yen.

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

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

As mentioned earlier, many members considered that it was not necessary to change the basic judgment on the economic and financial situation made at the previous meeting, retaining the view that the Bank should carefully monitor the effect of the yen's appreciation on economic activities and prices.

On this basis, the majority of members considered that, in the implementation of monetary policy in the immediate future, it was appropriate to continue the zero interest rate policy in line with the Bank's stance to maintain the policy until deflationary concern was dispelled, in view of the deflationary pressure arising from the appreciation of the yen.

Before coming to the above conclusion, members discussed monetary policy from various perspectives given the recent surge of the yen.

Some members expressed their views on how monetary policy could be implemented to deal with the yen's appreciation.

Most members commented that the foreign exchange rate was an important factor that should be given due consideration in the implementation of monetary policy because it influenced the economy and prices. At the same time, they expressed the view that monetary policy should be based on a comprehensive assessment of the economic and financial situation including the effects of exchange rate fluctuations. They remarked that it was not appropriate to try to achieve a certain exchange rate level through monetary policy--in other words, to place the foreign exchange rate as the direct objective of monetary policy--and that this was difficult in the first place.

Some members added that intervention in the foreign exchange market could be an effective measure to begin with against an excessive appreciation that diverged from the economic fundamentals.

In relation to this view, a few other members noted the lessons learned from monetary policy in the past. One member stated that the high inflation in the 1970s and the economic "bubble" of the 1980s could have been due partly to the excessive adjustment in monetary policy in order to counter the fluctuation of the exchange rate in the international financial environment at the time, and that these experiences were valuable lessons. Another member expressed the opinion that this view was also reflected in the Bank of Japan Law of 1997.

A different member analyzed the theoretical relationship between the foreign exchange rate and monetary policy, and elaborated on whether this applied in the current situation.

This member explained that, if interest rates could be reduced through monetary policy, the decline in interest rates could contribute to a depreciation of the yen. At present, however, there was no room for such rate cuts. The member continued that, in these circumstances, a possible additional policy measure that could exert downward pressure on the yen would be to create expectations of vicious inflation in the market by, for example, underwriting JGBs, and in that case, interest rate increases and the yen's depreciation might occur simultaneously. However, the member added that such a policy involved extremely large costs, and was not one that could be adopted easily. Most members agreed with this view.

Members also discussed the issues of unsterilized intervention and additional provision of funds (a further quantitative easing) again because market participants were speculating on the possibility of these measures given the recent surge of the yen.

As discussed at the meeting on August 13, many members questioned the significance of unsterilized intervention under the zero interest rate policy.

One member commented that whether the Bank was sterilizing intervention or not made no difference under the zero interest rate policy, whereby the Bank was continuously injecting ample funds into the market. In other words, it could be said that the Bank was already conducting unsterilized intervention--that is, leaving the yen funds in the market after yen-selling intervention, and supplying additional funds in the market through money market operations with a view to creating a "daily excess of reserves" of as much as 1 trillion yen. In relation to this view, the member referred to a recent paper written by central bankers abroad clearly stating that (1) both sterilized and unsterilized intervention had the same effect at the zero bound on nominal interest rate, because the unsterilized intervention could not lower the interest rate, and (2) changing the amount of the yen and U.S. dollars injected into the market would have little or no lasting impact on the exchange rate.

Further, a few members commented that, if there were views outside the Bank that the Bank was absorbing through its money market operations the funds created by the government's intervention, those views were far from the truth. They explained that, rather, the Bank's money market operations under the zero interest rate policy accommodated the effects of yen-selling intervention, since the Bank's operations created more excess funds than were created by the intervention. On this basis, they pointed out that the Bank should promote a wider understanding of the Bank's market operations that were injecting ample funds into the market using various money flows such as funds provided through interventions.

Next, members discussed the effects of injection of additional funds into the market.

Many members expressed the view that provision of additional funds in the market could not be expected to have any effect on economic activities or asset prices, considering that funds were accumulating in the accounts held by tanshi companies at the Bank, and bids in money market operations had fallen short of the amount of the Bank's offers.

One member theoretically assessed the significance of injecting more funds into the market under the zero interest rate policy. Money market operations by the central bank could be understood as a process of exchanging narrowly defined money for financial assets held by financial institutions. The zero interest rate policy increased the liquidity of short-term financial assets to the maximum and lowered their interest rates to close to zero. In this sense, there was hardly any difference between short-term financial assets and money--in other words, the two were almost perfect substitutes--under the zero interest rate policy. Therefore, even if more money were exchanged for short-term financial assets in this situation, the exchange of equivalent items could hardly have any effect on economic activities and asset prices.

Further, this member expressed the view that, in theory, the Bank would have to purchase assets that were still quite different from money--such as JGBs and long-term assets of the private sector--in order for the funds injected into the market to have some influence on the economy even in the above-mentioned circumstances. The member, however, stated that the Bank, as the central bank, could not take such measures easily as they would entail extraordinarily large negative outcomes.

Another member supported the above member's theoretical analysis. The member remarked that arguments were often put forward overseas for the adoption of such drastic measures despite their large negative consequences, based on the standpoint that Japan was experiencing serious deflation. The member commented that, in fact, Japan's economy had stopped deteriorating and prices were level, and therefore the situation did not call for such risky measures. The member added that it was important that the Bank endeavor to explain the current economic situation of Japan to people abroad so that it was correctly understood.

Members also discussed the relation between market expectations and monetary policy in view of the possibility that the market already expected the Bank to take further policy action at the meeting.

One member remarked that the exchange rate of 108 yen against the U.S. dollar, the Nikkei 225 Stock Average of 17,000 yen, and the current level of the Dow Jones Industrial Average were all at a critical point, and therefore there was a high risk of stock prices plunging or the yen surging if the Board did not decide on new action at the meeting.

Regarding this opinion, some members commented that the risk could not be denied that the market might react substantially depending on the decision made at the meeting. At the same time, however, the members remarked that, if the Bank took action that lacked a theoretical background or would produce no definite policy effects, simply to take advantage of the market's expectations, the outcome, if any, would only be temporary. In other words, even if the yen's appreciation was stopped temporarily, upward pressure on the yen would rekindle sooner or later unless the market's perspective of the outlook for the world economy changed. The members emphasized that, in that case, the same measure could not be used twice, and the credibility of all the Bank's policies would be lost: the consequences would be very harmful.

One of the above members commented that the current circumstances of money market operations and the fact that sterilized and unsterilized intervention made no difference under the zero interest rate policy seemed to have become widely understood by market participants. Therefore, such monetary policy measures could not be expected to have any effect, even temporarily.

On account of the above discussion, many members concluded that it was inappropriate for a central bank to take advantage of the market's perception and implement a measure that was not accountable with regard to its purpose and effects. Such conduct would in the end spoil the Bank's relations with the market.

Members also discussed the market's assumption that there was discrepancy between the stance of the government and the Bank on the yen's exchange rate.

On this point, many members presented the opinion that the government and the Bank shared the view that exchange rate stability reflecting economic fundamentals was desirable, and that excessive fluctuation of the rate could adversely affect the economy and prices.

One of the members stated that it had been a very displeasing phenomenon that, following the meeting between the Governor and the Minister of Finance on September 16, the media had made it seem as if deployment of a further monetary easing had already been decided by the Bank.

One member warned that the decision at the meeting could bring about serious consequences: it might stir up the market's speculation that the government and the Bank were locked in disagreement over foreign exchange policy. The member commented that the Bank's foreign exchange policy and that of the government required further coordination in order to be in line with Article 4 of the Bank of Japan Law of 1997--that the "Bank of Japan shall always maintain close contact with the government and exchange views sufficiently, so that its currency and monetary control and the basic stance of the government's economic policy shall be mutually harmonious"--and market participants also seemed to hold the same view. This member also elaborated on the relationship between monetary policy and fiscal policy, saying that implementation of monetary and fiscal policies should be synchronized to multiply their effects but monetary policy so far seemed to have been implemented after the effects of fiscal policy had played themselves out--which was too late.

Regarding the above argument, some members noted that the Bank's zero interest rate policy was consistent with the government's foreign exchange policy in the sense that the Bank had reduced interest rates to the lowest possible level and that it had increased liquidity in yen funds by providing excess funds of 1 trillion yen in the market daily and thereby creating a much greater effect than unsterilized intervention. They emphasized that promoting the market's understanding on this point was very important.

One of the members remarked that the attendance of government representatives at Monetary Policy Meetings with a right to make proposals for monetary policy reflected the spirit of Article 4 of the Bank of Japan Law--the Bank was maintaining close contact with the government and exchanging views sufficiently. Furthermore, according to the framework for monetary policy decision-making under the Bank of Japan Law of 1997, the Board was to decide policy following sufficient exchange of views between the government and the Bank, not only at the highest level at Monetary Policy Meetings, but at various levels, and this view had been widely shared at the time of the revision of the law. And as for the relationship between fiscal policy and monetary policy, the member stated that monetary policy should be implemented based on the prospects for the economy as a whole and prices, taking into account the anticipated effects of fiscal policy.

In addition, a few members remarked that the zero interest rate policy was the most effective measure it could possibly take. On these grounds, some members, including the above members, expressed the view that the zero interest rate policy had supported economic activity along with fiscal policy, by easing corporate financing conditions, underpinning confidence, and positively influencing asset prices. They considered that these positive effects continued.

Given the above arguments, members exchanged views on possible additional policy measures. Some members expressed the view that the Bank's commitment to continue the zero interest rate policy--an extraordinary policy--despite various arguments on the negative outcomes could contribute greatly to a recovery of the economy. One of them commented that this commitment had actually led to lower interest rates on term instruments, a reflection of the continued permeation of the effects of monetary easing.

A different member remarked that the Bank should be prepared for changes in the economic situation even though there was little room for an additional monetary easing. As a possible measure, the member suggested the enhancement of money market operations to ensure the further permeation of the effects of the zero interest rate policy. The member also stated that it was necessary to continue investigating possible measures including the introduction of new money market operations. Another member added that there still remained such policy options, and therefore, if problems emerged that could be resolved by improving money market operations, they should be solved promptly and flexibly.

One member added that it was at present necessary to give an appropriate explanation to market participants and to the general public of the zero interest rate policy and the permeation of its effects to promote wider understanding on this issue--in other words, to enhance accountability. The member continued that the Bank should elaborate on the policy at international conferences, such as at the G-7 meeting that was to be held in a few days. In addition, the Bank should explicitly state its concern about the negative impact of the yen's surge on the economy, and its intention to flexibly provide ample funds in the market taking into due account the effects of exchange rate fluctuation on the economy and prices.

At the end of the discussions, the majority of members agreed that, on the basis of their assessment of the economic and financial situation including the effects of the yen's appreciation, the Bank should continue the current zero interest rate policy in line with its stance to maintain its extremely easy monetary policy until deflationary concern was dispelled.

However, one member claimed that the Bank adopt quantitative easing accompanied by an inflation target.

The member gave the following reasons. First, recent developments in the foreign exchange rate and stock prices showed that the effects of the zero interest rate policy had played themselves out, and it was necessary to shift to monetary base targeting accompanied by consumer price index (CPI) targeting. Second, the yen's appreciation had been abrupt, and the economy would be seriously hit if the yen exceeded 100 yen against the U.S. dollar. Third, the Bank should clearly present the stance that it was giving due consideration to developments in the foreign exchange rate. Fourth, the growth of the monetary base was still sluggish and therefore further quantitative expansion was necessary. And fifth, monetary base targeting with a CPI target would be an effective countermeasure against various pressures on the Bank such as that for the Bank's underwriting of JGBs and increasing of JGB outright purchasing operations. This member further added that there was no room for the overnight call rate to decline any further, and in this situation the relationship between interest rates and the quantity of money no longer applied. However, there was still some room for other interest rates, such as those on term instruments, to decline, and this could be induced through quantitative easing.

Regarding this argument, some members questioned whether it was feasible to control the monetary base and whether there was still some room for interest rates to decline.

A few members noted that, in order to set and achieve a target for the monetary base, it was a prerequisite that the amount of banks' excess reserves could be controlled. However, in reality, it was not at all feasible to control excess reserves, and this was evident from experiences in the Bank's money market operations during the past few months, when excess reserves decreased despite the Bank's provision of ample funds in the market.

One of them explained this point in more detail. It was rational that banks were trying to hold minimum excess reserves given the permeation of the effects of the monetary easing and abatement of anxiety about the availability of liquidity. Since such rational behavior of banks could not be changed simply by setting a quantitative target, excess reserves could not be increased by means of such targeting.

Further, some members expressed the view that, if the Bank were to set a quantitative target, this would inevitably lead to the underwriting of JGBs or their outright purchases, both of which involved extremely large risks.

In response to this, the member who advocated the adoption of quantitative easing accompanied by an inflation target stated that there were various operational tools such as "repo" operations. Although the member acknowledged that the excess funds provided by the Bank were accumulating at tanshi companies, the member claimed that quantitative easing was worth a try. As for its consequences, the member added that the resulting excessive liquidity might flow into the stock market, having positive effects on stock prices.

VI.Remarks by Government Representatives

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

(1) Japan's economy seemed to have passed the worst point, but private demand remained weak and the employment situation was severe. Under these circumstances, the government judged that it was necessary to utilize the reserve budget allocated to additional public works to ensure an economic recovery, and it was taking measures so that a Cabinet decision would be made by the end of September. The government had already promised the compilation of a second supplementary budget for fiscal 1999 in the form of a so-called 15-month budget, and it was expected that the new Cabinet would take the necessary steps paying close attention to economic developments. The government was determined to continue to do its best to lay the foundations for a recovery in Japan's economy.

(2) With regard to the financial markets, a surge in the yen against the U.S. dollar, by depressing consumer and business sentiment and squeezing corporate profits, could have a serious impact on Japan's economy, which had at last escaped from the worst and had started to show a recovery. Thus, the government would like to request the Bank to give due consideration to this risk and take appropriate monetary policy measures.

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

(1) Economic conditions were improving somewhat reflecting the permeation of the effects of various policy measures, although the recovery in private demand was weak and the economy was still in a severe situation. A surge in the yen at this point when the economic situation was persistently severe could have a detrimental impact on the economy and was thus undesirable. The government therefore considered that appropriate measures should be taken paying careful attention to the trends in the foreign exchange market.

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

VII. Votes

The views of many members of the economic and financial situation were summarized as follows. First, Japan's economy had stopped deteriorating. Second, the negative impact of the rapid appreciation of the yen warranted close attention, but positive developments were observed in external demand and production. Third, the effects of monetary easing had further permeated the markets. Fourth, clear signs of a self-sustained recovery in private demand had not yet been observed. Fifth, downward pressure on prices remained. And sixth, given the above points, deflationary concern had not been dispelled yet. Thus, the basic judgment on the economic and financial situation remained almost unchanged from the previous meeting.

Based on this understanding, the majority of members considered that it was appropriate to maintain the zero interest rate policy 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 adopt an apparent quantitative targeting accompanied by a target for the growth rate of the CPI.

As a result, two policy proposals were put to the vote.

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 September 16 through October 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 will need to increase reserves by about 3 trillion yen by the end of March 2000 through market operations if it is assumed that the current annual growth in banknotes, which is about 6 percent, will 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 1).

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

The Bank of Japan will provide more ample funds and encourage the uncollateralized overnight call rate to move as low as possible. To avoid excessive volatility in the short-term financial markets, the Bank of Japan will, by paying due consideration to maintaining market function, initially^(Note) aim to guide the above call rate to move around 0.15%, and subsequently induce further decline in view of the market developments.

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

Votes for the proposal: Mr. M. Hayami, Mr. S. Fujiwara, Mr. Y. Yamaguchi, Mr. Y. Gotoh, Mr. S. Taketomi, Mr. T. Miki, and Mr. K. Ueda.

Votes against the proposal: Mr. N. Nakahara and Ms. E. Shinotsuka.

Mr. Nakahara voted against the chairman's proposal on the following grounds. First, the approval of the chairman's proposal could lead to a further appreciation of the yen and through this a deterioration in business sentiment, considering that the market suspected discord between the Ministry of Finance and the Bank over foreign exchange and fiscal policies. Second, the policy decision would lessen the possibility of a coordinated foreign exchange intervention the government was seeking. Third, the expression "until deflationary concern was dispelled" was ambiguous, and it was necessary to make a policy shift to CPI targeting with a specific numerical target. Fourth, the exchange rate of the yen and the Dow Jones Industrial Average were both at critical levels according to a technical analysis. Therefore, if the Bank did not take an additional monetary easing measure, the resulting disappointment among market participants could trigger a sharp rise in the yen and a plunge in the Dow. And fifth, maintaining the status quo would mean that the Bank was not communicating well with the market, and this could very likely have undesirable consequences.

Ms. Shinotsuka dissented for the following reasons. First, the zero interest rate policy, an ultimate easing measure, had positively influenced the economy as seen in the contraction of risk premiums. Recently, however, its limits were becoming apparent with the excess funds supplied by the Bank accumulating at tanshi companies. And second, to make room for flexible policy responses in the future, the Bank should continue to seek an appropriate time and way of terminating the zero interest rate policy.

On the basis of the discussions at the meeting, the chairman ordered the Bank's staff to deliberate the enhancement of money market operations tools to assure further permeation of the effects of the zero interest rate policy.

VIII. The Release of a Statement on the Current Monetary Policy

Some members emphasized the importance of promoting a wider understanding of the Bank's monetary policy. This was based on the following observation: (1) market participants were speculating on the Bank's monetary policy, and especially this meeting was attracting a lot of attention; and (2) the Bank's policy decision-making process and the degree of monetary easing under the zero interest rate policy were not fully understood. On these grounds, the members suggested the release of a statement on the current monetary policy, although the policy was not changed, followed by a press conference by the chairman.

In response to this suggestion, the chairman ordered the staff to prepare a draft of the statement. Due to the preparation of the draft, the meeting was adjourned from 2:59 p.m. to 3:27 p.m.

Following the members' discussion of the draft and completion of the statement, "On the Current Monetary Policy" (Attachment 2), the publication of the statement was put to the vote.

Votes for the publication: Mr. M. Hayami, Mr. S. Fujiwara, Mr. Y. Yamaguchi, Mr. Y. Gotoh, Mr. S. Taketomi, Mr. T. Miki, Ms. E. Shinotsuka, and Mr. K. Ueda.

Votes against the publication: Mr. N. Nakahara.

Mr. Nakahara dissented mainly for two reasons. First, there was no reason to release a statement just on that day, and the chairman's press conference would be enough. And second, presenting many issues in the statement would provoke unnecessary debate.

By majority vote, the immediate release of the statement, "On the Current Monetary Policy," was decided.

IX. Approval of the Scheduled Dates of Monetary Policy Meetings in October 1999-March 2000

At the end of the meeting, members approved the dates of Monetary Policy Meetings in October 1999-March 2000, for immediate release (Attachment 3).

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Attachment 1

For immediate release

September 21, 1999
Bank of Japan

The Bank today held a Monetary Policy Meeting, a regular meeting of the Policy Board on monetary policy.

By majority vote, the Policy Board decided to leave monetary policy unchanged.

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

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

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

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

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Attachment 2

September 21, 1999
Bank of Japan

On the Current Monetary Policy

(1) At the Monetary Policy Meeting held today, the Bank of Japan decided to continue the zero interest rate policy.

(2) The contents of discussions during Monetary Policy Meetings are usually published approximately one month after each Meeting as "Minutes." However, in view of the fact that the conduct of monetary policy has attracted unusually high attention, both domestically and overseas, against the backdrop of such developments as the rapid and large fluctuation in the foreign exchange rate, we considered it appropriate to explain the main points of contention in today's discussion immediately after the meeting.

(Zero interest rate policy and quantitative easing)

(3) Since the launch of the zero interest rate policy in February, the Bank has continued to provide the financial market with ample funds to guide the overnight call rate as low as possible, currently at virtually zero percent, as exhibited by the following:

• To keep the call rate at virtually zero percent in a stable manner, the Bank is continuing to provide funds in the amount of some 1 trillion yen more than the required reserve (on average about 4 trillion yen daily). However, since sentiment has permeated among financial institutions that they can always obtain almost cost-free funds, the incentive to hold funds has diminished. As a result, 70 to 80 percent of excess funds provided by the Bank is accumulating at such institutions as Tanshi companies (fund brokers).
• Even when the Bank tries to provide almost cost-free funds through its open market operations, there are cases where actual subscription by financial institutions falls short of the announced amount.

(Effects of providing additional funds)

(4) Recently we have heard some arguments that the Bank should provide more ample funds in order to stabilize the foreign exchange rate. However, given the current financial market situations, any additional injection of liquidity would only result in further accumulation of excess funds at institutions such as Tanshi companies. In such a situation, it is difficult to envisage any visible effects on interest rates, the behavior of financial institutions and non-financial institutions, and asset prices including the foreign exchange rate.

(5) There is a view that the Bank should take advantage of the market's perception that "additional fund provision" would work. However, material effects are not likely expected and at best temporary, if any. Furthermore, we as a central bank will not take a measure that is not accountable with regard to its purpose and effects.

(Foreign exchange rate and monetary policy)

(6) The Bank believes it desirable that the foreign exchange rate should move in a stable fashion reflecting economic fundamentals. Excessive volatility is very likely to have an adverse impact on the economy and prices. The recent appreciation of the yen has been too rapid and its effects on corporate profits, among other things, is a matter of concern. We believe this view is shared with the government.

(7) The foreign exchange rate in itself is not a direct objective of monetary policy. One of the precious lessons we learned from the experience of policy operations during the bubble period is that, monetary policy operations linked with control of the foreign exchange rate runs a risk of leading to erroneous policy decisions. Having said this, it does not mean that monetary policy is pursued without any consideration to the development of the foreign exchange rate. The Bank considers it important to carefully monitor the development of the foreign exchange rate from the viewpoint of how it affects the economy and prices.

(8) Since the recent appreciation of the yen has been rapid, we should carefully monitor its adverse impact on corporate profits, exports, and the overall economy. At the same time, however, we are seeing some signs of positive developments such as emerging effects of various policy measures already taken and the recovery of Asian economies. We believe that we are now at a stage to carefully focus attention on what effects these various factors exert on the economy.

(9) In relation to the foreign exchange rate policy, we have heard arguments in favor of non-sterilized intervention. In the reserve market, however, there are various flows of funds such as currency in circulation and Treasury funds other than those resulting from the intervention. The Bank conducts its daily market operations taking into account all the money flows, in order to create ample reserves to such an extent as described above. This strong commitment of fund provision is consistent with the government's current foreign exchange rate policy.

(Monetary policy for the periods ahead)

(10) The Bank of Japan has been pursuing an unprecedented accommodative monetary policy and is explicitly committed to continue this policy until deflationary concerns subside. The Bank views the current state of the Japanese economy as having stopped deteriorating with some bright signs, though a clear and sustainable recovery of private demand has yet to be seen. In pursuing the zero interest rate policy, we need to carefully examine its adverse side-effects, but deem it important to support the economic recovery by continuing easy monetary policy for the periods ahead.

(11) In the past few days, the market has substantially fluctuated by speculations on monetary policy. What should be clear is that the conduct of monetary policy is exclusively decided by majority vote at the Monetary Policy Meeting, a regular meeting of the Policy Board. It is never the case that our policy is determined in advance or in consultation with outside bodies. We would like to emphasize this point. The Bank will continuously endeavor to explain the policy decision-making framework under the new Bank of Japan Law and the thinking behind the conduct of monetary policy.

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Attachment 3

September 21, 1999
Bank of Japan

Scheduled Dates of Monetary Policy Meetings in October 1999 - March 2000