Minutes of the Monetary Policy Meeting

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

December 22, 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, November 12, 1999, from 9:00 a.m. to 12:18 p.m., and from 1:01 p.m. to 2:47 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. 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. 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. 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 December 17, 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 October 13, 1999

The Policy Board approved unanimously the minutes of the Monetary Policy Meeting, the "Green Paper," of October 13, 1999 for release on November 17, 1999.

II. Summary of Staff Reports on Economic and Financial Developments²

A. Money Market Operations in the Intermeeting Period

Market operations in the period since the previous meeting on October 27 were conducted in accordance with the guideline determined at that meeting.³

Throughout this period, the money market was extremely stable. The Bank announced a "morning projection for reserves" of an excess of 1 trillion yen and the overnight call rate moved stably at 0.02-0.03 percent.⁴ Reflecting the continued permeation of the effects of monetary easing in the market, financial institutions strengthened their stance of not holding excess reserves. As a result, excess reserves were decreasing, and the funds that the Bank provided were accumulating more conspicuously than before in the accounts at the Bank held by tanshi companies (money market broker-cum-dealers).

Meanwhile, the Bank had provided 18.2 trillion yen of year-end funds through operations on 20 consecutive business days. This was about twice the amount at the same time the previous year.

Despite the Bank's provision of massive funds, however, interbank interest rates on term instruments maturing beyond the year-end increased. This was because lenders held back from investing funds over the year-end in the money market.

Under these circumstances, the following interest arbitrage transactions were observed in the market.

First, institutional investors such as life insurance companies procured low-interest funds through repo transactions utilizing Japanese government bonds (JGBs) with tanshi companies--which raised funds from the Bank's repo operations--and invested the funds in private banks' certificates of deposit (CDs) and time deposits.

Second, private firms with high credit standing procured low-interest funds by issuing commercial paper (CP) given the fall in CP issuance cost, and also invested the funds in private banks' CDs and time deposits.

As these activities showed, firms' financing conditions for year-end funds were not particularly tight.

2Reports were made based on information available at the time of the meeting.
3The guideline was as follows:
The Bank of Japan will flexibly provide ample funds and encourage the uncollateralized overnight call rate to move as low as possible.
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.

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

1. Developments in foreign exchange markets

The yen fluctuated within a narrow range against the U.S. dollar, generally in the 104-107 yen range. The market remained focused on developments in the U.S. financial markets and economic activity there.

The euro, which had been rising against the U.S. dollar, declined recently. One factor behind this was the market's perception that the European Central Bank (ECB) was not likely to take further action of tightening in the near future since it had just raised its repo rate on November 4.

2. Overseas economic and financial developments

Stock prices were increasing conspicuously in overseas markets.

In the United States, Nasdaq continued to mark new historical highs given rises in high-tech stocks.

In Europe, long-term interest rates had been declining reflecting the market's view that the raising of the repo rate by the ECB on November 4 would prevent future inflation. Accordingly, stock prices were increasing on the whole, and CAC 40 in France had posted a new record high.

Stock prices in emerging economies were also increasing, reflecting the firmness in U.S. stock prices and upgrading of sovereign bond ratings for countries including Korea and Malaysia.

The U.S. economy continued to expand led by domestic demand. While wages increased conspicuously, producer and consumer prices were relatively stable. In this situation, the view was becoming more prevalent in the market that the inflationary pressure arising from the tightening of the labor market was being buffered by a rise in productivity.

In the euro area, economic recovery was accelerating moderately, with an increase in exports leading to an increase in production. Under these circumstances, the ECB increased its repo rate on November 4.

In NIEs and ASEAN countries, economic recovery was becoming increasingly clear. In these countries, increased exports mainly of goods related to information technology (IT) resulted in an increase in production, and this was gradually starting to have a favorable effect on private consumption through an improvement in income conditions. In Korea, especially, domestic demand was robust.

C. Economic and Financial Developments in Japan

1. Economic developments

Business fixed investment continued to be on a downward trend, although the pace of decline was moderating. Private consumption continued to show mixed developments. Housing investment had peaked out, and public investment seemed to have stopped increasing. Meanwhile, net exports were increasing due mainly to substantial growth in exports.

Reflecting these conditions in final demand and progress in inventory adjustment, production was increasing. It was highly likely that production would rise in the October-December quarter for the second consecutive quarter. Against the background of the upturn in production, some indicators suggested that the deterioration in employment conditions was coming to a halt. However, firms' stance of restraining personnel expenses remained unchanged, and employment and income conditions on the whole continued to be severe.

As described above, Japan's economy, which had stopped deteriorating, was turning and starting to improve with exports and production increasing. However, clear signs of self-sustained recovery in private demand had not been observed yet.

Domestic wholesale prices remained flat, partly due to the effect of the previous rise in the import price of crude oil and progress in inventory adjustment. Consumer prices also remained close to the level of the previous year.

As for the outlook, it was highly likely that the upturn in exports would continue for some time despite the appreciation of the yen, boosted by the strengthening recovery in overseas economies, especially East Asia. The pace of decline in business fixed investment as a whole was expected to moderate further, since investment in manufacturing industry seemed to have stopped declining. Regarding public investment, although construction was likely to decrease in early 2000, public works orders were expected to increase again by the end of the fiscal year due to the implementation of the Policy Measures for Economic Rebirth. In these circumstances, no large drop in final demand was expected in the near future, unless some large shock, such as a drastic change in U.S. economic conditions, occurred.

However, self-sustained recovery in private demand was not yet foreseeable. Although corporate profits had been improving, it was still difficult to predict when business fixed investment would start to increase clearly, since many firms were still focusing on restructuring their balance sheets. The impact of the appreciation of the yen on corporate profits also continued to require close monitoring.

Prices were expected to remain more or less flat in the near future, reflecting the rise in crude oil prices and the halt in the fall in domestic commodity prices due to the progress in inventory adjustment. However, downside risk to prices remained, since clear signs of self-sustained recovery in private demand had not been observed yet.

2. Financial developments

In the money market, the overnight call rate remained virtually zero. Interest rates on term instruments with relatively short maturity continued to be at historically low levels, but those on term instruments maturing beyond the year-end were increasing reflecting concerns about the Year 2000 problem.

Yields on Japanese government bonds (JGBs) rose to around 1.9 percent in late October against the background of concerns about a deterioration in the supply and demand conditions for JGBs that emerged along with expectations of a supplementary budget. However, they declined afterward as the market became convinced that investors were still very willing to purchase JGBs, and the yields were at 1.7-1.8 percent again. The Nikkei 225 Stock Average fell slightly in October reflecting a fall in the U.S. stock market, but they turned upward thereafter in response to the rebound in U.S. stock prices and marked 18,567 yen, the highest level since the beginning of 1999, on November 10. Stock price developments varied by industry, however; telecommunications, electrical machinery, and financial services rose while construction and real estate fell.

The Japan premium on short-term contracts remained very close to zero. The narrowing of the yield spread between JGBs and corporate bonds became conspicuous again, and this suggested that market participants had become more willing than before to take credit risks. It could also be said that the contraction of the yield spread was attributable to a decline in firms' credit risks given the improvement in the economic conditions and progress in corporate restructuring.

With regard to corporate financing, the cautious lending stance of private banks remained basically unchanged. However, banks seemed to have become more active in extending loans in the latter half of the fiscal year compared to the first half. This was due to (1) the easing of the constraint on lending caused by the severe fund-raising conditions for banks and their insufficient capital bases, and (2) banks' efforts to increase loans in accordance with their plans for restoring sound management submitted to the Financial Reconstruction Commission (FRC).

However, credit demand for economic activities remained weak, and firms continued to reduce debts using their accumulated on-hand liquidity. As a result, credit demand in the private sector continued to be dull, and private bank lending basically remained sluggish. Meanwhile, issuance of commercial paper (CP) was increasing in view of the approaching year-end.

The year-to-year growth rate of money stock (M2+CDs) declined slightly reflecting the sluggish credit demand. Meanwhile, the growth rate of the monetary base from a year earlier had been between 5.5 and 7.0 percent.

With business fixed investment generally decreasing and production increasing, firms were in a good position to restructure their balance sheets, as they enjoyed improved cash flow while reducing expenditure. This could be causing credit demand and growth in money stock to remain sluggish although the economy was turning and starting to improve.

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

A. The Current Economic Situation

On the current economic situation, many members shared the view that the increase in exports and the strong demand for IT-related goods had led to an increase in production, and this was in turn improving corporate profits and bringing deterioration in employment and income conditions to a halt. Some members remarked that Japan's economy had moved one step forward compared to the previous month. One of these members commented that the economy remained flat with positive and negative factors intertwined, but all the factors were improving gradually.

However, many members expressed the view that clear indications of recovery were not yet observed in private demand, such as private consumption and business fixed investment, although favorable signs had started to appear. Therefore, many members judged that the economy, which had stopped deteriorating, was turning to improve with exports and production increasing, but clear signs of a self-sustained recovery in private demand had not been observed yet.

Some members commented that, although public and housing investment had basically peaked out, their effects of underpinning demand remained.

Many members shared the view that exports had increased more conspicuously than before, reflecting the recovery of economies overseas, such as those of Asia.

Some members pointed out that, so far, the positive effects of the economic recovery overseas had outweighed the negative impact of the yen's appreciation. One of these members noted that, while the yen had appreciated from around June or July until recently, various organizations' growth projections for the world economy had been revised significantly upward. On this basis, the member considered that the impact of the yen's appreciation had been cancelled out by worldwide economic recovery. Another member commented that, since the slowdown in Japan's economy in 1997 was significantly aggravated by the turmoil in other Asian economies, it was probable that their current recovery would have substantial positive effects on Japan's economy.

Many members noted that production was increasing conspicuously reflecting the increase in exports and the firm demand for IT-related goods, as well as progress in inventory adjustment. These members generally shared the view that the increase in production had gradually started to positively influence corporate profits as well as employment and income conditions. But at the same time, members generally agreed that such improvements in the income conditions of firms and households had not led to an appreciable increase in business fixed investment or private consumption, and therefore a self-sustained recovery in private demand had not been confirmed.

In relation to business fixed investment, some members pointed out the following favorable developments. First, corporate profits were improving reflecting the increase in production and progress in corporate restructuring, and second, indicators showed that business fixed investment in manufacturing industry had nearly stopped declining. At the same time, however, many members were of the opinion that business fixed investment on the whole continued to be on a downward trend, although the pace of its decline had slowed.

With regard to private consumption, many members remarked that the increase in production was improving households' income conditions through a rise in overtime payments. Further, one of these members pointed out the following favorable developments in the labor market. First, the number of employees seemed to have stopped decreasing. Second, the ratio of job offers to applications had started to increase, and the ratio of new job offers to new applications had improved mainly in service industry. And third, the unemployment rate had declined for two consecutive months. Another member remarked that, if these trends in employment and income conditions continued, it would pave the way for a recovery in private consumption.

However, many members expressed the view that indicators for private consumption overall still showed mixed developments. Some members remarked that indicators related to private consumption in the first half of 1999 were relatively strong considering the severe income conditions, but some indicators for the July-September quarter were relatively weak. Against this background, one member remarked that the improvement in private consumption was currently at a pause.

Meanwhile, one member assessed the economic situation based on the indexes for business conditions. This member commented that the diffusion index and the composite index both suggested a strong possibility that the economy had bottomed out in April or May and had been recovering since then. However, the member also stated that the momentum of the recovery was still very weak and, although a moderate recovery was likely to continue through the first half of 2000, the prospects thereafter were highly uncertain.

As for prices, it was the view of many members that they had generally been flat and relatively stable.

One member raised a question of how one should consider the present situation where prices remained flat although the output gap was still large.

Regarding this issue, one member expressed the opinion that one could not relate the rate of price increase so closely to the size of output gap. This member commented that, while the overall output gap was still large, it had narrowed marginally reflecting the increase in exports, and this could be contributing to the stability of prices.

Further, another member described the background of the stability in prices from the viewpoint of firms. The member remarked that the decline in product prices attributable to a deterioration in the supply and demand balance in the short run had stopped, reflecting the completion of inventory adjustment and the increase in exports. The member added that, however, it was still difficult for firms to raise product prices given the persistently weak domestic private demand.

Meanwhile, one member commented on crude oil prices in relation to price developments. The member pointed out that stocks of crude oil were decreasing rapidly reflecting the embargo on exports from Iraq, and was expected to fall significantly below the optimal level in the October-December quarter of 1999. The member remarked that crude oil prices were likely to increase further and this could disturb the world economy.

B. Financial Developments

On the financial front, many members judged that (1) the financial markets had been generally stable since the previous meeting, and (2) the financial environment had continued to improve. To illustrate these two points, some members pointed out that long-term interest rates and foreign exchange rates had been relatively stable, stock prices were firm, and the credit spread (the difference between yields on private bonds and those on JGBs) was contracting. One of these members stated that the overall financial environment was supportive of a moderate economic recovery.

Some members noted the following conspicuous movements in the recent stock market: (1) Japanese stock prices continued to be sensitive to U.S. stock prices; and (2) there were distinct differences between industries. One of these members commented that investors were eager to purchase in world markets, including the Japanese, U.S., and European markets, the stocks of globally active firms that were growing amid the worldwide trend of advancing information technology. The member stated that this was one of the factors causing the linking of movements between Japanese, U.S., and European stock prices and the sharpening contrast between industries.

Another member stressed the negative side of the widening difference between industries. The member pointed out that the rise in one IT-related stock, a typical "new economy" stock, accounted for about half the rise in the Nikkei 225 Stock Average over the past month, and the number of falling stocks far exceeded those rising.

Meanwhile, comments were also made on long-term interest rates.

Some members remarked that long-term interest rates were relatively stable, but they also pointed out that upward pressure would likely be placed on them when market participants started to perceive an economic recovery.

On this point, another member stated that a rise in long-term interest rates would not be a risk to economic recovery if it was in line with the improvement in the economic fundamentals. However, the member added that a surge in long-term interest rates diverging from the fundamentals could hamper an economic recovery. The member therefore suggested that, if long-term interest rates surged diverging from the fundamentals, the Bank should provide ample funds in a timely and flexible manner so that the overnight call rate would firmly anchor long-term interest rates.

Regarding this comment, a few other members remarked that it was not appropriate for the central bank to try to directly control long-term interest rates, and engendering expectations in the market that the Bank could easily manipulate long-term interest rates would threaten the stability and healthy functioning of the markets. These members expressed the view that (1) a rise in long-term interest rates accompanying an economic recovery should basically be accepted, together with the small fluctuations often observed in market rates, and (2) in order to avoid long-term interest rates overshooting, it was important to analyze the economic conditions that formed the basis for movements in the rates and give adequate explanation to the markets, and thereby stabilize the market's expectations and create an environment where the rates could move in line with the economic fundamentals.

Regarding developments in the yen's exchange rate, one member pointed out that the yen-U.S. dollar rate seemed to have stabilized as concern about inflationary pressures in the United States abated. The member stated that this suggested that the recent appreciation of the yen could be regarded rather as a depreciation of the U.S. dollar.

Some members noted that firms' response was generally calm compared with past phases of yen appreciation. One of these members remarked that stock prices had been firm while the yen had been at around 105 yen to the U.S. dollar, and it seemed that the market did not consider this level to be a great hindrance to an economic recovery. Another member, however, commented that the maximum acceptable level of the exchange rate for many firms seemed to be in the range of 105-115 yen--that is, 110 yen plus or minus 5 yen--against the U.S. dollar, and if the yen appreciated dramatically beyond this range, it would pose a risk to economic recovery. This member added that, if such an appreciation occurred, market intervention should be carried out. Another member stated that the magnitude of the impact of yen appreciation on firms was very different when the rate was at around 120 yen against the U.S. dollar and when it was stronger than 108 yen.

On the basis of these discussions, members shared the view that careful attention was still required on developments in foreign exchange rates and their effects on the economy.

Regarding corporate financing, one member stated that firms' concerns about fund-raising had abated significantly under the zero interest rate policy. In addition, this member remarked that sufficient funds for economic activity were being provided, on the grounds that (1) banks appeared to be gradually shifting their focus from securing lending spreads to expanding the volume of loans, and (2) the conditions for corporate bond issuance were favorable. Furthermore, the member noted that low interest rates were supporting corporate profits through the reduction of interest payments.

At the same time, this member expressed the view that demand for funds remained weak due to firms' restructuring and their efforts to increase capital efficiency. The member, however, pointed out that demand for funds for repairing plant and equipment had started to appear reflecting the increase in production.

C. The Economic Outlook

On the economic outlook, many members considered that the current improvements in economic conditions would gradually promote positive developments, but generally agreed that deflationary concern had not been dispelled yet.

Members discussed a number of factors that could influence the economy.

Some members referred to the government's Policy Measures for Economic Rebirth. They commented that this package was likely to underpin demand through the first half of 2000, and that, therefore, the previously anticipated risk of a drop in public demand--or in other words, the risk of a sizable fiscal drag--after the turn of the year had lessened significantly.

In relation to exports, many members remarked on economic developments abroad, especially those in the United States.

Some members remarked that more people had come to share the view that inflationary pressure in the United States was being absorbed to a great extent by increasing productivity, and noninflationary expansion therefore would likely continue for the immediate future. One of these members remarked, based on the member's interviews with some corporate managers and analysts in the United States, that the view that the U.S. economy was in a phase of "new economy"--where advances in information technology, deregulation, and corporate restructuring were boosting productivity--was becoming popular once again. On the basis of these discussions, many members held the opinion that overseas economies would continue to recover in the immediate future and Japan's exports would most likely continue to expand.

One member explained that, although the U.S. unemployment rate was at a historically low level, prices were not rising for the following reasons. First, the capacity utilization of manufacturers was about 2 percentage points lower than the past average. And second, a high profit margin seemed to be buffering the impact of a rise in wages.

Some members pointed out several risks associated with the U.S. economy such as its expanding external deficit and low savings ratio. A few of these members remarked that, although it was not appropriate to assume as the most likely scenario in deciding Japan's monetary policy that these imbalances would necessitate economic adjustments, the possibility should be taken into account as a risk.

Members also discussed how the ongoing improvement in Japan's economy could influence the outlook.

A few members remarked that factors suggesting brighter prospects were starting to appear. They commented that a virtuous circle had begun to operate, with an increase in production leading to growth in corporate profits and household income. These members, however, noted that the possibility could not be ruled out that this positive cycle might fail to gain strong momentum due to structural problems and corporate restructuring. They therefore considered that there were not sufficient grounds yet to alter their judgment on the prospects for private demand.

Based on the above discussions, many members concluded that, although the economy was turning and starting to improve, the likelihood of an immediate self-sustained recovery in private demand was still remote.

Members held in-depth discussions concerning the outlook for private consumption and business fixed investment.

Many members held the opinion that the halt in the deterioration in employment and income conditions was lessening the risk of a decline in private consumption. However, some members also commented that it was still difficult to foresee a clear recovery in private consumption, citing the following reasons. First, many firms were still in the process of restructuring, and winter bonuses in general were expected to be smaller than the previous year. In view of this, it was uncertain whether there would be a clear improvement in income conditions in the future. Second, the rise in the propensity to consume, which had underpinned private consumption in the first half of 1999, was unlikely to continue.

A different member expressed a slightly more cautious view on the prospects for consumption. Specifically, the member pointed out that (1) according to the Family Income and Expenditure Survey, the self-employed, whose activity had underpinned consumption in the first half of fiscal 1999, seemed to have become less willing to spend, and (2) the share of IT-related expenditure--that is, telecommunications fees, and purchase of communications equipment, personal computers, and word processors--in total consumption in Japan was only about half that in the United States.

A few members also commented on several institutional changes that could provide the foundations for a recovery in private consumption.

One member remarked that many firms were trying to cut back personnel expenses by increasing part-timers and decreasing full-time employees, and thereby to decrease the labor share. In view of this situation, the member pointed out that, to foster recovery in consumption, it was important to (1) enhance the mobility of labor by, for example, providing skills training and making pensions portable, and (2) improve working conditions for part-timers. Another member noted the importance of removing anxiety about the future among consumers by reforming the pension and social security systems.

As for business fixed investment, many members remarked that (1) the recovery trend in corporate profits was a positive factor, and (2) leading indicators showed that the downtrend was slowing as a whole and was coming to a halt in manufacturing industry.

One of these members stated that a recovery in business fixed investment was gradually coming into prospect, citing the following positive factors. First, such indicators as the current ratio of business fixed investment to GDP suggested that the level of fixed investment was already quite low, and therefore, a further cut in business fixed investment was unlikely. Second, various business surveys showed that the number of firms considering that they still had excess capacity was decreasing gradually. And third, business sentiment was improving.

Many members expressed a view different from the above, that a self-sustained recovery in business fixed investment was still not foreseeable. As grounds for this, the members noted the following. First, many firms were still proceeding with balance-sheet adjustment--that is, reduction of excess capacity and debt. Second, land prices continued to decline. And third, the private sector's demand for funds remained sluggish.

One member expressed a slightly more cautious view that business fixed investment would only hit bottom in the second half of fiscal 2000 at the earliest. Specifically, this member pointed out that (1) the share of IT-related investment in the total of business fixed investment accounted for only about 10 percent in Japan, which was less than in the United States, and (2) the continuing rise in crude oil prices could become a risk factor for corporate profits.

On the basis of these discussions, many members agreed that, in judging the prospect of a recovery in business fixed investment, careful observation of firms' investment stance and changes in related indicators was necessary.

Members also discussed the outlook for prices.

One member expressed the view that, with the economy turning and starting to improve amid relatively stable prices, it could no longer be said that deflationary concern had not been dispelled.

In response to the above, a different member commented that, although it had become likely that the economy would grow slightly in fiscal 2000, a substantial contraction of the output gap was unlikely, and therefore, there was still a risk of the inflation rate remaining negative. On this basis, the member judged that deflationary concern had not been dispelled yet. This member added that there was little prospect of Japan's economy expanding faster than its potential growth rate and, therefore, little risk of inflation accelerating. The member concluded that it was appropriate to wait for the release of some economic indicators before deciding whether deflationary concern had been dispelled.

Another member basically agreed with the above opinion that deflationary concern remained. In the member's opinion, the recent amelioration of the economic situation was expected to alleviate the downward pressure on prices through a modest improvement in the supply and demand conditions, but such improvement might be short-lived given the unclear prospect of a recovery in private demand. Further, labor cost remained exposed to downward pressure due to firms' restructuring.

The member who disagreed with the view that deflationary concern had not been dispelled raised the question of how the judgment would be made whether it had or had not been dispelled, which was the basis for terminating the zero interest rate policy. Specifically, the member questioned whether the judgment should be based on (1) price developments, or rather, (2) real economic activity measured by the difference between the actual growth rate and the potential growth rate or by the output gap. On this point, a few members commented that price developments would be the main element, and in judging the outlook for prices, underlying factors such as the supply and demand balance and downward pressure on wages would also be examined thoroughly. Another member added that the prospect of a self-sustained recovery in private demand was a very important criterion at this stage in view of the aforementioned points of concern, and therefore required careful attention.

On the basis of the above discussions, many members generally agreed as follows: (1) prices were becoming increasingly stable given the recent improvements in the economy; (2) however, a self-sustained recovery in private demand was not yet in prospect; and (3) the impact of the yen's appreciation was still uncertain, and therefore, deflationary concern had not been dispelled yet. At the same time, some members stated that the ongoing improvement in the economy would definitely influence the outlook for prices and that it was becoming increasingly difficult to make judgments on deflationary concern.

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 monetary policy stance for the immediate future.

Many members' view of the economic and financial situation was as follows. First, Japan's economy, which had stopped deteriorating, was gradually turning to improve with exports and production increasing. Second, the financial environment was improving. Third, however, clear signs of a self-sustained recovery in private demand had not yet been observed. And fourth, prices were expected to remain generally flat in the immediate future, but downside risk remained.

Based on the above assessment, many members shared the view that deflationary concern had not been dispelled yet. Therefore, with regard to monetary policy for the immediate future, the majority of members considered it appropriate to continue the zero interest rate policy.

Two members objected to the continuation of the policy.

The first member claimed that the guideline for money market operations should be changed back to the one that had been employed before the adoption of the zero interest rate policy on February 12, and the overnight call rate should be raised to 0.25 percent.

The member argued that Japan's economy was no longer in the emergency state of the time when the zero interest rate policy was introduced. First, the economy was turning and starting to improve. Second, the increase in production was contributing to an improvement in corporate profits and household income, and this in turn would eventually have a positive influence on business fixed investment and private consumption. Third, the risk of a drop in public demand in 2000 had subsided. And fourth, prices were stable, and the economy was definitely not experiencing deflation.

The member further claimed that the negative outcomes of the zero interest rate policy were becoming more evident as time went by. Specifically, the member cited the following. First, the longer the extremely accommodative policy was maintained, the more serious the distortion of income distribution became. Second, market participants were taking risks based on the assumption that the policy would be extended for a considerable period, and if this situation continued any longer, the repercussions of the termination of the policy would become greater. And third, the policy was reducing firms' incentive to implement structural reform. Furthermore, the member noted that the emergence of extreme views requesting a further monetary easing or intentional creation of inflation despite the fact that the economy was improving seemed to indicate the public's ignorance of future costs of macroeconomic policies, and the emergence of such arguments was attributable in part to the continuation of the zero interest rate policy.

The member had not submitted a policy proposal at the past four meetings due to anxiety about the Year 2000 problem. The member, however, expressed the intention to submit a policy proposal at this meeting. The Bank had already adopted money market operations and lending policies to address Year 2000 liquidity problems and was actively providing year-end funds. The member therefore considered that the Year 2000 problem was not a factor that should have a substantial influence on monetary policy decision-making.

Some members commented on the above member's view.

One member agreed with the view that the economy was no longer in a state of emergency. However, the member expressed the view that the decision on the termination of the zero interest rate policy should be based on whether deflationary concern had been dispelled, and that it was not appropriate to end the policy in the current situation where there was still some possibility of the inflation rate remaining negative in the near future.

Another member agreed that monetary easing in fact allowed the survival of inefficient sectors in the short term, but noted that the lower cost of capital should be giving equal support to both inefficient and growth sectors. Therefore, it should be considered that inefficient sectors would eventually be weeded out if a competitive environment was maintained. The member also commented that the economy had firmed only slightly, and it was not the right time to change the current policy.

A third member remarked that a zero interest rate was extraordinary and not compatible with steady economic growth, and the rate should certainly be changed when the economy returned to a sustainable growth path. The member also emphasized that a further surge in the yen or a rise in long-term interest rates that diverged from the economic fundamentals might impede the activity of firms, which were expecting an economic recovery. On these grounds, the member commented that it was appropriate to continue the zero interest rate policy, with which the Bank could best counter these risks through the provision of liquidity.

The other member who objected to maintaining the zero interest rate policy proposed adopting monetary base targeting accompanied by a target for the rate of increase in the consumer price index (CPI), and increasing the amount of excess reserves to achieve these targets.

The member gave the reasons as follows. First, it was necessary that a steady recovery of Japan's economy be achieved while the economies of the United States and Asia were favorable. Second, the upward pressure on the yen needed to be reduced as much as possible. Third, the Bank should take additional monetary easing action concurrently with the Policy Measures for Economic Rebirth of the government. Fourth, setting a target for the rate of increase in the CPI and the growth rate of the monetary base would be effective in avoiding pressure being placed on the Bank for an increase in the outright purchase of JGBs. Fifth, the Bank was considered to have the responsibility to indicate a specific numerical target for price stability, an objective stipulated in the Bank of Japan Law of 1997. And sixth, adoption of inflation targeting would encourage more forward-looking and preemptive monetary policy decision-making because policy would be decided based on projections not only for prices but also for their underlying factors such as GDP, the unemployment rate, and money stock. The member added that the Bank should at least, like the Federal Reserve, release projections for money stock, GDP, the unemployment rate, and prices.

Some members commented on this member's view.

One member remarked that economic projections were based on various assumptions, and calculation of these figures would involve delicate issues. The member continued that inflation targeting was a scheme that set a numerical target for the future inflation rate and did not call for mechanical responses to developments in the actual inflation rate. Therefore, even if such a framework were adopted, monetary policy would still have to be based on a comprehensive judgment of various developments. Another member pointed out that the projections for real economic indicators and prices released by the Federal Reserve were averages or central tendencies of the figures calculated personally by each Federal Reserve governor and Reserve Bank president.

Moreover, a few members raised a question about the feasibility of the proposal, stating that the relationship was not clear between the intermediate target, which was the growth rate of the monetary base, and the final target, which was the rate of increase in the CPI--more specifically, the relationship between the growth rate of the two targets and the reasoning behind the time lag.

One of these members added that it was totally unfeasible to increase excess reserves as proposed, considering that excess reserves were actually decreasing despite the Bank's provision of ample funds.

The member who advocated monetary base targeting argued against the above views saying that (1) even if the Bank could not achieve the numerical target, it could enhance its accountability by explaining why, and (2) excess reserves could increase if the Bank created a larger "daily excess of reserves" of 3-4 trillion yen.

One member stated that it would be necessary to reconsider the meaning of price stability in the Bank of Japan Law of 1997, which stated that the objective of monetary policy was to contribute to the sound development of the national economy through the pursuit of price stability. The member also mentioned that it would also be necessary to consider, from the viewpoint of enhancing the Bank's accountability, the possibility of producing specific numerical figures--such as target figures, reference figures, and projections--for the operational, intermediate, and final target, and the usefulness of such figures.

V. Remarks by Government Representatives

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

(1) Japan's economy was improving moderately due to the permeation of the effects of various policy measures. However, the momentum for a recovery in private demand, which was the key to a self-sustained recovery of the economy, remained weak.

(2) In these circumstances, on November 11, the Government decided on the Policy Measures for Economic Rebirth, which aimed at achieving a full-fledged economic recovery and establishing a new foundation for economic development. The pillars of the package were the following: (1) measures to elicit the dynamism of the Japanese economy--for example, fostering of small firms and venture firms, development of technology, administrative deregulation and institutional reforms of growth sectors, and employment measures; (2) consolidation of new foundations for development in the 21st century--for example, upgrading of the nation's infrastructure, including network infrastructures; and (3) revitalization of the financial markets, securitization of real estate, and housing financing measures. Projects would total approximately 17 trillion yen, 18 trillion yen including measures for the nursing care system.

Part of the budget for the package would be appropriated in the second supplementary budget for fiscal 1999, which would be submitted to the Diet at the end of November. The Government considered that the implementation of the measures would facilitate the smooth transition from public sector-led growth to private sector-led growth, steer the economy toward a full-fledged recovery led by private demand, and build a solid foundation for long-term economic development.

(3) Concurrently with the implementation of the Policy Measures for Economic Rebirth, the Government would like to ask the Bank, as requested in this package, to continue implementing monetary policy appropriately and in a timely manner to ensure a recovery of the economy--for example, by flexibly providing ample funds in the market giving due consideration to developments in the financial markets, including the foreign exchange markets.

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

(1) The Government's view of the economic and financial situation and the content of the Policy Measures for Economic Rebirth were as explained by the representative from the Ministry of Finance. Together with the formulation of the package, the Government had revised the projection for economic growth in fiscal 1999 upward from the 0.5 percent predicted at the end of 1998 to 0.6 percent, in view of the current economic situation and the effects of the measures.

(2) The request concerning monetary policy was as expressed by the representative from the Ministry of Finance.

VI. Votes

The views of many members of the economic and financial situation were summarized as follows. First, Japan's economy was turning to improve with exports and production increasing. Second, the financial environment was improving. Third, however, clear signs of a self-sustained recovery in private demand had not yet been observed. Fourth, prices were expected to remain generally flat in the immediate future, but downside risk to prices remained. And fifth, given the above points, deflationary concern had not been dispelled yet.

Based on this understanding, the majority of members considered that it was appropriate to maintain the zero interest rate policy.

One member, however, proposed changing the guideline for money market operations back to that employed before the adoption of the zero interest rate policy on February 12, on the grounds that economic conditions were improving. Another member proposed implementing quantitative easing by setting a target for the rate of increase in the CPI and the monetary base.

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

Ms. Shinotsuka proposed the following as the guideline for money market operations for the intermeeting period ahead:

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

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

The proposal was defeated with one vote in favor, seven 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 November 16 through December 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 July-September quarter of 1999 to the average for the same quarter of 2000) to realize quantitative easing (expansion of the monetary base).¹Regardless 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:1. To realize approximately 10 percent annual growth of the monetary base (change from the average for the July-September 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 September 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, seven 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 flexibly provide ample funds and encourage the uncollateralized overnight call rate to move as low as possible.

Votes for the proposal: Mr. M. Hayami, Mr. S. Fujiwara, Mr. Y. Yamaguchi, 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 growth of money stock and the monetary base was slowing, and this could adversely affect the economy, such as by pushing up the yen. Second, since there was no room for further monetary easing under overnight call rate targeting, it was necessary to change the monetary policy regime. And third, the policy framework should be expressed in terms of specific numbers instead of the currently used ambiguous language so that the Bank could fill the requirement of accountability.

Ms. Shinotsuka dissented for the following reasons. First, the economy was turning and starting to improve, and therefore a self-sustained recovery in private demand seemed to be coming into prospect. Second, the negative effects of the zero interest rate policy were amplifying as time went by. And third, interest rates should be returned to a normal level immediately because the zero interest rate policy had been implemented to counter the risk of a deflationary spiral--in other words, in an emergency--and this risk no longer existed in the current economic situation. Even if the interest rate were raised to its level before the adoption of the zero interest rate policy, the monetary policy stance would continue to be extremely easy.

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 November 16, 1999 in the Monthly Report of Recent Economic and Financial Developments (the "Ivory Paper," consisting of "The Bank's View" and "The Background"). ⁵

5The original full text, written in Japanese, of the "Ivory Paper" was published on November 16, 1999 together with the English version of "The Bank's View." The English version of "The Background" was published on November 29, 1999.

Attachment

For immediate release

November 12, 1999
Bank of Japan

At the Monetary Policy Meeting held today, the Bank of Japan decided, by majority vote, to maintain its "zero interest rate policy" to assure permeation of the effects of monetary easing.

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