Minutes of the Monetary Policy Meeting

on December 17, 1999
(English translation prepared by the Bank staff based on the Japanese original)

February 16, 2000
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, December 17, 1999, from 9:00 a.m. to 12:15 p.m., and from 1:16 p.m. to 3:44 p.m. ¹

Policy Board Members Present
Mr. M. Hayami, Chairman, Governor of the Bank of Japan ²
Mr. S. Fujiwara, Deputy Governor of the Bank of Japan
Mr. Y. Yamaguchi, Deputy Governor of the Bank of Japan ³
Mr. S. Taketomi
Mr. T. Miki
Mr. N. Nakahara
Ms. E. Shinotsuka
Mr. K. Ueda
Mr. T. Taya

Government Representative Present
Mr. Y. Ohno, Senior State Secretary for Finance, Ministry of Finance ⁴
Mr. T. Haraguchi, Deputy Vice Minister for Policy Coordination, Ministry of Finance ⁵
Mr. T. Komine, Director-General of the Research Bureau, Economic Planning Agency

Reporting Staff
Mr. I. Kuroda, 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. T. Murayama, Advisor to the Governor, Secretariat of the Policy Board
Mr. S. Hida, Manager, Secretariat of the Policy Board
Mr. T. Kurihara, Manager, Policy Planning Office
Mr. S. Uchida, Manager, Policy Planning Office

The minutes of this meeting were approved by the Policy Board at the Monetary Policy Meeting held on February 10, 2000, as"a document which contains an outline of the discussion at the meeting" stipulated in Article 20, Paragraph 1 of the Bank of Japan Law of 1997. Those present are referred to by their titles at the time of the meeting.
Mr. Hayami was present from 9:09 a.m. During Mr. Hayami's absence, Mr. Fujiwara performed the duties of the chairman, pursuant to Article 16, Paragraph 5 of the Bank of Japan Law of 1997.
Mr. Yamaguchi was present from 2:35 p.m., after attending a G-20 meeting held in Berlin, and therefore voted only on the scheduled dates of Monetary Policy Meetings in January-June 2000.
Mr. Ohno was present from 10:54 a.m. to 12:15 p.m.
Mr. Haraguchi was present from 9:00 a.m. to 10:52 a.m., and from 1:16 p.m. to 3:44 p.m.

I. Summary of Staff Reports on Economic and Financial Developments ⁶

A. Money Market Operations in the Intermeeting Period

Market operations in the intermeeting period were conducted in accordance with the guideline determined at the meeting on November 26. ⁷During the period, the Bank provided ample funds, especially those maturing beyond the year-end, announcing almost every day a"morning projection for reserves" of an excess of 1 trillion yen. ⁸

As a result, the uncollateralized overnight call rate moved stably at 0.02-0.03 percent through December 14, 1999. On December 15 (the last day of the reserve maintenance period) and December 16 (the first day of the following period), the Bank provided more ample funds than usual, announcing a"morning projection for reserves" of an excess of more than 1 trillion yen, due to tight market conditions. Consequently, the rate stayed at 0.03-0.04 percent, virtually the zero percent level.

Interest rates on term instruments maturing beyond the year-end showed a relatively large fluctuation. Rates on one-month Euro-yen deposits dropped substantially from around 0.75 percent to the 0.2-0.3 percent level in early December, and then rebounded to the 0.4-0.5 percent level on December 16, the day before the meeting. Yields on short-term Japanese government securities also fell at one time and turned upward thereafter. The substantial drop in the term interest rates in early December was attributable to the fact that lenders in the money market reduced their offer rates for providing funds. This was done in view of the significant progress made by financial institutions in financing for the year-end given the Bank's ample provision of funds maturing beyond the year-end. The rates, however, rebounded later due to fund-raising by some foreign banks in a thin market. Therefore, although most financial institutions had already made substantial progress in procuring year-end funds, attention should still be paid to market developments.

The funds maturing beyond the year-end provided by the Bank amounted to 42 trillion yen as of December 16, 1999, the day before the meeting. The Bank would provide further funds if this was deemed necessary in view of interest rate developments, and thereby meet demand for increases in banknote issuance and financial institutions' demand for reserves stemming from the Year 2000 problem.

6Reports were made based on information available at the time of the meeting.
7The 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."
8The"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 surged to the 101-102 yen level from the 104-105 yen level against the U.S. dollar immediately after the previous meeting held on November 26, 1999. However, it weakened thereafter due to the following factors. First, Japan's monetary authorities were reported to have intervened in the market. Second, the preliminary estimates of Japan's GDP for the July-September quarter of 1999 and the results of Tankan--Short-Term Economic Survey of Enterprises in Japan--for December 1999 were somewhat weaker than expected. And third, U.S. stocks had been firm.

In addition to these factors, two developments in cross-border transactions had led to the weakening of demand for the yen: inflow of foreign funds had slowed, and Japanese institutional investors had stopped selling foreign bonds. In view of such developments, market participants felt that it would be risky to further purchase the yen.

The euro showed relatively unstable developments against the U.S. dollar reflecting such factors as economic developments in the euro area and remarks by the authorities, falling below US$1 per euro at one time and rapidly rebounding afterward. Among East Asian currencies, the Korean won appreciated notably reflecting recovery in the Korean economy.

2. Overseas economic and financial developments

There were no fundamental changes in overseas economies: the robust expansion in the United States, the accelerating growth in Europe, and the recovery spreading in Asia.

In the United States, economic expansion had continued, led by domestic demand especially private consumption and business fixed investment. It was reported that sales during the holiday season were better than in the previous year.

In Europe, not only exports but also private consumption had gained in firmness recently. Stock prices in France and the United Kingdom marked record highs.

In Hong Kong, a favorable economic cycle was observed; the rise in stock prices triggered by an increase in exports resulted in growth in private consumption. In China, a further slowdown in the economy was avoided because the effects of the government's additional stimulus measures permeated the economy and exports were strong. However, there were factors that might negatively affect the economy in the medium term, such as the reform in state-owned companies and issues concerning the country's accession to the World Trade Organization.

C. Economic and Financial Developments in Japan

1. Economic developments

Public investment had stopped rising, and the peaking out in housing investment had become clearer than before. Private consumption showed mixed developments on the whole, while more positive indicators were observed than in the summer of 1999. Business fixed investment, which had been on a downward trend, showed signs of leveling off. Net exports (exports minus imports) continued to expand due mainly to a rise in exports.

Reflecting these developments in final demand and progress in inventory adjustment, production continued to rise. Corporate profits were increasing due partly to the effect of restructuring, and corporate sentiment continued to improve. However, these positive developments in corporate profits and sentiment had not stimulated business fixed investment yet. Employment and income conditions were still severe as a whole reflecting efforts by firms to reduce personnel expenses, although some indicators suggested a halt in the deterioration.

In sum, Japan's economy, which had already stopped deteriorating, had started to improve, with exports and production increasing. The economic environment surrounding private demand was gradually improving, as seen in the continuing increase in corporate profits. However, clear signs of a self-sustained recovery in private demand had not been observed yet.

As for the outlook, exogenous demand was expected to underpin the economy in view of the upward trend in exports reflecting the robust overseas economies and the increase in orders for public works based on the second supplementary budget.

The bottoming out of business fixed investment was likely to become more distinct, reflecting progress in corporate restructuring and the improving profits. Firms, however, still took a cautious view and remained under pressure to repay their debts. It was therefore difficult to predict when business fixed investment would start increasing clearly.

As for prices, the current situation was expected to continue. Domestic wholesale prices were likely to be generally flat. While falls in prices of electric machinery and downward pressure on import prices due to the appreciation of the yen were observed, crude oil prices were rising substantially and the domestic output gap was gradually narrowing. Consumer prices were also expected to remain at the same level as the previous year. Meanwhile, corporate service prices were likely to continue falling moderately.

In sum, prices as a whole were expected to remain unchanged for the time being. However, it was still not certain whether the driving force of economic recovery would shift smoothly from exogenous demand to private demand and whether the output gap would thus continue to narrow. Attention should therefore still be paid to the risk that prices would fall again when exogenous demand started decreasing.

2. Financial developments

In the money market, the overnight call rate had stayed at nearly zero. Interest rates on term instruments maturing beyond the year-end recently fell markedly. Yields of Euro-yen interest rate futures for June 2000 delivery were at the 0.2-0.3 percent level, suggesting that the market believed the Bank would maintain its zero interest rate policy for the time being.

Yields on Japanese government bonds (JGBs) rose from mid- to late November to around 1.9 percent reflecting improved confidence in the economy. However, they fell to the current 1.70-1.75 percent level thereafter due to the yen's appreciation, and also to the preliminary estimates of the GDP for the July-September quarter and the results of the December Tankan, both of which were somewhat weaker than expected. Stock prices, after rising in November, weakened slightly due to the strengthening of the yen and profit-taking by foreign investors. They were currently moving at 18,000-18,500 yen.

The Japan premium had almost disappeared even for transactions maturing beyond the year-end. The yield spread between private and government bonds continued to narrow, particularly that between private bonds with relatively low credit ratings and JGBs.

There was no significant change in corporate financing. While basically retaining a cautious lending attitude, private banks narrowed their lending spreads slightly and major banks especially were gradually becoming more active in extending loans.

However, credit demand in the private sector had continued to be stagnant, and thus private banks' lending had remained sluggish. Corporate bond issuance had been stable, and the year-to-year increase in corporate bonds outstanding was slowing. Meanwhile, with the year-end approaching, commercial paper (CP) issuance was increasing due partly to the expanded CP operations maturing over the year-end conducted by the Bank.

The year-to-year growth of money stock (M2+CDs) had slowed somewhat due to the weakness in credit demand in the private sector described above.

II. Approval of the Minutes of the Monetary Policy Meeting Held on November 12, 1999

The Policy Board approved unanimously the minutes of the Monetary Policy Meeting of November 12, 1999 for release on December 22, 1999.

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

A. The Current Economic Situation

On the current economic situation, most members focused on the further improvement in corporate profits and on signs that business fixed investment, which had been on a downward trend, was leveling off. At previous Monetary Policy Meetings, some members had noted the fact that the increase in exports was contributing to an expansion in production and that this, in turn, was beginning to have a positive effect on corporate and household income. At this meeting, members were of the opinion that further positive signs were emerging in the corporate sector.

At the same time, many members pointed out that private demand was not showing distinct signs of a self-sustained recovery, as seen in the facts that (1) there were no clear indications that business fixed investment had stopped falling and had entered an upward phase, and (2) developments in private consumption remained mixed.

Based on this understanding, members assessed the state of the economy as follows:"Japan's economy, which had stopped deteriorating, has recently started to improve, with exports and production increasing. The economic environment surrounding private demand is gradually improving, as seen in the continuing increase in corporate profits. However, clear signs of a self-sustained recovery in private demand have not been observed yet."

Most members agreed, as in the previous meeting, that exports were on an upward trend. One member pointed out that this trend could be attributed to the robust economic growth in the United States, Europe, and East Asia. The member continued that the strength of the world economy had been brought about by the U.S. Federal Reserve's monetary easing in 1998, which had helped calm the turmoil in global financial markets, and by the strong growth of the information technology (IT) sector mainly in the United States. A few members expressed the view that there was a favorable interaction between Japan and other Asian countries. That is, an increase in Japan's imports from other Asian countries was supporting a recovery in those countries, and as a result, Japan's exports to them were increasing. Many members supported the above views but cautioned that the negative impact of the strong yen on exports needed to be watched carefully.

Many members pointed out that production continued to rise as a result of the increase in exports and progress in inventory adjustment. On this issue, one member noted that the permeation of monetary easing effects and the multiplier effects of fiscal spending and exports, both of which had been held back by delays to the structural reforms of Japan's economy, were at last contributing to an increase in production.

Members next discussed corporate profits, which were improving due to the increase in exports and production combined with restructuring efforts.

One member mentioned that there was, at the time of the first Monetary Policy Meeting in November, a possibility that positive cyclical mechanisms were already functioning. This member continued that confirmation at this point that corporate profits had started to grow firmly had great implications for the economic outlook. Specifically, the member cited the December Tankan survey, which showed that corporate profits were projected to improve in the current fiscal year despite the appreciation of the yen--for the second half of fiscal 1999, large manufacturers projected an exchange rate of 107-108 yen to the U.S. dollar--and the downward pressures stemming from structural adjustments in the economy.

Another member noted that the current improvement in corporate profits was not supported by a self-sustained recovery in private demand, and its foundation was very fragile. Specifically, the member pointed out the following. First, the improvement in corporate profits stemming from the rise in international commodity prices reflecting the recovery in Asian economies was almost totally offset by the appreciation of the yen. Second, the increase in production due to the rise in exports merely helped to cover fixed costs. And third, the current improvement in corporate profits was supported by corporate restructuring and improvements in net financial income due to the zero interest rate policy.

In view of these developments in corporate profits, many members shared the view that signs of change were emerging in the downward trend of business fixed investment.

One member pointed out that machinery orders and capacity utilization in the manufacturing industry were bottoming out, and business fixed investment had fallen to the level of depreciation costs. The member thus concluded that it was difficult to envisage a further decline in business fixed investment. Another member noted a recent acceleration in small nonmanufacturers' upward revision of their business fixed investment plans for the current fiscal year. The member said this phenomenon was typical of economic recovery phases in Japan and therefore should be watched carefully. A different member noted that, according to anecdotal evidence, construction of buildings for commercial use such as factories, warehouses, and stores was increasing and these developments showed that business fixed investment was bottoming out. This member, however, added that the contrast within sectors, firms, and regions was becoming noticeable.

The above members shared the view that there were signs that business fixed investment had stopped decreasing but clear signs of an increase had yet to be seen in statistical or anecdotal information.

One member held a slightly bearish view compared to the majority of members. This member said business fixed investment as a whole appeared to have stopped decreasing, but a closer look showed that (1) the share of nominal business fixed investment in nominal GDP remained high and thus adjustment of capital stock was likely to continue for a while, and (2) business fixed investment was growing only in IT-related sectors and certain service sectors while in other sectors it continued to decline. This member pointed out, however, that the share of IT-related investment in total business fixed investment was still small in Japan relative to the share in the United States, and that it thus had potential to grow, possibly becoming a major pillar of business fixed investment in the medium to long term.

With regard to private consumption, many members were of the opinion that it was showing mixed developments. One member noted that the rise in production and the improvement in corporate profits had helped slow the decline in employees' income, as seen in the recovery in winter bonuses at some companies to the levels of the previous year. Another member pointed out that domestic car sales were improving. These members agreed, however, that distinct signs of a recovery had yet to be seen in private consumption overall.

A few members commented that public investment by local governments was slowing.

Most members agreed that prices were generally unchanged. One member, however, expressed concern over oil prices. The member commented that the rise in oil prices was constrained at present because demand had been dampened by the warm winter in the United States and Europe and because oil producers such as Saudi Arabia were ready to increase production in case of any Year 2000-related problems. However, prices could shoot up to around US$40 per barrel if this situation changed.

Based on the above discussions, many members were of the opinion that the economy had started to improve. One member described the economy as follows:"It is gradually improving, and has climbed one step after pausing for some time." Another member said the economy had"moved half a step forward." After discussions, members decided to slightly upgrade their assessment of the economy to"Japan's economy, which had stopped deteriorating, has recently started to improve, with exports and production increasing," from the previous month's"Japan's economy, which had stopped deteriorating, is currently turning to improve." The following sentence was added to reflect the improvement in corporate profits:"The economic environment surrounding private demand is gradually improving, as seen in the continuing increase in corporate profits."

B. Financial Developments

On the financial front, most members agreed that (1) financial markets had generally remained stable, and (2) the favorable developments in financial markets were supporting economic activity.

On recent developments in financial markets, one member expressed the following view: (1) the steady rise in stock prices from the range of 17,000-18,000 yen in October to 18,000-19,000 yen in November showed that market participants welcomed the improvements in the corporate sector; and (2) the relatively stable movement of long-term interest rates at a low level since October suggested that the market expected the zero interest rate policy to continue for some time. The member also said that, judging from the Tankan survey, corporate financing conditions and the lending attitude of financial institutions had continued to improve and this was a positive factor for the real economy. Another member added that corporate financing conditions had already eased to a level sufficient to support the economy when it returned to a recovery track.

In relation to corporate financing, members discussed quantitative monetary indicators. One member said lending by private banks had decreased even though they had recently been placing more emphasis on expanding the volume of loans rather than securing lending spreads in order to achieve the targets laid down in their plans to restore sound management submitted to the Financial Reconstruction Commission. The reason for the decline was that corporate demand for funds remained weak as the top priority for corporate managers at present was to improve their balance sheets. The member also pointed out that there was a possibility that bank lending would decline further because funds borrowed to weather the Year 2000 problem would be returned after the turn of the year.

A different member expressed concern over the recent deceleration in the growth of money stock. This member pointed out that, in retrospect, wild fluctuations in money stock in the 1980s and 1990s had been warnings of large swings in the economy, and therefore, from a medium- to long-term perspective, movements in money stock were of great significance. The member continued that, even though the relationship between money stock and the real economy had become unstable and the financial system had stabilized, it was possible that recent movements in money stock were a warning of a deterioration in banks' ability to create credit and thus should not be taken lightly.

Another member argued that, although it was indeed important to watch movements in money stock, one should not place too much emphasis on them when assessing economic and financial conditions. The member continued that growth of money stock was slowing but the Marshallian k (money stock divided by nominal GDP) remained at a high level and, from a monetarist's point of view, this could signal inflationary risks. A different member was of the opinion that the present level of money stock was not necessarily high relative to the average nominal GDP in the medium term.

There was an active exchange of views on the yen. One member commented that the profitability of Japanese firms, which were making tremendous restructuring efforts to increase efficiency to meet global competition, could be hurt by an appreciation of the yen. This member emphasized that (1) it was crucial that the yen stabilized at around 105 yen to 115 yen to the U.S. dollar, and (2) market intervention should be carried out as necessary to prevent the yen from surging beyond that range.

A few other members also expressed concern over a further appreciation of the yen as Japan's economy was currently at a critical juncture where relatively small changes would determine whether it could get back to a self-sustained recovery path driven by private demand. One of the members made the following remarks. First, not only sharp fluctuations, but also the level of foreign exchange rates was critical to the profitability of small firms. Second, international coordination was indeed important, but domestic economic developments should be the primary basis for deciding whether to intervene in foreign exchange markets.

In response to the above views, a different member put forward the following opinion from the viewpoint that foreign exchange rates should be basically determined by market forces: (1) the balance of the three major currencies--the yen, the U.S. dollar, and the euro--in the foreign exchange market should not be changed artificially; (2) intervention might be appropriate in cases where market fluctuations were violent, but it was inappropriate to intervene with the objective of maintaining specific exchange rate levels; (3) a strong yen could support a recovery in Asian economies by boosting exports from those countries to Japan; and (4) the recent appreciation of the yen reflected a return of confidence at home and abroad in a recovery in Japan's economy, which had been on the verge of falling into a deflationary spiral.

Views on the outlook for long-term interest rates were also put forward. One member noted that concerns over a possible rise in long-term rates were easing because financial institutions had recently become willing to invest in bonds. The member continued, however, that it should be noted that market participants remained aware of the possibility that the supply-demand balance of bonds could deteriorate. A different member pointed out that, according to the OECD, the debt of Japan's general government sector was projected to increase beyond 110 percent of nominal GDP and therefore vigilance was required on the fiscal deficit, which could grow out of control.

C. The Economic Outlook

On the economic outlook, members agreed that fiscal policy and exports would continue to underpin the economy for the time being. However, many members shared the view that, although economic conditions were improving, clear signs of a recovery in private demand had yet to be seen, and thus, it should still be considered that deflationary concern had not been dispelled yet.

As for public investment, some members expressed the view that implementation of the second supplementary budget for fiscal 1999 would help avoid a sharp fall in public investment toward fiscal 2000. In relation to exports, many members shared the view that they would continue to increase reflecting the briskness of overseas economies. On these grounds, some members expressed the view that exogenous demand would continue to underpin the economy in 2000.

As a risk to this scenario, some members referred to the sustainability of the growth of the U.S. economy. They said that, if the U.S. economy stalled, Japan's economy would be affected considerably through a fall in Japanese and U.S. stock prices and a rise in the yen. One of these members pointed out that U.S. consumer prices and long-term interest rates had already started to rise, and expressed concern that a surge in the latter would affect U.S. stock prices. Meanwhile, another member remarked that careful attention would have to be paid to improvements in the supply side, such as increases in productivity, as this was the key to the U.S. economy's success in avoiding swings between phases of overheating and adjustment.

Members also discussed the outlook for private demand, and many of them shared the view that there were no clear signs of its self-sustained recovery yet.

As for business fixed investment, one member remarked that, although firms were not yet actively making such investments, the environment was becoming favorable. Specifically, the member pointed out the following: (1) firms' profitability was improving due partly to a reduction in personnel expenses; (2) private consumption, despite the negative impact of restructuring, had managed to avoid falling and was showing mixed developments; (3) against this background, foreign investment in Japan had resumed; and (4) IT-related investment was sure to expand amid global competition.

Another member pointed out that it was necessary to watch closely the progress of corporate restructuring in judging the outlook for the economy, and referred to the relationship between the break-even-point ratio and business fixed investment as follows. According to empirical regularity, business fixed investment started to grow twelve to 18 months after the start of the improvement in firms' break-even-point ratio. Therefore, there was a possibility that business fixed investment would bottom out and start to recover in the near future, because firms' break-even-point ratio, when seasonally adjusted using a particular method, had peaked out in the July-September quarter of 1998 and had been improving since then. The member added that the following observations were consistent with the above regularity. First, it seemed probable from the results of December's Tankan survey that business fixed investment would increase to some extent in the second half of fiscal 1999. And second, positive developments in IT-related investment had started to be observed.

On the break-even-point ratio, one member commented that (1) although it had started to improve, the level remained high, (2) there was a substantial gap between large and small firms, and (3) the relationship between the ratio and business fixed investment was not clear. The member therefore concluded that, when judging the development of business fixed investment, not only the break-even-point ratio but also other factors should be taken into account. This member added that developments in corporate financing, which underpinned business fixed investment, showed that credit demand for new business fixed investment was extremely weak, and that there was only credit demand for inventory financing under the special loan guarantee system.

Another member mentioned the possibility that business fixed investment would start to increase if drastic changes occurred in IT-related industries or if land prices stopped declining. However, this member shared the view of the other members that business fixed investment was not likely to show any clear increase at this point as firms' sales forecasts remained modest. Further, another member remarked that (1) if corporate profits and cash flow improved, firms would use the funds to pay back debts and thus such an improvement would not necessarily boost business fixed investment, and (2) IT-related investment accounted for less than 20 percent of total business fixed investment, and therefore had a limited effect on overall economic growth.

On the employment and income conditions for households, a few members pointed out as a favorable factor that the number of employed was bottoming out. However, the consensus of members, including those above, was that it would take a while for the current improvement in corporate profits to lead to an improvement in employment and income conditions, on the grounds that firms' restructuring and the structural adjustment of the economy would continue to restrain household income. One of these members remarked that employment and income conditions had not improved as much as statistics indicated. The member pointed out that (1) large firms' restructuring had made some advancement, but small firms had not made any progress in cutting jobs, and (2) the unemployment rate was falling because many people had given up job searching and were no longer registered as unemployed.

Members generally agreed therefore that, for the time being, private consumption would show mixed developments without any clear signs of improvement.

Based on the above outlook for the economy, members discussed the outlook for prices. Most members shared the view that prices would continue to be flat. However, since there were no clear signs of a recovery in private demand yet, continued close attention would be required to potential downward pressures on prices. Therefore, they concluded that deflationary concern had not yet been dispelled.

While agreeing that prices would remain nearly unchanged, one of these members forecasted that prices might decline slightly, taking account of the effects of the strong yen on corporate activity and prices. Another member presented the results of a simulation of inflation rates for various cases, postulating a certain probability distribution and assuming the GDP growth rate for 2000 to be zero to 2 percent and the current potential growth rate to be zero to slightly under 2 percent. This member, noting that the results of this type of simulation should be analyzed with care, gave a brief account of the results: (1) the average inflation rate for 2000 would be nearly zero; (2) there was a relatively high probability that the rate would become negative; and (3) it was not very likely that the rate would rise. The member concluded therefore that deflationary concern had not yet been dispelled. In response to this remark, another member stated that it was unreasonable to conclude, from the fact that the average of inflation forecasts for 2000 was around zero percent, that deflationary concern had not been dispelled yet, and that such data should be interpreted with greater caution.

Some other members remarked that a fall in prices caused by technological innovations, such as those in IT-related industries, should be distinguished from undesirable price falls caused by slack supply and demand conditions. One of these members commented in this connection that, when judging the trend in prices, the supply-demand balance should be watched rather than the movement of each price indicator. The member continued that it was necessary to judge the trend by looking at the supply-demand gap, not just in a narrow sense as calculated using a production function but also in a much broader sense.

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, had recently started to improve, with exports and production increasing. Second, the economic environment surrounding private demand was gradually improving, as seen in the continuing increase in corporate profits. Third, the financial environment continued to be favorable. Fourth, however, clear signs of a self-sustained recovery in private demand had not been observed yet. And fifth, prices were expected to remain generally unchanged for the time being, but downward pressure on prices continued to warrant careful monitoring.

Taking account of the economic situation as assessed above, one of the members pointed out that it continued to warrant careful monitoring in regard to the risk of a further appreciation of the yen and of a rise in long-term interest rates that deviated from the economic fundamentals.

Based on the above assessment, many members judged 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.

At the meeting, discussions were made on several points related to the future direction of monetary policy.

First, one member questioned whether the view of the current economic situation--i.e., the economic environment surrounding private demand was gradually improving, as seen in the continuing increase in corporate profits--was compatible with the judgment that deflationary concern had not been dispelled yet.

On this point, one member expressed the view that deflationary concern had not been dispelled yet given that (1) the driving force of economic recovery was in the process of shifting from exogenous demand to private demand, and (2) the yen's appreciation and firms' balance-sheet restructuring still placed downward pressure on the economy. A different member remarked that whether business fixed investment would start to rise was one of the issues to be watched closely.

Another member summarized the above views: (1) the economic environment surrounding private demand had just started to improve; (2) inventory adjustment was progressing, and diffusion indexes of employment, production capacity, and supply and demand conditions for products from the Tankan survey revealed that deterioration in the supply-demand balance in the economy had stopped; and (3) however, clear signs of a recovery in business fixed investment and private consumption were not yet found. The member remarked that, comparing the upside risks to the economy with the downside risks, the two had almost balanced. On this basis, the member pointed out that, in judging whether deflationary concern had been dispelled, it was important to determine (1) when and how the improvement in the economic environment surrounding private demand would stimulate spending activities of firms and households, and (2) whether the resultant improvement in the supply-demand balance could be sustainable.

Further, a different member pointed out that, if a shock occurred to the economy after raising interest rates and thus the Bank was forced to change its target interest rate back to zero, the credibility of the Bank's monetary policy could be impaired.

Second, concern was expressed about structural adjustment being deferred, which was a negative effect of the zero interest rate policy. The member who took this view claimed that firms with impaired balance sheets containing a large amount of interest-bearing liabilities were able to continue to exist because financing costs were kept low by the zero interest rate policy. The member emphasized that, therefore, if the zero interest rate policy supporting such firms was prolonged, this would only redistribute income to these firms from households, which otherwise could have earned more interest income.

In relation to this view, a member commented as follows: (1) the zero interest rate policy had been maintained based on the judgment that raising interest rates would damage the economy; and (2) given that firms had become strongly aware of the crucial importance of increasing their profitability and banks' lending rates varied greatly according to each firm's creditworthiness, the zero interest rate policy would not lead to the preservation of inefficient firms. The member remarked on these grounds that it was important to consider whether it was still necessary to raise interest rates immediately in order to promote structural adjustment further, or indeed whether this was feasible at all.

Third, a member remarked that the risk of a further rise of the yen remained, and an additional monetary easing measure would become necessary if the yen surged far above 100 yen to the U.S. dollar. This member explained that, when the yen appreciated in late November 1999, market participants were in fact anticipating that the Bank would indicate, by increasing the"morning projection for reserves," its intention to carry out a further monetary easing. The member continued that, although the"morning projection for reserves" of an excess of 1 trillion yen had turned out to be consistent with maintaining the overnight call rate at zero percent, this amount had virtually represented the Bank's stance on monetary policy, and therefore interest rates and the yen's level were highly likely to be influenced if this amount was increased.

A member argued against this view as follows: (1) the effects of additional funds injection were uncertain when the overnight call rate had already declined to close to zero; and (2) if the Bank decided to adopt a policy reacting to irrational expectations of the market, there was a risk that such policy action would be called for repeatedly and, as a result, the credibility of the Bank's monetary policy would be impaired. The member added that the last measure available for an additional monetary easing would be to increase the outright purchase of JGBs, which could be expected to cap the yen's rise. However, the measure could be implemented only if the economy was in a deflationary spiral because it would involve great cost to the economy.

To summarize the above discussion on the direction of future monetary policy, a member remarked that preparing for both upward and downward risks was the key to effective monetary policy in 2000. Specifically, the member noted that it was necessary to prepare for the risk of deflationary pressure intensifying again due to a weakening of domestic demand or for external shocks such as a sharp contraction in the U.S. economy and a plunge in U.S. stock prices. At the same time, if the economy continued to improve, it would be essential to judge the appropriateness of maintaining the extremely easy monetary policy, by giving due consideration to its compatibility with the economic situation.

On the basis of the above discussion, some members stressed the need to clearly explain to the market and to the public the decisions made at Monetary Policy Meetings, the thinking behind those decisions, and the factors that the Board was focusing on. These members shared the view that such action would be the short cut to stabilizing expectations of the market and smoothly implementing monetary policy.

Meanwhile, two members objected to the maintenance of the zero interest rate policy.

The first member claimed that the guideline for money market operations should be changed back to that employed before the monetary easing on February 12, 1999--i.e., the overnight call rate target should be raised to 0.25 percent.

The member explained as follows. First, the economy had started to improve, and the economic environment surrounding private demand was gradually improving. This suggested that abatement of deflationary concern was in prospect. If the zero interest rate policy was continued even in this situation, the credibility of the Bank's monetary policy would be impaired. Second, new industries were budding due to technological innovation and deregulation. For example, some firms in the nonfinanical sector were entering the financial industry, and competition in information technology was becoming prevalent, resulting in improvements in the quality of services provided to consumers. Thus, the foundation was being provided for these growth industries to become the driving force for economic growth. And third, the contrast was becoming conspicuous between new growth industries and those confronted by structural adjustment. In these circumstances, policies to support the latter industries could be called for more strongly.

The second member advocated adopting monetary base targeting accompanied by a target for the rate of increase in the consumer price index (CPI), and increasing excess reserves to achieve these targets.

The member gave the reasons as follows. First, according to the indexes of business conditions of the Economic Planning Agency, the momentum for a recovery had been weak since the economy bottomed out in April or May 1999. The indexes also suggested that overall economic activity around March 2000 would still be sluggish. Second, private consumption was not so strong as in the summer of 1999, and the ratio of business fixed investment to GDP was starting to rise although adjustment in excessive capacity was still insufficient. Further, the GDP deflator had been negative for three consecutive quarters. Third, in these circumstances, it was necessary to promptly decide on additional monetary easing, synchronizing the action with the government's economic policy package, and thereby push up the economy's growth rate to the level of its potential. Fourth, the monetary policy regime should be changed from the current zero interest rate policy to quantitative targeting because the former was an inflexible policy allowing only two courses of action--i.e., either to continue or terminate the policy. And fifth, inflation targeting had been adopted worldwide, and this policy was considered to contribute greatly to stabilizing market participants' expectations and to increasing the Bank's accountability for its policies as well as its responsibility for the consequences.

The member advocating a raise in the target interest rate remarked that, under the zero interest rate policy where the Bank was committed to maintaining the policy until deflationary concern had been dispelled, the commitment was helping to stabilize market expectations and was also clearly putting out the Bank's message to the market. The member expressed concern that this effect would be gone with the termination of the zero interest rate policy, and therefore claimed that the Bank should consider releasing its medium-term projections of economic indicators, such as the inflation rate and the supply-demand balance. The member who suggested further monetary easing also claimed, repeating the member's point from previous meetings, that the Bank should release its projections of the inflation rate and GDP to correctly convey its view of the economy to the market.

V. Remarks by Government Representatives

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

(1) Japan's economy had passed the worst point, and was improving moderately due to the economic recovery in Asia as well as 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, the Government decided on the Policy Measures for Economic Rebirth on November 11 in order to achieve a full-fledged economic recovery and establish a solid new foundation for economic development. Following this, a second supplementary budget for fiscal 1999 was adopted at an extraordinary session of the Diet. The Government would implement the various measures included in the Policy Measures for Economic Rebirth steadily and continue to give due consideration to the economic situation in formulating the fiscal 2000 budget. Through these efforts, the Government aimed to realize a smooth shift from public to private sector led growth, and steer the economy toward a full-fledged recovery driven by private demand. The Government would also start reviewing taxes in line with the report on tax reform for fiscal 2000, which was formulated by the Tax Commission on December 16.
(3) The Government would like to ask the Bank to continue implementing monetary policy appropriately and in a timely manner to ensure economic recovery--synchronizing its actions with the Government's measures--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) Japan's economy had not yet recovered from its severe situation, as the momentum for a recovery in private demand remained weak; however, activities continued to improve moderately due to the influence of the economic recovery in Asia as well as the effects of various policy measures. Specifically, private consumption remained at a standstill despite a slight improvement from early autumn. Fixed investment of some manufacturers seemed to be bottoming out reflecting an increase in machinery orders. Business fixed investment as a whole, however, continued to decline substantially.
(2) The Government would strongly promote the implementation of the Policy Measures for Economic Rebirth in order to realize a smooth shift from public to private sector led growth, steering the economy toward a full-fledged recovery, and establishing a solid new foundation for economic development in the 21st century. The Government would like to ask the Bank to continue implementing monetary policy appropriately and in a timely manner to ensure economic recovery, for example by flexibly providing ample funds in the market giving due consideration to developments in the financial markets, including the foreign exchange markets.

VI. Votes

The views of many members of the economic and financial situation were summarized as follows. First, Japan's economy, which had stopped deteriorating, had started to improve, with exports and production increasing. Second, the economic environment surrounding private demand was gradually improving, as seen in the continuing increase in corporate profits. Third, the financial environment remained favorable. Fourth, however, clear signs of a self-sustained recovery in private demand had not yet been observed. Fifth, prices were expected to remain generally flat for the time being, but attention should still be paid to the downward pressure on prices. And sixth, 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.

Meanwhile, one member proposed changing the guideline for money market operations back to that employed before the adoption of the zero interest rate policy on February 12, 1999, on the grounds that abatement of deflationary concern was in prospect. Another member proposed adopting a full-scale quantitative targeting accompanied by a target for the rate of increase in the CPI.

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 December 16 through January 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 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). ^(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: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, six against. One member abstained from voting.

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(Attachment 1).

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. S. Taketomi, Mr. T. Miki, Mr. K. Ueda, and Mr. T. Taya.

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

Mr. Nakahara voted against the chairman's proposal on the following grounds. First, while there was little upside risk to the economy, there remained substantial downside risk such as the negative impact of the strong yen and the ebbing of the effects of policy measures. Therefore, maintaining the current policy was not appropriate. Second, growth of the monetary aggregates such as money stock was slowing further, and this could lead to upward pressure on the yen. Third, a clear policy stance should be indicated in view of the possibility, amid the fiscal deficit expansion, of growing calls for the Bank to underwrite JGBs and increase JGB outright purchasing operations. And fourth, the current guideline lacked accountability, being written in ambiguous language and not making clear to the public what the policy target was, or when and how it would be attained.

Ms. Shinotsuka dissented for the following reasons. First, abatement of deflationary concern was in prospect as seen in the upward revision of the Board's judgment of the economy. If the zero interest rate policy was continued despite this, the credibility of the central bank would be impaired. Second, the zero interest rate policy, if continued any longer, would further delay structural adjustment and amplify the difficulty in terminating the policy. And third, it was necessary to raise the interest rate at this point when the economy could be judged to have passed the worst stage, and be ready to make prompt policy responses when necessary.

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 December 21, 1999 in the Monthly Report of Recent Economic and Financial Developments (consisting of"The Bank's View" and"The Background"). ⁹

9The original full text, written in Japanese, of the Monthly Report of Recent Economic and Financial Developments was published on December 21, 1999 together with the English version of"The Bank's View." The English version of"The Background" was published on December 28, 1999.

VIII. Approval of the Scheduled Dates of Monetary Policy Meetings in January-June 2000

At the end of the meeting, members approved the dates of Monetary Policy Meetings in January-June 2000, for immediate release(Attachment 2).

Attachment 1

For immediate release

December 17, 2000
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: