Minutes of the Monetary Policy Meeting

on August 11, 2000
(English translation prepared by the Bank staff based on the Japanese original)

September 20, 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, August 11, 2000, from 9:01 a.m. to 12:15 p.m., and from 12:53 p.m. to 5:18 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
Mr. T. Taya

Government Representative Present
Mr. Y. Murata, Senior State Secretary for Finance, Ministry of Finance
Mr. E. Kawade, Director-General of the Coordination Bureau, Economic Planning Agency

Reporting Staff
Mr. M. Matsushima, Executive Director
Mr. M. Masubuchi, Executive Director
Mr. S. Nagata, Executive Director
Mr. I. Yamashita, Director, Financial Markets Department
Mr. S. Murayama, Director, Research and Statistics Department
Mr. E. Hirano, Director, International Department
Mr. M. Shirakawa, Advisor to the Governor, Policy Planning Office
Mr. M. Amamiya, Chief Manager, Planning Division 1, Policy Planning Office
Mr. T. Yoshida, Senior Manager, Research and Statistics Department

Secretariat of the Monetary Policy Meeting
Mr. I. Yokota, 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. H. Yamaoka, Senior Economist, Policy Planning Office
Mr. S. Shimizu, Senior Economist, Policy Planning Office

The minutes of this meeting were approved by the Policy Board at the Monetary Policy Meeting held on September 14, 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.

I. Approval of the Minutes of the Monetary Policy Meeting Held on June 28, 2000

The Policy Board approved unanimously the minutes of the Monetary Policy Meeting of June 28, 2000 for release on August 16, 2000.

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

A. Money Market Operations in the Intermeeting Period

Market operations in the intermeeting period were conducted in accordance with the guideline determined at the previous meeting on July 17, 2000. ³ As a result, the overnight call rate remained within a range of 0.02-0.03 percent.

As regards financial institutions' accumulation of reserves, the pace slowed in early August as expectations that the zero interest rate policy would be terminated weakened temporarily. Recently, these expectations had strengthened again, prompting financial institutions to accelerate slightly their accumulation of reserves.

In mid-July, investors such as life insurance companies shifted their surplus funds to the call market from ordinary deposits at banks. This resulted in a temporary increase in the amount of funds outstanding in the uncollateralized call market. Subsequently, this trend subsided and the amount outstanding fell back to the level before mid-July.

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."

B. Recent Developments in Financial Markets

1. Developments in domestic financial markets

Toward late July, stock prices had dropped and short- and long-term interest rates had declined. Subsequently, stock prices stopped declining and interest rates rose as expectations that the zero interest rate policy would be terminated strengthened again.

The fall in stock prices was initially triggered by the filing of reconstruction proceedings under the Civil Rehabilitation Law by department store operator Sogo Co. Thereafter, weakness in U.S. Nasdaq stocks and the decision to postpone the sale of the temporarily nationalized Nippon Credit Bank prompted widespread selling by investors, foreign investors in particular, pushing stocks down to their lowest level for 2000 in early August. A decline in information technology (IT)-related stocks in response to a similar development in the U.S. market contributed to a considerable extent to the drop in overall stock prices, and the direct impact of the failure of Sogo seemed to be limited. Selling of Japanese stocks by foreign investors had subsided recently, and the market stopped declining. As for the outlook, the market generally expected the Nikkei 225 Stock Average to be confined to a narrow range around 16,000 yen for a while. This was because, while there were concerns that the market's supply-demand balance could deteriorate due to firms' unwinding of cross shareholdings ahead of their interim book closings, there were no drastic changes in firms' forecasts for increased corporate profits.

Long-term interest rates decreased somewhat toward the beginning of August as expectations that the zero interest rate policy would be terminated eased following the fall in stock prices. Compared with previous cases where a fall in stock prices was accompanied by a fall in long-term interest rates the decline in long-term interest rates was relatively small. This was due to the following factors. First, the market continued to expect that the zero interest rate policy would be terminated by September. And second, the market was concerned that issuance of Japanese government securities would increase if a supplementary budget for fiscal 2000 was formulated. Long-term interest rates had since increased to 1.70-1.75 percent again.

In the money market, interest rates on term instruments fluctuated substantially reflecting the strengthening and weakening of expectations of a termination of the zero interest rate policy. Interest rates recovered from the beginning of August and were at a level that factored in a possible increase of 0.25 percentage point in the uncollateralized overnight call rate at this Monetary Policy Meeting.

The yield spread between corporate bonds and government bonds showed signs of widening in the case of corporate bonds with low credit ratings, but this expansion was seen as a correction to the recent contraction in the spread. Thus the impact of Sogo's failure could be considered to be limited. The Japan premium remained negligible with no impact from Sogo's failure.

2. Developments in foreign exchange markets

The yen had declined to around 109.50-110.00 yen against the U.S. dollar by the end of July partly due to the fall in Japanese stock prices. Thereafter it briefly rose to 107-108 yen as expectations that the zero interest rate policy would be terminated heightened. Volatility spreads showed that the market expected the yen to rise in the medium term based on the view that the recovery in Japan's economy would continue.

C. Overseas Economic and Financial Developments

In the United States, although the robust expansion led by domestic demand continued, the view that the economy was slowing down grew stronger as household spending, such as housing investment and consumption of durable goods, started to slow. GDP data for the second quarter of 2000 showed a marked decline in the growth rate of private consumption, and in the Beige Book released on August 9, 2000 an increasing number of Federal Reserve Banks reported a slowdown in private consumption. On the supply side, productivity continued to increase, helping keep prices stable.

In U.S. financial markets, inflationary concern abated further, and Treasury, interest rate swap, and corporate bond yields all followed a downward trend. In the federal funds rate futures market, expectations of an interest rate rise at the next Federal Open Market Committee (FOMC) meeting on August 22 abated. U.S. stock prices as a whole remained stable; while Nasdaq stocks declined reflecting the downward revision of some high-tech corporations' earnings forecasts, the Dow Jones Industrial Average remained firm reflecting the decline in interest rates.

In the euro area, both domestic and external demand continued to expand and production also increased robustly. Prices rose gradually in response to the rise in crude oil prices and the depreciation of the euro. The consumer price index for June rose by 2.4 percent from a year earlier, above the European Central Bank's definition of price stability of a year-on-year increase of below 2 percent.

NIEs and ASEAN economies remained buoyant, as exports of IT-related goods to countries such as Japan and the United States were rising and the effect of economic stimulus measures had permeated throughout these economies. In Indonesia, where political instability had continued, the rupiah gradually stopped deteriorating, as Indonesia and the International Monetary Fund moved a step closer to signing an agreement on economic reform.

D. Economic and Financial Developments in Japan

1. Economic developments

With regard to exogenous demand, net exports continued to follow an upward trend, and public investment seemed to remain at a high level reflecting the progress in the implementation of the supplementary budget for fiscal 1999. As regards domestic private demand, business fixed investment continued to increase. The recovery in private consumption as a whole continued to be weak, although there were somewhat encouraging signs in some indicators. Housing investment remained more or less unchanged.

Reflecting these developments, production was increasing, and corporate profits and sentiment continued to improve. The income situation of households remained severe with no substantial change in firms' stance of reducing personnel expenses. Employees' income, however, had stopped decreasing as the recovery in corporate activity started to spread to the household sector, as evident in the slight year-on-year increase in summer bonus payments made so far.

There was no significant change in prices.

As described above, Japan's economy was recovering gradually, with corporate profits and business fixed investment continuing to increase.

A close look at the household sector showed that there were at present no factors that would justify changing the view that the momentum for recovery in the sector was weak. Although the index of living expenditure level, sales of household electric appliances, and outlays for travel were firm, sales at department stores and chain stores continued to decline. However, with regard to the volume of consumer goods supplied, in addition to a considerable rise in imported goods, domestic goods were rising moderately, suggesting that actual consumption was not as weak as sales statistics indicated.

As for summer bonus payments, the Monthly Labour Survey showed that special cash earnings rose in June by 1.7 percent from the level of the previous year. Increases were sharp in very small firms (establishments with 5 to 29 employees) in particular, and with more firms of this size expected to pay summer bonuses from July onward, special cash earnings in the June-August period were very likely to be higher than the same period of the previous year. It could be judged that wages and salaries on the whole had stopped decreasing considering the trend in special cash earnings and the increase in regular and overtime earnings compared with the previous year.

As for the inventory cycle in the manufacturing sector, although inventories of IT-related producer goods were being accumulated reflecting buoyant demand, inventories and shipments remained well-balanced as many firms were trying to limit inventories of producer goods unrelated to IT.

On the economic outlook, the following assessments could be made. Business fixed investment was expected to continue to increase, in light of developments in leading indicators such as machinery orders, which had risen from the previous quarter for four consecutive quarters. Private consumption was very likely to start rising moderately given the expected improvement in household income and relatively stable consumer sentiment reflecting the improvement in the employment situation.

As for the outlook for prices, the domestic supply-demand balance was expected to continue improving, and downward pressure on prices stemming from weak demand was declining significantly. However, other factors that were affecting prices--technological innovation, the streamlining of distribution channels, and deregulation--were expected to exert downward pressure on prices, while higher crude oil prices were likely to exert upward pressure temporarily. Under these circumstances, price indexes on the whole were expected to be stable or slightly weak.

2. The financial environment

Private banks basically retained their cautious lending attitude. Major banks, however, continued to try to increase their lending. Fund-raising conditions in the capital markets for such instruments as corporate bonds and commercial paper (CP) remained favorable. So far firms had not postponed or suspended bond/CP issuance in reaction to the filing of reconstruction proceedings by Sogo.

The improvement in economic activity had not resulted in an increase in corporate demand for external funds, because firms' cash flow was increasing. Also, firms' efforts to reduce debt continued. These factors were contributing to the continued weakness in credit demand in the private sector.

Against this background, the year-on-year rate of decline in private banks' lending remained more or less unchanged. Some noted that demand for funds to invest in areas related to semiconductors and raw materials was increasing, but the overall balance of lending had not started to increase as firms continued to step up efforts to repay debt.

The year-on-year growth rate of the monetary base for July was lower than the previous month, mainly due to the slower growth in banknotes in circulation. The year-on-year growth rate of money stock (M2+CDs) had been steady recently with that for July at 2.0 percent.

In this financial environment, the lending attitude of financial institutions was perceived by firms as having become less severe, while firms' financial positions continued to improve. In short, corporate financing conditions were easing.

The number of corporate bankruptcies, which had been unchanged, was recently increasing as the positive effects of the special loan guarantee system were subsiding. The construction sector's share of bankruptcies was growing.

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

A. The Current Economic Situation and the Economic Outlook

On the current economic situation, members shared the view that the economy was recovering gradually, with corporate profits and business fixed investment continuing to increase. As for the outlook for the economy, many members expressed the view that the economy was likely to recover gradually, led mainly by business fixed investment. Accordingly, the majority of members agreed that the economy had reached the stage where deflationary concern had been dispelled.

Many views were exchanged on domestic private demand.

With regard to the corporate sector, many members said that business fixed investment had been increasing. These members expressed the view that it would continue to grow firmly, given the following trends in leading indicators: (1) machinery orders had surged in June with orders for all types of machines increasing year on year; (2) machinery orders were expected to see a double-digit quarter-on-quarter increase for July-September; and (3) construction starts of non-residential buildings had been increasing year on year. One of these members remarked that the recovery in business fixed investment was likely to gain momentum.

One member, however, expressed a cautious view on the outlook for business fixed investment. This member pointed out the following, with regard to the surge in machinery orders. First, the increase in orders for computers mainly reflected an increase in orders from the financial and insurance sectors, and the contribution from other sectors, including IT-related manufacturers, was small. Second, machinery orders through agencies, which are regarded as giving an accurate indication of trends in business fixed investment by small and medium-sized firms, were forecasted to decrease. Third, the achievement ratio for the quarterly forecast of machinery orders had been falling after reaching a peak in the January-March quarter. In response to this, another member said that the uptrend in business fixed investment seemed to have started to spread to a wide range of industries, from IT-related manufacturers to IT users and T-business industries (traditional heavy industries), which had been lacking in momentum for recovery. Also, the uptrend in business fixed investment seemed to have started to spread to a variety of sizes of firms, from large to small and medium-sized firms, although small and medium-sized firms were lagging slightly.

A few members pointed out that the improvement in production had become clearer and corporate profits had continued to rise steadily. One member remarked that production was recovering with a gradual shift in demand from external to domestic demand. These members said that the improvement in corporate sentiment could be confirmed in the recently released Business and Investment Survey of Incorporated Enterprises. However, one member added that one should not expect a significant improvement in corporate profits since firms were still restructuring their balance sheets and the momentum of the recovery in prices was weak.

To sum up, one member described the momentum of the recovery in the corporate sector as being stronger than had been expected.

With regard to the household sector, members discussed the employment and income situation, which was considered at the previous meeting to require further examination before a final decision to lift the zero interest rate policy was reached.

As for indicators relating to employment, some members pointed out that the number of employees had decreased slightly year on year. These members also, however, called attention to the fact that (1) the number of new job offers had recently been showing a significant increase, (2) the ratio of job offers to applicants had been increasing gradually, and (3) the unemployment rate had not increased substantially.

As for wages and salaries, many members noted that special cash earnings for June had shown a year-on-year increase. These members said that this, together with the results of various other surveys, indicated that summer bonus payments for fiscal 2000 would be about the same as, or slightly higher than, a year earlier. Further, many members remarked that total income per employee--the sum of regular and overtime earnings, which had been rising year on year for nearly a year, and special cash earnings--might have started to increase moderately.

On this basis, one member judged that employees' income as a whole--the product of the number of employees and wages--had stopped decreasing. Another member said that the positive effects of the improvement in the economy were gradually spreading to the household sector. On these grounds, the majority of members agreed that the employment and income situation had stopped deteriorating and was starting to improve.

Next, members exchanged views on private consumption. One member judged that private consumption continued to show mixed developments, pointing to the fact that (1) passenger car sales for July were relatively weak, and (2) the consumption stimulating effect of the unusually hot weather this summer would be limited. In contrast, a few members said that private consumption might start increasing moderately as (1) the index of living expenditure level for April-June had shown a quarter-on-quarter improvement, (2) indicators relating to consumer confidence had generally been showing an improvement, and (3) the propensity to consume was recently increasing slightly. Another member remarked that private consumption might improve very slowly, given the current employment and income situation.

However, some members including these members said that it would take some time before a clear recovery in the household sector would come into prospect, given the continued pressure from corporate restructuring. One of these members remarked that it would take time for the recovery in the corporate sector to spread to the household sector, because, against a background of pressure to adjust balance sheets and enormous competition, improvements in firms' cash flow would be first used to repay debt and to improve internal reserves, then for business fixed investment and dividend payments, and finally for wages. This member continued that income in the corporate sector would not easily flow into the household sector. This member said that, taking into account structural factors, such as the structural changes in consumption and concern over the social security system, it could be judged sufficient for the time being if private consumption, which had been showing mixed developments, started to improve slowly. The member continued that judging from developments in consumer sentiment, the spending behavior of households remained broadly in line with their disposable income, and thus it could be said that private consumption had reached a level that could be considered as normal. Another member expressed the view that when structural adjustment and corporate restructuring were being undertaken, the improvement in the household sector would lag behind that of the corporate sector. Thus one should not necessarily consider the slow pace of improvement in the household sector as cause for concern at this stage.

One member remarked that the developments in domestic private demand discussed above could be confirmed from anecdotal information as well. This member referred to examples of improvement observed in various industries and said that economic activity was becoming more brisk in a wider variety of sectors.

A different member commented that the diffusion index of Indexes of Business Conditions had not reached 100 percent in the current phase of economic recovery, and thus the extent to which the improvement of the economy had spread was limited and the momentum of the recovery was weak.

On the economic outlook, many members agreed that the economic growth rate was unlikely to rise significantly since various structural problems remained, but unless there were major adverse external shocks, the economy was likely to recover gradually, led mainly by business fixed investment. A few of these members said that the prospects for a self-sustained recovery in private demand were growing gradually. Further, a few members remarked that the supply-demand balance was expected to improve moderately, judging from developments in aggregate demand, including the continued increase in exports and relatively firm housing investment.

One member expressed a more cautious view of the economic outlook than other members and said that the economy might slow down from autumn 2000 on the following grounds. First, the ratio of the coincident indicators to the lagging indicators for business conditions showed that the economy was already approaching its peak, which in terms of quarters could be the July-September quarter. Second, fiscal spending was expected to decrease from the autumn, and this was likely to coincide with the beginning of a cyclical slowing down of the economy. Third, the U.S. economy and Asian economies might slow down and thus the external environment surrounding the Japanese economy could not be viewed optimistically. Fourth, corporate profits might stop increasing since the terms of trade had started to deteriorate.

In response to this, one member objected to the view that a decrease in fiscal spending would have a negative impact on the economy. This member said that (1) the size of the expected decrease in fiscal spending was much smaller than that in 1997, (2) the economic environment had changed from 1997 when the Asian financial crisis erupted and concern about instability in the Japanese financial system mounted, and (3) the economy had been improving clearly although fiscal spending had started to decrease significantly from the second half of 1999, according to GDP data.

With regard to developments in prices, many members expressed the view that although some price indexes were slightly weak, downward pressure on prices stemming from weak demand was declining significantly while an economic recovery was expected to continue moderately. A few members pointed out that the risk of prices declining was abating partly because of a moderate improvement in wages and salaries.

A few members, however, expressed concern over the downtrend in consumer prices and the GDP deflator. In view of the difference between developments in wholesale and consumer prices, one of these members called attention to the fact that the downward pressure on prices was stronger at the retail end than the wholesale.

Responding to this, some members pointed out that factors unrelated to developments in demand--such as appreciation of the yen, technological innovation, and rationalization of the distribution system, and a narrowing of the price difference between Japan and abroad reflecting these trends--had been exerting downward pressure on consumer prices. Another member remarked that given that the GDP deflator fell sharply in 1996 when economic growth hit a record high for the 1990s, it was important, when judging the basic trend of prices, to examine carefully the factors behind the price indexes, such as the supply-demand balance and developments in profits and income. This member continued that at present, judging from the sharp rise in corporate profits and the increase in employees' income, it was inappropriate to conclude only from the fall in price indicators that deflation was occurring.

One member commented that crude oil prices would continue to require close monitoring since they were expected to be volatile at a high level in the future due partly to a fall in inventories at small and medium-sized oil refiners, which accounted for the bulk of the U.S. oil refining industry. This member also expressed concern that land prices had in some cases fallen below their theoretical price calculated using the cash-flow method.

B. Financial Developments

On the financial front, many views were exchanged on the effects of the failure of Sogo on market sentiment. Most members said that the impact on markets was limited.

With regard to the developments in stock prices, many members commented that the volatility since the middle of July could be attributed mainly to the adjustment of high-tech stock prices reflecting the fall in U.S. Nasdaq stocks, and the effects of Sogo's failure were limited. A few of these members pointed out that a breakdown by industry showed that the contribution of falls in high-tech related stocks, such as those of electrical machinery manufacturers, was significant. A different member stated that judging from the recovery in bank stock prices to the levels of before mid-July 2000, concerns over the financial system had not heightened as they had in 1997 and 1998.

Many members remarked that the expansion in the credit spread in the corporate bond market was limited and the Japan premium continued to be almost zero. One member expressed the view that although foreign investors were selling Japanese stocks, they were not shifting investment away from yen assets as they seemed to be reinvesting the funds in yen-denominated bonds.

A different member remarked that it was unlikely that Sogo's failure would rekindle concern over the financial system, given that (1) major financial institutions did not expect a sharp increase in their nonperforming loans disposal for fiscal 2000, and (2) losses from the disposal of nonperforming loans could be covered by profits even if fairly severe assumptions about land prices and other factors were used in calculating the value of assets.

Based on the above assessment of developments in various markets, members generally agreed that so far Sogo's failure had not triggered any significant spread of concern over the financial system, nor induced any notable deterioration in market sentiment.

One member, while agreeing with other members that the direct impact of Sogo's failure on markets was limited, noted that, viewing the situation with a longer time frame, adjustments in stock prices started in spring 2000. Thus, the member would like to examine further how the stock markets would reflect Japan's economic growth and corporate profits in the medium to long term. Another member pointed out that it was likely that selling of stocks would continue since the following bullish factors for stock prices were gradually starting to disappear: (1) the zero interest rate policy; (2) purchases by foreign investors; and (3) the strength in IT-related stocks.

Some members expressed their views on corporate bankruptcies. One member said that one should pay attention to the fact that consumer confidence was improving despite the gradual increase in the number of bankruptcies, and there was no need to become overly concerned about the increase in the number of bankruptcies itself. A different member said that although there was still a possibility that large-scale bankruptcies would occur, it was unlikely that they would be a negative surprise for the market and fuel uncertainty over the financial system.

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

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

Many members' view on the economic and financial situation was as follows. First, Japan's economy was recovering gradually, with corporate profits and business fixed investment continuing to increase. Second, the employment and income situation had stopped deteriorating and was starting to improve. Third, the economy was likely to recover gradually led mainly by business fixed investment, unless there were major adverse external shocks. Fourth, downward pressure on prices stemming from weak demand was declining significantly. And fifth, in the financial market, no significant spreading of concern over the financial system or notable deterioration in market sentiment was observed.

On the basis of the above assessment, many members shared the view that the economy had reached the stage where deflationary concern had been dispelled.

Thus, with regard to monetary policy for the immediate future, the majority of members considered it appropriate to raise the uncollateralized overnight call rate target to around 0.25 percent, thereby terminating the zero interest rate policy. Many members stressed that it was vital to clearly explain various issues related to termination of the zero interest rate policy and the Bank's thinking behind it to the general public and the market to gain their understanding.

Many members commented that the two points that had been identified at the previous meeting as points that needed to be checked had now been confirmed: (1) that the economy had reached the stage where deflationary concern had been dispelled; and (2) that the impact of the failure of Sogo on market developments and sentiment was limited. Therefore, they considered that the economy had reached a situation where the zero interest rate policy should be terminated. They stated that the uncollateralized overnight call rate target should be raised to around 0.25 percent--the level before the zero interest rate policy was introduced.

One member commented on possible effects that termination of the zero interest rate policy would have on the market. First, stocks could temporarily come under downward pressure, but it was unlikely that the market would be seriously affected. Second, a 0.25 percentage-point rise in the uncollaterized overnight call rate was unlikely to change the trend in the foreign exchange market as the interest rate differential between the United States and Japan would hardly change. And third, the impact on long-term interest rates would also be limited provided that market participants continued to have confidence that the Bank would continue its accommodative monetary policy. The member added that, given the current economic situation, it was considered the right time to terminate the zero interest rate policy.

Many members were of the view that termination of the zero interest rate policy was a small adjustment to the degree of the Bank's monetary easing, and thus the accommodative monetary conditions to support the recovery of the economy would continue. One member pointed out that since the zero interest rate policy was introduced, private research institutes had revised upward their forecasts for economic growth by about 1-2 percentage points and estimates of firms' profitability had been revised upward. On this basis, a 0.25 percentage-point increase was very small and monetary conditions, in light of the current economic situation, continued to be extremely easy. Another member commented that the condition for terminating the zero interest rate policy, an economic situation where deflationary concern had been dispelled, would be satisfied in the early stages of a self-sustained recovery of the economy. Therefore, even if the Bank terminated the zero interest rate policy, this did not mean a change in the Bank's stance to support the recovery of the economy through monetary policy.

One member, however, said that given the fact that the economy was not yet judged to be on a steady recovery path, it would not be appropriate to adjust, even slightly, the Bank's easy monetary policy. Further, the member referred to the case of the United States in 1994, and pointed out that the Federal Reserve acted with utmost prudence after fully examining the economic situation.

Some members expressed the view that termination of the zero interest rate policy was a prudent policy change that took into account uncertainty and risks in the future. A few members explicitly stated that, in view of the now clear economic recovery, continuation of monetary easing adopted at the bottom of the business cycle could increase the risk of large fluctuations in the economy and prices, necessitating a drastic adjustment in interest rates in the future. In this regard, adjustments to the degree of monetary easing in accordance with the improvement of the economy would contribute to sound economic development in the long term. A different member commented that, if the economic situation changed significantly after termination of the policy, the Bank would need to flexibly change policy in a timely manner.

Some views were put forward concerning the relationship between monetary policy and structural adjustment. One member considered that the problem of firms' excess debt could continue to place negative pressure on the economy over a long period. Thus, from the perspective of monetary policy, it was important to examine carefully the growth path of the economy and developments in prices, both of which would be affected by such structural problems. Another member commented that the current state of the Japanese economy was the result of a complicated combination of structural and cyclical factors, and that it was natural to adjust the level of interest rates in accordance with the cyclical strength of the economy.

Members discussed the relationship between the Bank's monetary policy and the Government's economic policy.

Some members expressed the view that monetary policy would remain consistent with the Government's economic policy on the following grounds. First, the Government and the Bank were working toward the same goal of achieving a self-sustained economic recovery led by private demand. And second, monetary policy would still be very stimulative even after termination of the zero interest rate policy. One of them commented that, as long as the goal was the same, the Bank and the Government could take different policy measures to achieve the goal. Another member noted that monetary policy actions should not automatically be synchronized with fiscal policy measures. Rather, monetary policy would be fundamentally in line with the Government's economic policy when the former, taking into consideration the effect of fiscal policy, was conducted with a view to achieving a self-sustained recovery of private demand while maintaining price stability. In relation to the above discussion, a different member expressed the view that termination of the policy was in line with two articles of the Bank of Japan Law of 1997: Article 3 which stipulated that the autonomy of the Bank shall be respected, and Article 4 which stipulated that the Bank's monetary policy shall be harmonious with the basic stance of the Government's economic policy.

On the basis of the above discussion, one member who advocated termination of the zero interest rate policy commented that the following point should be made clear if the Bank decided to terminate the zero interest rate policy at this meeting. The Bank's decision was based on the judgment that the condition for terminating the zero interest rate policy had been satisfied--in other words, deflationary concern had been dispelled--and not because the Bank wanted to demonstrate its independence, as some had speculated.

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

One of these members said that the member was not fully confident that the economy had reached a stage where deflationary concern had been dispelled, while recognizing that it was steadily approaching that stage. The member considered that it was appropriate to continue the zero interest rate policy.

The reason for this view was that the member would like to confirm the following: (1) that stock prices, which seemed to have stopped declining, had started to show an uptrend, reflecting a positive economic outlook for the medium to long term; and (2) that the economy had recovered above a certain level and justified an increase in interest rates. Regarding the second point, the member presented an analysis of the optimal interest rate derived from the Taylor Rule, commenting that the level of the optimal interest rate should be evaluated with a certain amount of latitude. According to the calculations, the optimal interest rate in the current economic situation, where there was a large supply-demand gap, was in the range of slightly above to slightly below zero percent. The member continued that, given such factors as the current level of inflation, the cost of waiting was small, and the Bank should therefore continue the zero interest rate policy until the optimal interest rate had more clearly risen above zero.

In response to the above view, one of the members who supported termination of the zero interest rate policy commented as follows. While the second point above attached importance to the size of the supply-demand gap at a particular point in time, it could be said that the direction of changes in the gap was also a major factor that could affect price developments. Thus, in judging that deflationary concern had been dispelled, it was important that there were clear prospects for an improvement in the supply-demand balance.

Another member advocated adopting monetary base targeting accompanied by setting a target for the rate of increase in the consumer price index (CPI), and increasing current account balances at the Bank to achieve these targets.

The member remarked that the Bank should implement further quantitative easing and continue it for a certain period of time for the following reasons. First, the output gap remained quite large. Second, while there were hardly any risks of inflation, the decline in the CPI was a matter of concern. Third, termination of the zero interest rate policy would reduce current account balances at the Bank by about 1 trillion yen. Therefore, in a situation where growth in the monetary base and the money stock was slowing, there was a risk that termination would cause a further deceleration in monetary aggregates, and this could negatively affect stock prices and the yen's exchange rate. And fourth, the Bank should release a specific policy target and provide a means of gauging the performance of the Bank's monetary policy, and use these to enhance discussions on monetary policy within the Bank and promote communication with the market.

In relation to the above view, one of the members who advocated termination of the zero interest rate policy analyzed the relationship between an increase in interest rates and the monetary aggregates. First, after the policy rate was raised, the monetary base would decline somewhat at first as the provision of excess reserves would no longer be necessary, but the monetary base could increase thereafter due to an increase in demand for cash as the economy recovered. Second, developments in the money supply were linked closely to lending rates and interest rates on deposits, both of which were offered to firms and households, and thus it was unlikely that the money stock would decline immediately following changes in the monetary base.

Some members expressed regret over the way information was disclosed and handled before the meeting, pointing out that views and opinions to be presented at the meeting had been circulated prior to it through various channels, and that this had caused unnecessary confusion. One of these members commented that the confusion was partly due to the Bank's insufficient explanation of its thinking, and therefore in conducting monetary policy in the future, the Bank should make greater efforts to communicate smoothly with other parties including the Government, and also improve the dialogue with the market.

V. Remarks by Government Representatives

The representative from the Ministry of Finance (MOF) made the following remarks.

(1) Japan's economy continued to improve moderately, but the employment situation remained severe. Private consumption had been more or less unchanged. Although the improvement in business fixed investment had become clearer, its sustainability and the extent to which it would spread would continue to require close monitoring. It was not yet clear whether the substantial improvement in corporate profits would lead to an improvement in the employment and income situation and an increase in private consumption. The GDP deflator and the CPI continued to decrease year on year. Under such circumstances, attention should be paid to the fact that the recent bankruptcy of a major corporation had increased uncertainty about the future of the economy and was affecting financial markets.

Given the above situation, the economy required further monitoring to determine whether deflationary concern had been dispelled and a full-scale recovery of economy led by private demand could be achieved.

(2) The Government would continue with fiscal measures in order to realize a full-scale recovery of the economy. To this end, the Cabinet had recently decided to use the contingency fund for public works. The Government will steadily implement the budget for fiscal 2000 to realize a smooth shift in the driving force for an economic recovery from public to private demand and to achieve a full-scale economic recovery led by private demand. Since the outlook for the economy was not clear yet, the Government considered it appropriate to decide future fiscal policy after studying preliminary GDP data for the April-June quarter.

(3) The G-7 statement released at the Okinawa summit said that Japan's macroeconomic policies should continue to be supportive to ensure domestic demand-led growth. The Government would continue to conduct appropriate economic management to this end.

(4) The Government would like to ask the Bank to maintain the current guideline for market operations and provide ample funds to the market in a flexible manner giving due consideration to developments in financial markets, including the foreign exchange market, harmonizing its actions with the Government's measures to ensure a recovery of the economy.

The representative from the Economic Planning Agency (EPA) made the following remarks.

(1) Japan's economy continued to improve moderately due to the effects of various policy measures and of the economic recovery in Asia. There continued to be momentum for a self-sustained recovery of the economy, mainly in the corporate sector. However, the employment situation remained severe, and private consumption was generally unchanged. Moreover, the recent sluggishness in consumption, falls in stock prices, and deterioration in some leading indicators suggested that one could not confirm that the economy had returned to a self-sustained recovery track. As for corporate bankruptcies, the number was at a relatively high level and the amount of liabilities owed by firms that had gone bankrupt was increasing. Furthermore, developments such as the acceleration in the pace of corporate restructuring, the progress in the disposal of nonperforming assets, and trends in overseas economies were causes for concern and thus required close monitoring.

Therefore, developments in interest rates or a change in monetary policy at this time, however small, could be perceived as a shift away from a policy with an emphasis on economic recovery. And such a perception would have an enormous impact on business sentiment.

(2) Considering the current state of the economy, it was necessary to continue conducting economic and fiscal policy in a timely and flexible manner, with a focus on economic recovery. The Government would like to ask the Bank to continue conducting monetary policy that would contribute to economic recovery--for example, by flexibly providing ample funds in the market giving due consideration to developments in financial markets, including the foreign exchange market. At present, it was premature to terminate the zero interest rate policy.

VI. Votes

A. Submission of Two Policy Proposals

Based on the above discussion, the majority of members considered it appropriate to raise the uncollateralized overnight call rate target to around 0.25 percent and thereby terminate the zero interest rate policy.

However, one member proposed adopting quantitative easing accompanied by a target for the rate of increase in the CPI and the growth rate of the monetary base.

As a result, two policy proposals were submitted.

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 CPI (excluding perishables) in the October-December quarter of 2002 as a medium-term target of price stability. In achieving this target, the Bank will raise the average balance of current accounts at the Bank in the intermeeting period ahead to about 7 trillion yen, and by continuing to increase the amount thereafter, induce approximately 15 percent annual growth of the monetary base (change from the average for the January-March quarter of 2000 to the average for the same quarter of 2001) to realize quantitative easing (expansion of the monetary base).

Regardless of the above target for the monetary base, the Bank will provide ample funds should there be a risk that financial markets might destabilize, for example, should demand for liquidity surge.

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. A statement on the guideline would be decided separately.

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

The chairman elaborated on the above proposal as follows. First, termination of the zero interest rate policy signified a small adjustment to the degree of monetary easing in line with the improvement of the economy. Second, even after the zero interest rate policy was terminated, the uncollateralized overnight call rate would still be extremely low. Thus, monetary conditions would remain largely relaxed and support the recovery of the economy. And third, with the termination of the policy, it was hoped that the public would become more confident that the economy was recovering. It was also hoped that the dynamism of the market would be enhanced as a result of the termination.

B. Discussion and Voting on the Request by the Government to Postpone the Vote

Following the chairman's proposal to terminate the zero interest rate policy, the representatives from the MOF and the EPA requested the chairman to adjourn the meeting because the MOF and the EPA needed to discuss whether to file a request for postponement of the vote on the proposal and, the representatives might need to contact the Minister of Finance and the Minister of State for Economic Planning. The chairman approved the request. (The meeting adjourned at 2:51 p.m. and reconvened at 3:10 p.m.)

After the meeting reconvened, the MOF and EPA representatives stated that, as a result of their discussion, they had decided to request that the vote on the chairman's proposal be postponed on the grounds that it was premature to terminate the zero interest rate policy given the economic situation and recent developments in financial markets. Subsequently, the MOF and EPA representatives filed a request, pursuant to Article 19, Paragraph 2 of the Bank of Japan Law, that the Policy Board postpone until the next Monetary Policy Meeting a vote on the chairman's proposal regarding the guideline for money market operations in the intermeeting period ahead.

Members discussed the Government's request.

A few members asked the Government representatives for a clear explanation of the reasons for their request to postpone the vote. The MOF representative explained that, compared to the Bank, the Government was slightly more cautious in its evaluation of the economic situation and developments in the financial markets. For example, the Government judged that (1) although the economy was recovering led by the corporate sector, the employment and income situation remained severe, and (2) developments in financial markets, including the stock market, still warranted close attention. The EPA representative expressed the view that at this point in time more prudence should be exercised with regard to policy decisions, pointing to various downside risks to the economy such as (1) uncertainty in the outlook for U.S. stocks, (2) the slight lull in the recovery of Asian economies, (3) a possible decline in support from fiscal measures, and (4) uncertainty about the effects of financial institutions' disposal of nonperforming loans.

Another member asked for clarification regarding the circumstances in which Article 19, Paragraph 2 of the Bank of Japan Law of 1997, which stated the right of Government representatives to request a delay on a vote, could be applied, and more specifically, whether cases where there was a difference between the Government's and the Bank's views of the economy were included.

A different member answered that when revision of the Bank of Japan Law was deliberated, the following example was put forward: Article 19, Paragraph 2 could be applied when an unexpected or a highly technical proposal was made and the Government needed time to think over and fully explain its position on the proposal.

On discussions relating to revision of the Bank of Japan Law, the Bank's staff introduced the following. First, a relevant section of the"Report concerning the Revision of the Bank of Japan Law" submitted by the Financial System Research Council to the Minister of Finance on February 6, 1997. ⁴And second, the response of Mr. Toshiro Muto, who was the Deputy Vice Minister for Policy Coordination at the Ministry of Finance when revision of the Law was being debated, to a question posed to the Government at the Diet on May 14, 1997. ⁵

4"It is important to give the Government an opportunity to fully explain its views at monetary policy meetings in order to ensure consistency between the policies of the Bank and the Government and secure transparency in the decision-making process. Therefore, since the framework provides a means to coordinate the differing views of the Government and the Bank on monetary policy, the Policy Board should make sure that the Government fully explain its views before taking a vote."
5"When a proposal put forward at a monetary policy meeting is broadly in line with what the Government had been expecting and the Government's position on that proposal has been almost decided, the Government representatives can immediately explain their views and the Board make a judgment... However, there might be cases where the Government's stance on a new proposal has not yet been decided. In such cases, the Government would need a certain amount of time, not too long, to examine the proposal and decide its stance. There also may be cases where Government representatives, in response to a question from a Policy Board member, might not be fully prepared to explain the Government's views. I am afraid I cannot yet give a clear answer on what sort of cases the Article could apply to, but, the situations I have just mentioned, although somewhat unspecific, may give some idea of the circumstances under which the Government can request that a vote be postponed."

Members discussed their views on the above.

One member said that the Policy Board should accept the Government's request for the following reasons. First, if the Policy Board pressed ahead with adoption of the chairman's proposal, the credibility both at home and abroad of the Japanese authorities would be critically damaged and this could cause trouble for future economic policy. Second, the difference between the Bank's and the Government's view of the economic outlook was especially large in areas such as business fixed investment and exports, and they should discuss further their differences of opinion. Third, the Bank was using extremely abstract language to describe its policy goal, and as this seemed to be the cause of the current debate, the Bank and the Government should make efforts over a period of one month to discuss and reach a common understanding on the Bank's policy goal. Fourth, only two and a half years had passed since the Bank of Japan Law of 1997 came into effect and the meaning of independence of the Bank was already being questioned. Therefore an adequate cooling-down period might be needed. Fifth, it should not be overlooked that in a parliamentary democracy, the Government's request to postpone the vote was thought to be backed by the ruling parties and the Diet. And sixth, the decision whether to terminate the zero interest rate policy should be made after confirming the results of the preliminary GDP data for the April-June quarter. The member continued that it was a matter of extreme gravity that the Government had requested the vote to be postponed, citing as an example the business practice of corporations where the management had a full exchange of views with major stock holders prior to stockholders' meetings.

In response to this, many other members expressed their opposition to the request to postpone the vote. One member said that although there was a gap between the Bank's and the Government's views on the economic situation, it was a very subtle difference in the judgment on the outlook for the sustainability of economic recovery since (1) they concurred in judging that the economic recovery was being led mainly by the corporate sector, and (2) the Bank too was taking into consideration various risk factors on the future course of the economy. The member continued that it was a prearranged procedure in line with the framework provided by the Bank of Japan Law that the Bank made decisions autonomously after extensive debate, including discussion of the Government's views, when the Government requested a postponement of a vote. Furthermore, it went without saying that the Bank should take responsibility for the decisions it made. Another member commented that the difference between the two views of the economy was extremely subtle and might not be a convincing reason to postpone the vote.

A different member said that while the Bank considered that the condition for termination of the zero interest rate policy, an economic situation where deflationary concern had been dispelled, would be satisfied in the early stages of an economic recovery, the Government seemed to think that such a situation could not be said to exist until it became certain that private demand was recovering. If this was the case, a slight difference in the views of the Government and the Bank was inevitable. The member, however, added that, with regard to the Bank's policy goal, the Bank and Government's views should be consistent. The member remarked that as a result of the discussion with the Government representatives, the direction of the Bank's policy and that of the Government was judged to be the same.

After the above discussion, the Government's request to postpone the vote on the chairman's policy proposal was put to the vote pursuant to Article 19, Paragraph 3 of the Bank of Japan Law. As a result, the Government's proposal that a vote on the chairman's proposal be postponed was defeated with one vote in favor, eight against.

C. Votes on the Guideline for Money Market Operations in the Intermeeting Period Ahead

Mr. Nakahara's proposal and the chairman's proposal were put to the vote.

Mr. Nakahara's proposal was defeated with one vote in favor, eight against.

The chairman's proposal was decided by majority vote.

Votes for the proposal: Mr. M. Hayami, Mr. S. Fujiwara, Mr. Y. Yamaguchi, Mr. S. Taketomi, Mr. T. Miki, Ms. E. Shinotsuka, and Mr. T. Taya.

Votes against the proposal: Mr. N. Nakahara and Mr. K. Ueda.

Mr. Ueda dissented for the following reasons. First, it would be desirable to examine developments in the stock market for a little while longer. Second, the optimal interest rate had at last reached a level around zero, but it would be desirable to wait for the rate to rise clearly above zero. And third, judging from trends in inflation, the cost of waiting would be negligible. He added that his view of the economic situation did not differ significantly from that of other members.

Mr. Nakahara voted against the chairman's proposal on the following grounds. First, a decision to terminate the zero interest rate policy could have a large impact on the Bank's independence and the relationship between the Bank and the Government with respect to the conduct of economic policy. Second, the difference between the views of the Bank's staff and the Government on the economic outlook was especially large in areas such as business fixed investment and exports, and this meant that accountability was insufficient. Third, the decision would further reduce credibility of policy coordination between the Government and the Bank both at home and abroad, and thus it would be desirable to take time out to exchange views and reach a common understanding. Fourth, effectively ending the quantitative easing would not have a positive effect on financial markets, affecting stock prices and the foreign exchange market negatively. And fifth, the justification for raising interest rates when a fairly wide output gap existed could not be explained by orthodox economic theory. Furthermore, the move would go against the mainstream of thinking in the world of academic economists and could create a view among foreign countries that the Bank was a heretic.

After the votes, the Government representatives expressed deep regret that their request to postpone the vote on the chairman's proposal had been voted down. They continued that the Government would like the Bank to continue implementing monetary policy in an appropriate and flexible manner--for example, by providing ample funds in the markets, giving due consideration to the economic situation and developments in financial markets under the new guideline--and make sure that the decision at this meeting would not cause the economic recovery to stall or have a negative effect on financial markets. The representatives added that they planned to announce later in the day the fact that they had requested a postponement of the vote on the chairman's proposal and the reason for the request.

In response to this, the chairman expressed the view that (1) it could be said that there was no significant difference between the Government and the Bank in their views of the outlook for the economy and basic thinking on economic policy, and (2) the decision at this meeting was a small adjustment to the degree of monetary easing, and monetary conditions continued to be supportive of economic recovery. The chairman continued that the decision today might be perceived as a confrontation between the Government and the Bank, but the decision was duly made in line with the transparent framework of exchanging views provided by the Bank of Japan Law. He said it was necessary to explain this point clearly to the public to avoid any misunderstanding. The chairman stressed that the Bank would continue to make appropriate policy decisions, maintaining close contact with the Government in line with the framework established by the Bank of Japan Law, i.e., the Government's views should be discussed at Monetary Policy Meetings and the debate at the meetings should be disclosed in the minutes of the meetings.

VII. The Release of a Statement on the Change of the Guideline for Money Market Operations

A statement on the change of the guideline for money market operations for the intermeeting period ahead was formulated based on members' discussion of a draft statement that the chairman had ordered the staff to prepare.

A view was put forward that, in drawing up the statement, the Bank should take into account the fact that its monetary policy should be consistent with the Government's economic policy. After some discussion on this point, members supported the idea to include a sentence saying that the Bank would"conduct monetary policy in an appropriate and flexible manner."

Publication of the statement was put to the vote. By majority vote, the immediate release of the statement,"Change of the Guideline for Money Market Operations"(see Attachment 1), was decided.

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

Vote against the proposal: Mr. N. Nakahara.

The chairman said that the Policy Board's decision to reject the Government's request to postpone the vote on the change of the guideline for money market operations would also be publicized in a statement(see Attachment 2). The chairman would hold a press conference after the meeting, following the established custom when a policy change was decided.

VIII. 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. By majority vote, the Board determined"The Bank's View," for publication on August 15, 2000 in the Monthly Report of Recent Economic and Financial Developments (consisting of"The Bank's View" and"The Background"). ⁶

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

Vote against the proposal: Mr. N. Nakahara.

Mr. Nakahara dissented for the following reasons. First, the CPI and the GDP deflator, which both are more closely related to final demand than the wholesale price index, were declining at a faster pace. And second, the output gap remained large. It was therefore inappropriate, when the decline in actual price indicators such as the CPI and the GDP deflator was accelerating, to judge and to state in the report that the downward pressure on prices stemming from weak demand was declining significantly.

In closing the meeting, the chairman expressed his deep regret over the fact that there had been media reports on developments at the meeting while the meeting was still in progress. The chairman urged all those present to be extremely careful about the confidentiality of the discussion at Monetary Policy Meetings.

6The original full text, written in Japanese, of the Monthly Report of Recent Economic and Financial Developments was published on August 15, 2000 together with the English version of"The Bank's View." The English version of"The Background" was published on August 25, 2000.

Attachment 1

For immediate release

August 11, 2000
Bank of Japan

Change of the Guideline for Money Market Operations

1. At the Monetary Policy Meeting held today, the Bank of Japan decided, by majority vote, to change the guideline for money market operations for the intermeeting period as follows:

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

2. In February 1999, the Bank of Japan adopted the zero interest rate policy, unprecedented both in and out of Japan, to counter the possibility of mounting deflationary pressure and prevent further deterioration in economic conditions. Furthermore, it announced in April 1999 to continue the zero interest rate policy until deflationary concern is dispelled.

3. Over the past one year and a half, Japan's economy has substantially improved, due to such factors as support from macroeconomic policy, recovery of the world economy, diminishing concerns over the financial system, and technological innovation in the broad information and communications area. At present, Japan's economy is showing clearer signs of recovery, and this gradual upturn, led mainly by business fixed investment, is likely to continue. Under such circumstances, the downward pressure on prices stemming from weak demand has markedly receded.

Considering these developments, the Bank of Japan feels confident that Japan's economy has reached the stage where deflationary concern has been dispelled, the condition for lifting the zero interest rate policy.

4. Since the middle of this July, the Bank of Japan has been closely monitoring the possible impact the collapse of Sogo Department Store might have. So far, it has not triggered any significant spread of concern over the financial system, nor induced any notable deterioration in market sentiment.

5. Today's decision signifies a small adjustment to the degree of monetary easing in line with the improvement of the economy, thereby contributing to long-term sustainable growth.

Even after the zero interest rate policy is terminated, monetary conditions remain largely relaxed in that the unsecured overnight call rate is still extremely low around 0.25 %. The Bank of Japan will conduct monetary policy in an appropriate and flexible manner to support the economic recovery consistent with price stability.

Attachment 2