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Minutes of the Monetary Policy Meeting

on August 13 and 14, 2001
(English translation prepared by the Bank's staff based on the Japanese original)

September 25, 2001
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 Monday, August 13, 2001, from 2:00 p.m. to 4:19 p.m., and on Tuesday, August 14, from 9:01 a.m. to 1:04 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. T. Miki
Mr. N. Nakahara
Mr. K. Ueda
Mr. T. Taya
Ms. M. Suda
Mr. S. Nakahara

Government Representatives Present
Mr. H. Fujii, Deputy Vice Minister for Policy Planning and Coordination, Ministry of Finance
Mr. H. Takenaka, Minister of State for Economic and Fiscal Policy, Cabinet Office 2
Mr. K. Iwata, Director General for Economic Assessment and Policy Analysis, Cabinet Office 3

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

Secretariat of the Monetary Policy Meeting
Mr. I. Yokota, Director, Secretariat of the Policy Board
Mr. Y. Nakayama, Advisor to the Governor, Secretariat of the Policy Board
Mr. H. Onobuchi, Manager, Secretariat of the Policy Board
Mr. K. Etoh, Senior Economist, Policy Planning Office
Mr. S. Nagai, Senior Economist, Policy Planning Office

  1. The minutes of this meeting were approved by the Policy Board at the Monetary Policy Meeting held on September 18, 2001 as "a document which contains an outline of the discussion at the meeting" stipulated in Article 20, Paragraph 1 of the Bank of Japan Law of 1997. Those present are referred to by their titles at the time of the meeting.
  2. Mr. Takenaka was present on August 14.
  3. Mr. Iwata was present on August 13.

I. Summary of Staff Reports on Economic and Financial Developments4

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 12 and 13, 2001 so that the outstanding balance of current accounts at the Bank was around 5 trillion yen.5 As a result, the uncollateralized overnight call rate was extremely stable at 0.01 percent, except for a few individual days when it rose to 0.02 percent, including July 31. The weighted average of the rate marked a historic low of 0.01 percent until August 10 in the current reserve maintenance period.

The Bank provided funds maturing over the end of September more actively than the previous year to respond to an increase in demand for funds maturing over end-September, which was the end of the semiannual accounting period for most firms. A new system to facilitate bidding procedures in market operations started operating on July 23. Bill purchasing operations at the head office and all branches of the Bank, which were conducted twice after the start of the new system, went smoothly as was shown in the fact that the ratio of the amount bid to the amount offered exceeded that in the operations conducted only at the head office. This was due to the increase in the number of eligible financial institutions and an improvement in accessibility.

  1. 4Reports were made based on information available at the time of the meeting.
  2. 5The guideline was as follows:
    The Bank of Japan will conduct money market operations, aiming the outstanding balance of the current accounts at the Bank at around 5 trillion yen.
    Should there be a risk of financial market instability, e.g., a rapid surge in liquidity demand, the Bank will provide ampler liquidity irrespective of the guideline above.

B. Recent Developments in Financial Markets

Stock prices were weak, declining to the lowest levels since the start of the year. Long-term interest rates rose to 1.4-1.5 percent at one point, and interest rates on short-term instruments maturing beyond end-September had also strengthened recently. In the foreign exchange market, the yen had recently appreciated to around 122 yen against the U.S. dollar, after being traded in the 123-126 yen range for sometime.

Stock prices continued to follow a downtrend due mainly to the following factors: successive downward revisions of earnings forecasts by IT-related firms in Japan and the United States; weakness in bank stocks due to concerns about increase in nonperforming loans (NPLs) to be disposed of and an expansion of unrealized capital losses on stocks; and intensifying downward pressure caused by unwinding of cross-shareholdings. Concerns about a further slide in stock prices remained strong among market participants, as stock prices overseas were falling due to diminishing expectation of a recovery of the U.S. economy in the second half of the year.

Long-term interest rates rose to 1.4-1.5 percent at one time after the previous meeting due to concerns over a possible deterioration in the supply-demand balance reflecting discussions regarding the supplementary budget in fiscal 2001. Medium-term interest rates also rose reflecting financial institutions' profit-taking sales given weak stock prices. Market participants considered that developments in the interest rates would be unstable and susceptible to factors related to deterioration in the supply-demand balance for a while, although some market participants bought back bonds from the latter half of the week starting August 6. Interest rates on short-term instruments maturing beyond end-September strengthened as some city banks started to raise funds early. However, at this point such developments seemed to be within the range of fluctuation caused by seasonal factors.

In the foreign exchange market, the yen continued to fluctuate in the range of 123-126 yen against the U.S. dollar without particular direction, as uncertainty about the economic outlook became stronger both in Japan and the United States and stock prices in both countries continued to show unstable developments. It appreciated to around 122 yen from August 9, however, due partly to heightened market speculation of modification of the strong dollar policy by the U.S. authorities.

C. Overseas Economic and Financial Developments

A simultaneous deceleration in the world economy had become more distinct since the previous meeting.

In the United States, real GDP for the April-June quarter increased at an annualized rate of 0.7 percent from the previous quarter, which was the lowest growth since the January-March quarter in 1993. Demand in the household sector, such as private consumption and housing investment, was firm. Adjustment in the corporate sector, however, intensified, as business fixed investment decreased substantially due to a deterioration in corporate profits. Moreover, with the recent slower growth of labor productivity, downward pressure on corporate profits from the cost side became clear. The unemployment rate for July remained unchanged from the previous month. However, the employment situation continued to deteriorate, as evident in a decrease in the number of employees in both manufacturing and nonmanufacturing industries due to production adjustment in the corporate sector. Meanwhile, prices were stable. The beige book released on August 8, 2001 by the Federal Reserve Board (FRB) pointed out the overall sluggishness in retail sales and this seemed to be generally perceived as confirming the weakness in the U.S. economy.

Economies in the euro area were also decelerating. In the corporate sector, production was on a downtrend, mainly in Germany and France, due to slower growth in exports to the United States. Business fixed investment was slowing reflecting a deterioration in business confidence. In the household sector, private consumption was firm, but consumer confidence was deteriorating recently. In Germany, negative developments were observed, for example, growth in the volume of retail sales continued to slow reflecting an increase in the number of unemployed. In Italy, real GDP showed negative growth in the April-June quarter.

East Asian economies continued to slow. Production was on a decreasing trend, as exports of goods, mainly IT-related ones, to the United States and Japan continued to decrease.

In the international financial markets, long-term interest rates were falling and stock prices remained generally volatile in the United States and in the euro area reflecting an acceleration in the simultaneous slowdown of the world economy. U.S. federal funds rate futures factored in an expectation of a cut of 25 basis points in the federal funds rate in the next Federal Open Market Committee (FOMC), which was scheduled for August 21, 2001 and an additional cut before the year-end.

In the emerging markets, yield spreads between Argentine government bonds and U.S. Treasuries expanded significantly toward mid-July due to concerns about the solvency of the Argentine government. In line with this, a fall in government bond prices and a depreciation of currencies were observed in Latin American countries such as Brazil and in some East European countries. A worsening of the turmoil in Argentina came to a halt, after a bill to reduce fiscal expenditures was approved by the congress and aid was decided by the International Monetary Fund. However, yield spreads between Argentine government bonds and U.S. Treasuries remained wide, and thus continued to require monitoring.

D. Economic and Financial Developments in Japan

1. Economic developments

Adjustments in economic activities were intensifying further, reflecting a substantial decline in exports and production.

With regard to final demand, private consumption remained flat on the whole. On the other hand, housing investment and public investment were decreasing. Exports continued to decline substantially, reflecting not only a slowdown in overseas economies but also sluggish demand for IT-related goods. Against this background, business fixed investment was decreasing.

Production continued to decline sharply, reflecting such developments in final demand and strong pressure for adjustment in inventories of electronic parts and some materials. Household income was weakening gradually due to a deterioration in corporate profits.

Shipments of semiconductors and personal computers worldwide remained very sluggish, as was evident in their substantial fall in the April-June quarter from the projections in spring. Under these circumstances, exports, which had already declined substantially in the January-March quarter, continued to fall at a similar pace in the April-June quarter due to a decline in demand for IT-related goods and capital goods. Exports of intermediate goods such as steel and chemicals were decreasing further recently. It was likely that business fixed investment was declining, although not rapidly, since shipments of capital goods for the April-June quarter dropped sharply and machinery orders for the July-September quarter were projected to decrease.

Production was expected to continue following a downtrend for the July-September quarter due partly to pressure for inventory adjustments mainly in producer goods, after declining sharply in the April-June quarter. In this situation, new job offers, which had been increasing until May, started to decrease in June, and household income was weakening gradually as nominal wages mainly in special cash earnings decreased further from a year earlier for small firms in nonmanufacturing industries.

For private consumption, growth in passenger car sales increased further and developments were firm in some indicators, such as department store sales and statistics related to services industries, although the index of living expenditure level for the April-June quarter declined from the previous quarter. Consumer confidence remained generally unchanged, after declining in spring.

Regarding the economic outlook, it could be expected that production would rebound in line with a recovery in exports if inventory adjustments in IT-related goods worldwide peaked out around the end of 2001. However, cautious views on developments in overseas economies and global demand in IT-related goods, in terms of the timing and the pace of recovery, were recently growing. In Japan, with the prolonged adjustments in economic activities mainly in production, corporate profits and household income were likely to weaken, and the possibility that the adjustments might be further prolonged and expand to a wider range could not be ignored.

Regarding prices, wholesale prices continued to fall, by around 0.2 percent, compared to three months earlier. The breakdown revealed that, in addition to prices of IT-related goods, those of steel, construction-related goods, and other materials were expanding their decline. The Corporate Service Price Index declined further from the previous year. The Consumer Price Index (CPI) continued to be weak. Prices as a whole required monitoring since downward pressure was very likely to emerge due to the weakness in demand.

2. Financial environment

Credit demand in the private sector seemed to be declining faster again recently, after the pace of decline slowed in the second half of 2000 and the first half of 2001. The amount of funds raised in capital markets was increasing more rapidly as was evident in the fact that the outstanding amount of CP marked a record high for the four consecutive months. Banks' lending, however, was falling at a faster rate than before.

The fall in banks' lending was largely attributed to sluggish demand for funds. Banks were, however, eager to increase lending to blue-chip firms, while being cautious about lending to firms with lower creditworthiness. This polarization in banks' lending attitude was ongoing. Financial institutions' lending attitude was perceived by small enterprises as having become somewhat severe recently. The Senior Loan Officer Opinion Survey on Bank Lending Practices at Large Japanese Banks also indicated that banks were becoming somewhat cautious in their lending to small firms, although there was no significant change in their attitude to lending to large firms. The majority of fundraisers in capital markets were large firms with high creditworthiness, and fund raising through those markets was increasing considerably.

Monetary aggregates increased robustly, in contrast to the downtrend in credit aggregates such as banks' lending, due to a substantial decline in the opportunity cost of holding liquid assets under extremely low interest rates. The year-on-year growth rate of the monetary base in July was 8.0 percent, even higher than the 7.6 percent of the previous month, as post offices increased their cash holdings in preparation for an expected massive withdrawal of postal savings due to mature. The year-on-year growth rate of money stock (M2+CDs) in July was 3.3 percent, higher than the previous month, mainly due to the shift of funds from postal savings. A closer look at each component of money stock showed that growth in M1 (cash currency + deposit money) contributed most.

The number of corporate bankruptcies remained at around 1,500 cases per month. About a quarter of bankruptcy cases were attributable to the termination of special guarantee systems for the financial stabilization of small and medium-sized enterprises at the end of March 2001, and a closer look revealed that the construction sector's share of such bankruptcies was rising gradually.

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

A. Current Economic Situation

Members agreed that the current state of the economy was more severe than at the time of the previous meeting on July 12 and 13. As the background to this assessment, many members pointed out that a decline in exports and production was spreading more widely through the economy and adjustments in the corporate sector were starting to affect the household sector through cuts in employment and wages. One of these members described the economy as "deteriorating." Another member expressed the view that "the pace of the deterioration was more rapid than at the time of the previous meeting."

As for the corporate sector, the majority of members shared the view that a downtrend in exports and business fixed investment was becoming clear and the decline in production was becoming greater than before.

Many members pointed out that due to the prolonged adjustments in IT-related industries, adjustments were spreading to areas outside IT-related industries, as was evident in a decline in shipments and an accumulation of inventories in a wide range of industries such as steel, chemicals, general machinery, and transport equipment. One of these members said that some firms in materials industries faced a decline in production and a fall in product prices due to sluggish domestic demand and a shift of Japanese firms' production to overseas, and some people in the materials industries perceived the economy as being in a deflationary spiral.

Members discussed the effects of the deterioration in the corporate sector on employment, household income, and private consumption. Many members shared the view that the decline in production had caused a fall in household income, including summer bonuses, citing a decrease in nominal wages and new job offers in June. Some members commented on a significant weakness in wages in small nonmanufacturers. These members remarked on the possibility that there was an increasing number of self-employed people leaving the labor market, as the unemployment rate remained unchanged despite a fall in the number of employees. One member noted that downward pressure on wages was growing as nonviable firms were eliminated and old firms were replaced by new ones.

With regard to private consumption, many members said that there were both strong and weak indicators and its development remained flat on the whole so far. However, they shared the view that private consumption was likely to deteriorate given the weakness of employment and household income. As factors which might dampen consumer sentiment, one member pointed out the negative wealth effect stemming from the bursting of the IT bubble, estimating that the total market value of Japan's stocks had plunged to around 350 trillion yen from about 500 trillion yen in the past one and a half years. A different member pointed out concerns about employment and the social security system, including pensions.



Regarding prices, a few members said that the pace of the fall in prices stemming from weak demand was accelerating, as was evident in the fact that the year-on-year fall in various price indicators had been increasing. One member expressed the opinion that a fall in prices would inevitably continue in line with the correction of the high cost structure of Japan's economy, and that the Bank's commitment to continue the current procedures for money market operations until the CPI registered stably zero percent or an increase year on year assumed that demand would recover sufficiently to dispel the downward pressure on prices from the supply side.

B. Economic Outlook

Members agreed that the key elements for the economic outlook continued to be adjustments in IT-related industries worldwide and global economic developments including those in the United States.

Many members shared the view that the fall in IT-related demand was more severe than expected and the prospect of the completion of most inventory adjustments worldwide had receded further into the future. One member expressed the opinion that production might not recover smoothly even when inventory adjustments progressed, judging from the fall in orders of IT-related goods. Another member expressed the view that adjustments in capital stock might take a long time as the supply of IT-related goods was excessive due to the aggressive investment to increase production capacity in the past. A different member said that growth in IT-related industries would be strong in the long term but currently these industries were in an adjustment phase, and demand for IT-related goods would not recover until next-generation products that could boost demand were introduced.

Regarding the economy in the United States, the majority of members shared the view that business fixed investment and production continued to decline, and even if the economy started to recover moderately in the future, the timing of the recovery would be delayed and its pace would inevitably be slow. A few members said that developments in the household sector would be a key element in predicting the U.S. economic outlook. One of these members commented that the firmness in private consumption had been underpinned by the growth in household income, but household income could be affected by the deterioration in corporate profits and productivity. A few members including this member raised as cause for concern (1) a description citing a slowdown in consumption in the report released in August by the FRB and (2) the fact that consumer confidence was deteriorating. A different member pointed out that an improvement in households' ability to borrow money due to a rise in housing prices had been one of the factors underpinning consumption. On this basis, this member said that there was a possibility that the rise in housing prices was caused by a bubble and this mechanism might collapse if housing prices fell in the future. This member pointed out as cause for concern the fact that past U.S. labor productivity data had been revised downward and were not as high as previously thought, and said that the effects of tax refunds might have already played themselves out.

One member noted that the slowdown in the economies in Europe and Asia had become more distinct. A different member said that a simultaneous slowdown in economies worldwide was becoming clearer than before and expressed concern regarding the impact on Japan's economy of a decrease in the volume of global trade, particularly in East Asian and ASEAN economies.

Many cautious views of Japan's economic outlook were also put forward since the environment surrounding Japan's economy had become more severe. Regarding the timing of the completion of production adjustments, many members shared the view that it was likely to be delayed since inventories were not decreasing despite the decline in production. One member analyzed time-series data of indices of industrial production and commented that production would recover after April 2002 at the earliest. A different member, pointing to a delay in inventory adjustments in materials industries, said that they would be completed in and after the first half of fiscal 2002.

A few members expressed the opinion that it had become clear that firms' plans for profits and investment in the June Tankan were optimistic, referring to new information obtained in the intermeeting period such as (1) a downward revision in firms' forecasts of their earnings and (2) firms' plans for production cuts and restructuring. A different member emphasized the severe situation in corporate profits, pointing out that (1) the degree of downward revision currently in the earnings forecasts of general electrical machinery and communications firms was extremely large for such a short interval of time and (2) earnings forecasts for the second half of 2001 could still be revised downward.

Many members expressed concern that the risk was increasing that the adjustments in the corporate sector would affect the household sector. A few members said that considering the situation of corporate production and profits, winter bonus payments could not be expected much. Against this background, many members said that closer monitoring of private consumption was required although it remained unchanged until recently.

Given the economic outlook, members shared a cautious view regarding price developments in the future. One member said that it was becoming highly probable that the output gap would expand due to a decline in business fixed investment and thus downward pressure on prices would increase further in the future. A few members commented on the weakness in wages and said that it required monitoring whether the decline in wages in the nonmanufacturing sector would lead to a fall in service prices and consumer prices eventually. Some members pointed out the possibility that the decrease in household income might weaken demand further and push down prices. One member summed up the above discussion and said that, although the Bank had forecasted a downtrend in prices to some extent when it adopted monetary easing measures in March 2001, prices could fall further than had been expected given economic developments since that time.

A few members summed up the above economic and financial developments, comparing them with the "Outlook and Risk Assessment of the Economy and Prices" (hereafter, the Outlook Report) released in April 2001. Regarding the four risk factors to the economy mentioned in the Outlook Report, namely (1) developments in overseas economies and in IT-related industries, (2) developments in asset prices, (3) the effects of structural adjustments, and (4) uncertainties felt by the public with respect to the future, many of these members shared the view that the first two were materializing and exerting downward pressure on the economy. A few members said that the market seemed to have already begun to factor in the short-term deflationary impact of structural adjustments on the economy, the third risk factor in the Outlook Report. Therefore, many members shared the view that the possibility was decreasing that the standard scenario--progress in the adjustment in the U.S. economy would gradually reduce downward pressure on Japan's exports and production in the second half of fiscal 2001--would materialize. One member said that a downward revision was now becoming necessary to the forecast of the majority of Policy Board members in April that the growth rate in real GDP for fiscal 2001 would be 0.3-0.8 percent. A different member said there was no clear sign of any development that would push the growth rate of real GDP above zero percent. One member expressed a more severe view than other members that the standard scenario had already collapsed.

Some members raised other points for the economic outlook which required attention.

One member said that the shift of Japanese firms' production to overseas could hinder a recovery in Japan's economy. This member explained that domestic production was showing a tendency to fall more than domestic demand since manufacturers of IT-related goods and electrical appliances were accelerating the pace at which they were shifting their production to China against the background of (1) its low wages, (2) low land prices, (3) improved quality of the products, and (4) the currency system, which virtually pegged the renminbi to the U.S. dollar, and this trend was spreading to other sectors such as automobile-related industries. This member continued that the impact of the developments in the Chinese economy on economies in Asia including Japan would be substantial, unless China not only entered the World Trade Organization (WTO) but also realigned its currency to a level which reflected the competitiveness of the economy. Another member expressed the view that the hollowing-out of Japanese industry might increase as business models were reconstructed in response to progress in structural reforms.

A different member said that Japan's regional economies were weakening considerably and the risk of this situation worsening warranted monitoring. This member explained the background to this view as follows: (1) developments in factories by region suggested that the damage caused by the sluggishness in IT-related industries and exports was severe in the rural areas; (2) the shift of population from these rural areas to the metropolitan areas was increasing; and (3) these areas were likely to be adversely affected by a reduction in public investment.

The same member continued that developments in oil prices required close monitoring and expressed the view that (1) oil prices remained flat because of a reduction in oil production by OPEC, despite a slowdown in economies worldwide, and (2) it was likely that oil prices would rise toward the end of 2001 as demand for oil increased toward winter. This member pointed out as cause for concern increasing political tension in the Middle East and said that oil prices might surge depending on developments there.

C. Financial Developments

Many members pointed out that both developments in stock prices, which had been fluctuating in the lowest range since the start of the year, and the effects of these developments gave cause for concern. One member said that stock prices were expected to remain volatile until the end of September, since market participants were cautious about negative factors such as downward pressure caused by financial institutions' sales of stocks to realize capital gains before they closed their books and to unwind cross-shareholdings, in addition to a fundamental factor, a deterioration in firms' earnings. A different member explained that market participants were expecting some policy action, as they considered that the effects of the monetary easing measures taken in March 2001 had fully played themselves out. Another member expressed the view that unwinding of cross-shareholdings was restraining stock prices, and drastic measures, such as (1) firms' efforts to improve their returns on equity (ROE), including purchasing of their own stocks and (2) a revision of the securities tax system to cause an inflow of personal savings into stock market, were necessary for a recovery in stock prices. One member took a severe view of the outlook for U.S. and Japanese stock prices that (1) since the performance of U.S. firms was polarized, the U.S. Nasdaq composite index could experience a large decline, while the Dow Jones Industrial Average might exceed its record high and (2) it was inevitable that Japanese stock prices would hit a new low for the year.

Given such developments in stock prices, a few members said that it was necessary to closely monitor the effects of the fall in stock prices on corporate and household confidence and on financial institutions' lending attitude. One of these members said that, although an economic recovery should have been expected as a result of a rise in asset prices stimulating household consumption, the recent stock prices were so low that the opposite situation required attention. A different member referred to the recent downgrading of banks' credit ratings and commented that the market's evaluation of banks remained severe and attention should be paid to the possibility that a further fall in stock prices might heighten the market's anxiety about the effects on the soundness of financial institutions of the introduction of mark-to-market accounting for financial instruments.

Many members commented on the lending attitude of financial institutions. These members shared the view that banks' lending stance had become more polarized between blue-chip firms and others. One of these members said that moves by banks to secure interest margins that reflected firms' creditworthiness had intensified since this summer, and it should be noted that this might lead to a "credit crunch" for small firms. This member added, however, that these trends should basically be interpreted as a positive move that would help banks to restore sound management. A different member commented on the significant increase in the planned amount of NPL disposal by major banks for fiscal 2001 reflecting revisions to their plans for restoring sound management submitted to the Government. This member said that it was necessary to watch the effects of the disposal of NPLs and changes in banks' lending attitude closely. Concluding the discussion on this topic, one member pointed out that the procyclical nature of banks' credit extension to the economy had started to be observed to some extent, and it was necessary to pay attention to the risk that banks' lending attitude might become more severe due to a fall in stock prices.

A few members commented on the foreign exchange market, noting that the yen had appreciated against the U.S. dollar during August 9-10, just a few days before this meeting. One member said that the yen might appreciate further for the time being since institutional investors had become cautious about foreign investment and the U.S. economy remained sluggish for a long time. A different member expressed the view that given their severe view of the economy and firms' performance in the United States, an increasing number of investors in Japan and Europe were retrieving their U.S. dollar-denominated investments. Another member pointed out that, given the slowdown in the U.S. economy, U.S. industry had started to call for modification of the strong dollar policy. This member pointed out that (1) Japanese firms were starting to be concerned that a depreciation of the yen could lead to a dumping problem and import restrictions, (2) although foreign exchange rates should basically be determined by the market mechanism, it was important for foreign exchange rates to be stable and large fluctuations in foreign exchange rates should be avoided in the current situation where Japanese firms were restructuring themselves to survive fierce global competition, and (3) the authorities should not make comments on developments in foreign exchange rates as long as they moved stably based on the fundamentals of the economy.

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

Members discussed the monetary policy stance for the immediate future.

Based on a comparison of the current situation with that at the previous meeting, when the guideline for market operations was maintained unchanged, the majority of members shared the following view: (1) adjustments in IT-related industries were deeper and were likely to be more prolonged than had been expected; (2) deterioration in corporate profits, business fixed investment, and production had become more evident and adjustments were spreading to industries other than those related to IT; and (3) such adjustments in the corporate sector were gradually spreading to the household sector through deterioration in employment and income conditions, and the adjustment pressure would persist for the time being. A few members added that downside risks to the economy arising from financial aspects were increasing, as seen in weak stock prices, and the increase in the disposal of NPLs, and a more cautious lending attitude among financial institutions. Based on the above assessment of the economy, the Policy Board shared the view that it was appropriate to take additional easing measures at this meeting. Some members emphasized the additional easing measures the Board was about to take had two objectives: the first was to tackle the current deterioration of the economy, and the second to tackle preemptively the risks in the future.

With regard to additional easing measures, the majority of members considered that it would be appropriate to raise the outstanding balance of current accounts at the Bank from around 5 trillion yen to around 6 trillion yen under the new procedures for money market operations decided on March 19, 2001 and examine the effects thereafter. One member said that raising the balance by 1 trillion yen was appropriate because it was the maximum amount possible at present that could be raised through money market operations. Other members generally agreed with this view.

One member, however, emphasized that it was the last chance to change the policy, and said that the Bank should partially change the procedures for money market operations decided on March 19, 2001 and set a target with a clearer time horizon that the year-on-year inflation should be zero percent or more by the January-March quarter of 2003, while at the same time increasing the outstanding balance of current accounts at the Bank to 7 trillion yen.

A few members expressed the opinion that the expected effects of an increase in the outstanding balance of current accounts at the Bank would be that (1) interest rates would decline further, although very marginally, (2) financial institutions would be encouraged to take risks and diversify their portfolio, and (3) the expectations of firms and households would be positively affected.

A few members commented that the additional measures should be appropriate to deal with the recent vulnerability on the financial front. One member expressed the view that financial markets might become more fragile as a result of a fall in stock prices toward the end of September, and it would be appropriate to reduce the risk preemptively with the Bank's provision of liquidity. A different member said that it was important to dispel concerns about liquidity in view of the interim book closings, given that the financial system could become unstable depending on future developments in the economy, although the Japan premium and credit spreads were at present low.

A few members said that the Bank should show its strong determination to achieve economic recovery and price stability by taking monetary easing measures at this meeting.

Many members including these members said, however, that it was necessary to note that such effects were not necessarily certain, although the easing measures could be expected to be effective to some extent. These members pointed out that a positive momentum in the economy triggered by progress in structural reforms including initiatives taken to solve the NPL problem would be necessary for the monetary easing to be effective.

One member concluded the discussion on this topic by saying that in view of the deterioration of the economy, it was necessary to take policy measures at this stage in expectation of some effects, although it was not certain what the level of those effects would be in the current situation where short- and long-term interest rates were already extremely low. This member continued that the progress in the Government's structural reforms in terms of concrete plans was encouraging, in its decision on the Guidelines on FY 2002 Budget Requests as well as the discussions on the "Reform Schedule," a detailed timetable for the implementation of structural reforms following "Structural Reform of the Japanese Economy: Basic Policies for Macroeconomic Management" (hereafter the "Basic Policies") released in June 2001. The member added that the additional monetary easing had the effect of supporting such progress.

One member commented on the effects of the monetary easing on the foreign exchange market that the easing measures would have a limited influence to cause depreciation of the yen for the following reason: market expectations of modification of the strong dollar policy by the U.S. authorities were heightening as the U.S. economy was decelerating. A few members including this member said, however, that the Bank should accept depreciation of the yen if it occurred in the natural course of events.

Many members expressed the view that, from the standpoint of increasing the outstanding balance of current accounts at the Bank smoothly in accordance with the procedures for money market operations decided in March 2001, it would also be desirable to increase the Bank's outright purchases of Japanese government bonds (JGBs). A few members commented on the possibility that an increase in the Bank's outright purchases of JGBs could reinforce the effectiveness of the Bank's monetary easing. One member pointed out that (1) given the current situation in the financial system, it was difficult to expect much easing effect via banks, and the main channel would be the financial markets, and (2) increasing the Bank's outright purchases of JGBs could be more effective as a means of rebalancing financial institutions' portfolios than providing funds only by means of market operations of short-term instruments that were highly substitutable for current accounts at the Bank. A different member said that an increase in the Bank's outright purchases of JGBs could have a larger easing effect by affecting risk premiums on JGBs and inducing a further decline in yield curves which had already been lowered by the Bank's commitment in terms of policy duration.

The majority of members expressed the view that they should pay close attention to the market's reaction to an increase in the Bank's outright purchases of JGBs since market participants were recently cautious about factors affecting the supply-demand balance of JGBs, for example, discussions relating to a supplementary budget. One member said that an increase in the Bank's outright purchases of JGBs should be implemented provided that the Bank followed strictly the guideline decided in March 2001 to limit the outstanding amount of JGBs it could hold to "the outstanding balance of banknotes issued." A few other members added that it was essential to (1) make it clear that an increase in the Bank's outright purchases of JGBs was not aimed at supporting JGB prices and (2) avoid any misunderstanding in the market such as that it was intended for government financing. One of these members said that the Guideline on FY 2002 Budget Requests approved by the Cabinet recently indicated clearly the Government's intention to maintain fiscal discipline and this could prevent an increase in the Bank's outright purchases of JGBs from causing undesirable side effects.

A few members requested the staff to explain the necessity and the possible methods of increasing the Bank's outright purchases of JGBs, and the staff made the following remarks.

(1) When setting a new target for the outstanding balance of current accounts at the Bank of around 6 trillion yen, it would be appropriate to increase the Bank's outright purchases of JGBs from the viewpoint of providing a larger supply of long-term funds, which were the basis of the balance, in order to reduce the burden on short-term market operations.

(2) When increasing the amount of JGBs the Bank bought outright, it would be appropriate to increase the amount of purchases for the month, which had been conducted at a pace of 400 billion yen per month, rather than conducting the outright purchase operations to deal with each under-subscription in short-term market operations as it occurred. It was necessary to set a clear guideline regarding the number of operations and amount purchased per month to avoid unnecessary market speculation about the Bank's moves that might lead to instability in the market.

(3) It was appropriate that the amount of increase in the Bank's outright purchases of JGBs be 200 billion yen, judging from the recent market developments. Considering the ability of counterparties participating in the operations to gather JGBs to be purchased, the staff would like to recommend that it would be appropriate to increase the number of operations to three times a month from the current twice a month, rather than increasing the amount of each operation.

(4) If the Board decided to increase the outstanding balance of current accounts at the Bank at this meeting, it would be appropriate to avoid market speculation about the timing and amount of the Bank's purchases by including the above staff proposals for increasing the Bank's outright purchases of JGBs in the public statement about the policy change decided at this meeting.

(5) With an increase of 200 billion yen per month, it was unlikely that the outstanding amount of JGBs the Bank held would reach the ceiling for the outstanding amount of banknotes issued at an early stage, given the moderate growth of the outstanding amount of banknotes issued.

Members engaged in a discussion of issues regarding macroeconomic policies in general to achieve price stability. One member said that (1) in an ordinary economic environment, monetary policy would have a significant effect on prices in the medium to long term, but (2) in the current situation where the economy was almost in a liquidity trap, the effects of monetary policy were limited and fiscal and foreign exchange policy were likely to be more effective, and (3) therefore, it was not productive to try to stabilize prices by monetary policy alone while severely tightening fiscal policy. Another member expressed the opinion that (1) given that prices were determined by the balance of aggregate supply and demand, fiscal policy would certainly affect them, (2) a tighter fiscal policy would exert downward pressure on them, and (3) fiscal policy could, however, contribute to stabilize prices through making the spending attitude of households more positive if the Government employed policy measures to gain public confidence in the medium- to long-term sustainability of Japan's fiscal balance and the social security system, including the pension provision.

A different member argued that the most important task was to take the economy out of deflation as soon as possible, and therefore (1) the Bank should provide ampler liquidity, (2) the Government should stimulate effective demand by improving the quality of government spending and also should improve the business environment through tax system reforms and deregulation, and (3) only a combination of the Bank's and the Government's policies and efforts by the private sector could halt the fall in prices. The member added that in this situation the Bank was expected not only to provide ample funds to the money market but also clarify its determination to combat deflation, thereby improving the expectations of firms and households. A different member remarked that it was important that the Bank communicates closely with the Government, as there was a possibility that media reports emphasizing the differences between the views of the Bank and the Government might have negative effects on the sentiment of economic entities and on the international credibility of Japan.

Regarding monetary policy in the future, some members expressed the opinion that the Bank should further examine what monetary policy measures could be taken to cope with a continued worsening of the economy.

A few members commented on inflation targeting in this regard. One member said that (1) in the current economic situation, there were no measures with no side effects that could be employed to achieve a price target, and setting a specific target for prices was difficult, and (2) the Bank should examine carefully whether, if the Bank referred to a desirable level for prices in some manner, it would have favorable effects on the formation of expectations in the private sector. A different member said that the Bank should change its commitment that it would continue the current procedures for market operations until the CPI registered "stably zero percent or an increase year on year," and instead set a specific target within a certain time frame, giving the following reasons: (1) the Bank's responsibility as the central bank to combat deflation would become heavier in future, given that the current suspension of the system of adjusting pension in line with changes in prices might be lifted; and (2) the Bank should set a target for the introduction of policy assessment, given that a policy assessment system for the Government and public corporations was being introduced.

IV. Remarks by Government Representatives

The representative from the Cabinet Office made the following remarks.

(1) According to the Policy Board's discussions earlier in the meeting, Japan's economy was deteriorating more than expected, and the Government shared this view of the economy. The GDP data for the April-June quarter were expected to be very weak, and thus monetary policy was the focus of expectation.

(2) The Government was currently formulating concrete plans for structural reforms based on the "Basic Policies" released in June 2001. As fiscal policy consistent with structural reforms, the Government decided to reduce expenditure by 5 trillion yen and increase spending by 2 trillion yen, in order to limit the issuance of new government bonds to less than 30 trillion yen in fiscal 2002, in accordance with the Prime Minister's firm resolve. In the Policy Board's discussions earlier in the meeting, reference was made to fiscal policy measures to stimulate the economy. The Government was examining thoroughly the effects of inducing demand and production in the process of formulating the general account budget requests. The Government was preparing the "Reform Schedule," which would clarify tasks and schedules. If necessary, budgets would be allocated for the "Advanced Reform Program" which could be implemented immediately, giving due consideration to the management of short-term aggregate demand.

(3) In the political arena, there were a large number of opinions which considered monetary policy as a panacea, and these opinions were very different from those expressed in the Monetary Policy Meetings. Although monetary policy was a highly specialized matter and it was vital to maintain the Bank's independence and expertise in the policy-making process, dialogue with people in the political arena was also important in view of the Bank's accountability.

(4) The following factors were commonly observed in foreign countries that succeeded in structural reforms: (a) the authorities and the public both fully acknowledged the need for action in the face of an impending crisis; and (b) the Government's stance was consistent throughout the reforms. In view of the latter, the Government would like to ask the Bank to examine various possible monetary policy options, including ways of conveying its messages to the public, in order to clarify further its determination to combat deflation.

(5) On these grounds, the Government would like to ask the Bank to have a bold attitude toward further quantitative easing.

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

(1) The Cabinet approved the Guidelines on FY 2002 Budget Requests, which would be the first step in advancing structural reforms. In order to limit the issuance of new government bonds to less than 30 trillion yen, the expenditure would be cut significantly, while an additional appropriation would be made for prioritized items.

(2) Prices continued to decline even after the introduction of monetary easing measures in March 2001. The current continuous fall in prices would dampen demand, reducing firms' incentive to invest through an increase in real interest rates and causing households to postpone spending. In addition, real debt burden did not decrease, despite firms' efforts to reduce their excess debt. The Government considered that more effective monetary easing was necessary in the current situation where the downtrend in prices was unlikely to change and would like to ask the Bank to conduct monetary policy in a timely manner.

(3) The effects of the Bank's market operations using short-term instruments were limited under virtually zero short-term interest rates, and measures that would improve market expectations were essential. From this viewpoint, the Government would like to ask the Bank to examine a variety of policy options which would have a greater effect on the economy, including increasing outright purchases of JGBs and strengthening the commitment in terms of policy duration.

V. Votes

Based on the above discussion, the majority of members considered it appropriate to raise the outstanding balance of current accounts at the Bank from around 5 trillion yen to around 6 trillion yen under the procedures for money market operations decided in March 2001.

As a result, the following proposals were submitted.

Mr. N. Nakahara proposed the following procedures for money market operations:

The Bank of Japan will conduct money market operations targeting an year-on-year increase of zero percent or more in the CPI (excluding perishables, on a nationwide basis) on average in the January-March quarter of 2003.

The proposal was defeated with one vote in favor, eight against.

This member also proposed the following guideline for money market operations for the intermeeting period ahead:0

The Bank of Japan will conduct money market operations, aiming at an outstanding balance of the current accounts at the Bank of around 7 trillion yen. Should there be a risk of financial market instability, e.g., a rapid surge in liquidity demand, the Bank will provide ampler liquidity irrespective of the guideline above. In addition, in order to smoothly achieve the outstanding balance, the Bank will remove the following restriction mentioned in the New Procedures for Money Market Operations and Monetary Easing determined on March 19, 2001: --"The outright purchase is, on the other hand, subject to the limitation that the outstanding amount of long-term government bonds effectively held by the Bank, i.e., after taking into account of the government bond sales under gensaki repurchase agreements, be kept below the outstanding balance of banknotes issued."

The proposal was defeated with one vote in favor, eight against.

To reflect the majority view, the chairman formulated the following proposal.

The Chairman's Policy Proposal:

The guideline for money market operations in the intermeeting period ahead will be as follows:

The Bank of Japan will conduct money market operations, aiming the outstanding balance of the current accounts at the Bank at around 6 trillion yen.

Should there be a risk of financial market instability, e.g., a rapid surge in liquidity demand, the Bank will provide ampler liquidity irrespective of the above guideline.

A public statement will be decided separately.

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

Vote against the proposal: Mr. N. Nakahara.

Mr. N. Nakahara dissented mainly for the following reasons. First, given the deterioration of the economy in the intermeeting period, raising the outstanding balance of current accounts at the Bank by 1 trillion yen at this point was insufficient and was likely to be too late, and thus the Bank should take more drastic measures. Second, the Bank should recognize the critical state of the economy and consider taking even unconventional monetary policy measures. And third, the Bank should take more seriously the fact that the state of the economy had fallen far below the standard scenario in the Outlook Report.

VI. Discussion on the Public Statement

Following the above decision, members discussed the draft of a public statement prepared by the staff and put it to the vote. By majority vote, the Board decided to publish "Change in the Guideline of Money Market Operations"(see Attachment 1).

Votes for proposal: Mr. M. Hayami, Mr. S. Fujiwara, Mr. Y. Yamaguchi, Mr. T. Miki, Mr. K. Ueda, Mr. T. Taya, Ms. M. Suda, and Mr. S. Nakahara.

Vote against the proposal: Mr. N. Nakahara.

Mr. N. Nakahara dissented for the same reason as he opposed the proposal regarding the guideline for money market operations in the intermeeting period ahead.

The chairman said he would hold a press conference after the meeting, following the established custom when a policy change was decided.

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. By majority vote, the Board decided to publish "The Bank's View" on August 15, 2001 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. T. Miki, Mr. K. Ueda, Mr. T. Taya, Ms. M. Suda, and Mr. S. Nakahara.

Vote against the proposal: Mr. N. Nakahara.

Mr. N. Nakahara dissented mainly for the following reasons. First, the seriousness and extent of the deterioration in the economy were not described in sufficient detail in "The Bank's View." Second, the outlook for the U.S. economy described in "The Bank's View" was too optimistic, and thus should not be stated as if it were the general view. Third, "the substantial decline in production would cause domestic demand to decrease and in turn generate the risk of adjustments in economic activities to spread even further" had already materialized. Fourth, "The Bank's View" did not mention the fact that downward pressure on prices was strengthening further. And fifth, it did not fully reflect the decrease in public investment and its effects on economies in rural areas.

  1. 6The original full text, in Japanese, of the Monthly Report of Recent Economic and Financial Developments was published on August 15, 2001 together with the English version of "The Bank's View." The English version of "The Background" was published on August 16, 2001.

VIII. Approval of the Minutes of the Monetary Policy Meetings

The Policy Board approved unanimously the minutes of the Monetary Policy Meetings of June 28, 2001, and July 12 and 13 for release on August 17, 2001.


Attachment 1

For immediate release

August 14, 2001
Bank of Japan

Change in the Guideline for Money Market Operations

  1. At the Monetary Policy Meeting held today, the Bank of Japan decided to change the guideline for money market operations. In addition, the Bank will increase its outright purchase of long-term government bonds in order to smoothly provide liquidity under the new guideline.
    1. 1) Change in the guideline for money market operations (by majority vote)
      The outstanding balance of current accounts held at the Bank of Japan will be raised from around 5 trillion yen to around 6 trillion yen (Attachment 2).
    2. 2) Increase in outright purchase of long-term government bonds
      The amount of the outright purchase of long-term government bonds will be increased from the current 400 billion yen per month to 600 billion yen per month.
  2. Economic adjustments are deepening as industrial production is sharply declining due to a fall in exports. Risks are increasing for the adjustments to spread to wider areas as falling production is expected to cause an associated decline in domestic demand. Recent capital market developments at home and abroad may also adversely affect the real economy. A weaker demand could intensify downward pressure on prices in the coming period.
  3. Earlier this year, the Bank has taken monetary easing measures unprecedented in the history of central banking, with firm determination to prevent a continuous decline in prices and to form a basis for sustainable economic growth. Consequently, ample liquidity has been provided to financial markets and interest rates have declined to extremely low levels.
    However, given the adverse recent and prospective developments regarding growth and prices, the Bank considered it appropriate and necessary to further strengthen monetary support for economic recovery under the new framework established in March.
  4. The Bank will continue to make every effort as a central bank to support Japan's economy so that it could return to a stable and sustainable growth path.
  5. However, given economic developments worldwide and the seriousness of confronting problems, it is not an easy task to revitalize Japan's economy. Progress in structural reforms is indispensable for monetary easing to exert its full potential, which would help restore Japan's economy to a stable and sustainable growth path.
  6. In this regard, it is encouraging that concrete steps for reforms have started to take place under the strong leadership of the government. A series of monetary easing measures, including today's decision, is consistent with providing maximum support for such reform efforts in various areas. The Bank of Japan strongly hopes that the government and the private sector will make further steady progress in structural reforms, while overcoming associated short-term pains.

Attachment 2

For immediate release

August 14, 2001
Bank of Japan

At the Monetary Policy Meeting held today, the Bank of Japan decided, by majority vote, to set the following guideline for money market operations for the intermeeting period:

The Bank of Japan will conduct money market operations, aiming for the outstanding balance of current accounts held at the Bank at around 6 trillion yen.

Should there be concern for financial market instability such as a rapid surge in liquidity demand, the Bank will provide ample liquidity irrespective of the above guideline.