Minutes of the Monetary Policy Meeting
on October 11 and 12, 2001
(English translation prepared by the Bank's staff based on the Japanese original)
November 21, 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 Thursday, October 11, 2001, from 2:00 p.m. to 4:04 p.m., and on Friday, October 12, from 9:00 a.m. to 1:05 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. S. Murakami, Senior Vice Minister of Finance, Ministry of Finance 2
Mr. H. Fujii, Deputy Vice Minister for Policy Planning and Coordination, Ministry of Finance 3
Mr. H. Takenaka, Minister of State for Economic and Fiscal Policy, Cabinet Office 4
Mr. Y. Kobayashi, Director General for Economic and Fiscal Management, Cabinet Office 5
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. 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 November 15 and 16, 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.
- Mr. S. Murakami was present on October 12.
- Mr. H. Fujii was present on October 11.
- Mr. Takenaka was present on October 12 from 9:00 a.m. to 12:10 p.m.
- Mr. Y. Kobayashi was present on October 11 for the whole of the session, and on October 12 from 12:10 p.m. to 1:05 p.m.
I. Summary of Staff Reports on Economic and Financial Developments 6
A. Money Market Operations in the Intermeeting Period
Market operations in the intermeeting period were conducted in accordance with the guideline determined at the previous meeting on September 18, 2001. 7 The Bank provided ample liquidity to the money market by aiming at maintaining the outstanding balance of current accounts held at the Bank at above 6 trillion yen.
Developments in financial markets during the intermeeting period could be divided into the following three phases.
In the first phase, from the previous meeting, September 18, to the end of September, liquidity demand surged due to (1) the effects of the terrorist attacks in the United States and (2) the interim book closings at the end of September. In response to this, the Bank provided ample funds so that the outstanding balance of current accounts at the Bank exceeded 10 trillion yen for some days. Against this background, the uncollateralized overnight call rate moved stably at 0.002-0.003 percent during this period, including September 28, the day of the interim book closings.
In the second phase, the week from October 1 to October 5, liquidity demand weakened as (1) financial markets at home and abroad regained their stability, and (2) factors stemming from the interim book closings subsided. Given these developments in financial markets, the Bank reduced its funds provision to the money market gradually. The weighted average of the uncollateralized overnight call rate, however, declined to a historic low of 0.001 percent reflecting the fact that market participants felt that they had more abundant liquidity than before.
And in the third phase, from October 9 to October 10, some foreign banks in Japan had started to hold a large amount of excess reserves. In this situation, although there were abundant funds in the call market as a whole, there had been some cases that the call rate rose slightly as some specific funds borrowers found it difficult to find funds lenders. Some market participants regarded this phenomenon as a deterioration of the functioning of the call market.
The background to this phenomenon was as follows. First, the cost for some foreign banks of raising yen funds had become significantly negative since the terrorist attacks, so that they could gain margins even if they simply deposited the accumulated yen in their non-interest bearing current accounts at the Bank. And second, at the same time, these banks considered that, with the current extremely low interest rates, and taking into account operational and other costs, it was not worth investing yen funds in the call market.
- 6Reports were made based on information available at the time of the meeting.
- 7The guideline was as follows:
For the time being, the Bank will provide ample liquidity to the money market by aiming at maintaining the outstanding balance of current accounts held at the Bank at above 6 trillion yen.
B. Recent Developments in Financial Markets
1. Developments in domestic financial markets
The extent of the decline in Japanese stock prices after the terrorist attacks was smaller than that in stock prices in the United States and Europe. Since October 2001, Japanese stock prices had been recovering along with a rebound in stock prices overseas. Many market participants considered that the direct effects of the terrorist attacks on the Japanese stock market had abated to some extent.
Many market participants considered, however, that stock price developments would remain unstable reflecting developments in the U.S. economy and the pace of progress in the structural reforms in Japan, especially nonperforming-loan (NPL) disposal, and thus implied volatility was fairly high. A breakdown of stock prices by industry showed that, in addition to air transportation and transportation equipment, banks as a whole were notably sluggish.
Long-term interest rates basically remained flat, and many market participants considered that they would move approximately in the 1.3-1.4 percent range for the time being.
Developments in credit spreads, which are the yield differentials between private and Japanese government bonds (JGBs), revealed that credit spreads for bonds issued by firms with high credit ratings basically remained flat, while those for bonds issued by firms with BBB or lower ratings widened slightly. This reflected (1) a deterioration of the economy, (2) unstable stock prices following the terrorist attacks, and (3) heightened sensitivity in the market to credit risks after the bankruptcy of a large Japanese retailer. In particular, credit spreads for bonds issued by banks had been widening notably.
2. Developments in the foreign exchange market
The yen appreciated against the U.S. dollar, temporarily reaching 115-116 yen on September 20, reflecting intensifying uncertainty about the U.S. economic outlook after the terrorist attacks. It depreciated thereafter, due partly to foreign exchange intervention by the Japanese monetary authority and a recovery in U.S. stock prices. It was moving around 120 yen to the U.S. dollar recently.
C. Overseas Economic and Financial Developments
Noticeable developments in overseas economies and financial markets after the terrorist attacks were (1) a simultaneous deterioration in confidence worldwide, (2) a deterioration in employment conditions, especially in the United States, and (3) a growing tendency to avoid risks in financial markets.
In the United States, although employment conditions had been on a deteriorating trend before the terrorist attacks, it became more severe after the attacks as many firms, including airlines, announced plans to further reduce employee numbers. Consumer confidence was deteriorating rapidly.
Against this background, the Federal Open Market Committee (FOMC) lowered its target for the federal funds rate from 3.5 percent to 3.0 percent on September 17 and from 3.0 percent to 2.5 percent on October 2. U.S. federal funds rate futures almost factored in expectation of a cut of 25 basis points in the federal funds rate at the next FOMC meeting on November 6, 2001.
On the fiscal policy side, following the terrorist attacks, the U.S. Congress passed on September 14 the 2001 Emergency Supplemental Appropriations Act for Recovery from and Response to Terrorist Attacks on the United States, which would provide a total of 40 billion dollars, and on September 21 a measure to provide a total of 15 billion dollars to support the airline industry.
In Europe, a slowdown of major economies, such as Germany, France, and Italy, was becoming distinct reflecting a slowdown in the growth of exports. Specifically, (1) production, mainly of IT-related goods, was following a decreasing trend, (2) the growth of business fixed investment was decelerating, and (3) employment conditions and consumer confidence were deteriorating. Prices were becoming stable.
In NIEs and ASEAN economies, production was decreasing reflecting a continued fall in exports, mainly in IT-related goods, to the United States and Japan. These economies that were heavily dependent on the United States were directly affected by the ongoing downward revisions to the U.S. economic outlook. Especially in Taiwan and Singapore, whose economies depended greatly on IT-related exports, the economic deterioration was distinct. In China, although the growth in exports had slowed, the economy remained buoyant reflecting strong domestic demand, which continued to be supported by an increase in fiscal spending and direct investment from abroad.
In international financial markets, market participants in various countries had a growing tendency to avoid risks. In the United States, credit spreads between private bonds with different credit ratings widened after the terrorist attacks, and firms with low credit ratings had been unable to issue new bonds since the start of October. Yield spreads of Argentine, Brazilian, and Turkish government bonds vis-à-vis U.S. Treasuries were widening substantially.
D. Economic and Financial Developments in Japan
1. Economic developments
Adjustments in economic activity were becoming more severe, as the substantial decline in production had a negative influence on employment and income conditions. In addition, the terrorist attacks in the United States had further heightened uncertainty in Japan's economy.
With regard to final demand, exports continued to decline substantially, reflecting the slowdown in overseas economies and sluggish demand worldwide for IT-related goods. In terms of destination, a decline in exports to Europe had become distinct recently, while exports to the United States and Asia remained weak. Business fixed investment was also decreasing noticeably while the environment for exports deteriorated. Housing investment remained sluggish and public investment was declining. Private consumption remained almost flat, although somewhat weak indicators such as sales of personal computers and passenger cars were observed recently.
Production continued to decline considerably, reflecting the decline in final demand and strong pressure for adjustments in inventories of goods such as electronic parts and materials. The Index of Industrial Production for August indicated that while inventory adjustments of electronic parts began to make progress, those of materials lagged behind.
Corporate profits, especially in manufacturing industries, decreased significantly reflecting the decline in production, and business sentiment worsened further. The diffusion indexes of business conditions in the September Tankan (Short-Term Economic Survey of Enterprises in Japan) indicated the following developments: while (1) sentiment in IT-related industries, which had improved significantly in 2000, deteriorated significantly, (2) deterioration of sentiment in materials and construction-related industries had become distinct recently, and (3) somewhat weak sentiment in nonmanufacturing industries such as services was spreading. Against the background of these developments in the corporate sector, the employment and income conditions for households were becoming more severe.
The direct negative impact of the terrorist attacks in the United States was limited to some industries such as the tourism and travel industry for the time being. However, a view was prevalent that overseas economies would slow further due to the terrorist attacks and, as a result, Japanese exporting firms were increasingly cautious about the business outlook.
As for the economic outlook, exports were likely to decline for a while as the slowdown of overseas economies was becoming more distinct. Business fixed investment and public investment were likely to decrease, and private consumption was likely to weaken gradually. Reflecting these developments, production was likely to continue falling substantially until the end of 2001.
Downward pressure on production from adjustments in inventories of IT-related goods was expected to subside in 2002 if the current inventory adjustments proceeded further. However, as the decline in industrial production was affecting household income more strongly than before, it might take quite a while for overall production to stop declining, given the decline in government spending and delay in adjustments in overseas economies. Moreover, if the downturn in U.S. private consumption affected by the terrorist attacks led to a substantial decline in Japan's exports such as those of automobiles to the United States, attention should be paid to the risk that another round of inventory adjustments in Japan would be induced by this development.
With regard to prices, domestic wholesale prices were declining somewhat faster for the following reasons: (1) technological innovation; (2) the fall in prices of electronic parts, steel, and nonferrous metals reflecting an easing of the supply-demand balance at home and abroad; and (3) the abatement of the effects of the past depreciation of the yen and high crude oil prices to date. Consumer prices were weakening owing mainly to the decline in prices of imported products and domestic products competing with them.
The balance between supply and demand in the domestic market would gradually exert stronger downward pressure on prices. Furthermore, technological innovation, deregulation, and the streamlining of distribution channels were likely to continue to exert downward pressure on prices, and the pace of decline in various price indexes was likely to be unchanged or accelerate slightly for the time being.
2. Financial environment
In the intermeeting period, there were three key developments in the financial environment.
First, as market participants worldwide had become more risk averse, marginal changes were observed in the Japanese corporate bond market: for example, credit spreads of some bonds widened and issuance of some corporate bonds became difficult. Second, corporate financing by small firms was slightly restrained. And third, monetary aggregates such as the monetary base and money stock showed high growth.
In the corporate bond market, market participants took a more severe view of corporate bonds issued by firms with BBB or lower ratings reflecting their growing tendency to avoid risks following the terrorist attacks and the bankruptcy of a large Japanese retailer. Against this background, these low-rated bonds had not been issued since the beginning of October.
Financing conditions of small enterprises remained basically easy, but the September Tankan indicated small enterprises' fund-raising conditions and the lending attitude of financial institutions as perceived by these enterprises were becoming slightly more severe.
The growth rate of monetary aggregates such as the monetary base and money stock was becoming higher recently. The year-on-year growth rate of the monetary base was high, reaching 14.2 percent in September. The year-on-year growth rate of M2+CDs rose to 3.7 percent in September.
II. Summary of Discussions by the Policy Board on Economic and Financial Developments
A. Current Economic Situation
Most members shared the view on the current state of the economy that (1) adjustments in economic activity had become more severe since the previous meeting on September 18, 2001, as the substantial decline in production had a negative influence on employment and income conditions, and (2) the terrorist attacks in the United States had further heightened uncertainty about Japan's economy.
One member pointed out that although many of the domestic economic indicators available at the moment covered only the period before the terrorist attacks, they showed that already (1) adjustments in the corporate sector were gradually affecting the household sector, mainly in employment and income, and (2) private consumption was somewhat weak. Another member noted that the ongoing adjustments in IT-related industries were gradually affecting (1) other manufacturing industries such as materials, (2) some nonmanufacturing industries, and (3) other sectors, such as the household sector, which was being affected in terms of employment and income conditions.
A different member said that the economy had been deteriorating on the whole. The member continued that the intensified deceleration of the U.S. economy had contributed to the acceleration of the deterioration in Japan's economy even before the terrorist attacks, and these were likely to further spur the deterioration.
Members exchanged views on overseas economic and financial developments, taking into account the effects of the terrorist attacks in the United States.
Regarding the effects of the attacks in international financial markets, most members noted that (1) disruptions in trading and settlement had been generally avoided, (2) stock prices had stabilized after a temporary negative shock and stock prices worldwide had been recovering since October, and (3) credit spreads were, however, expanding in line with market participants' growing tendency to avoid risks. Regarding the direct effects on the economy, these members pointed out that the terrorist attacks caused a deterioration in confidence and the heightening of uncertainty about the outlook worldwide, including the outlook for the United States.
Regarding the U.S. economy, many members noted that a weakness in indicators related to private consumption was becoming distinct after the terrorist attacks, although some indicators had shown that adjustments in the economy were intensifying and continuing for longer than expected even before the terrorist attacks, as was evident in the deterioration in the confidence of households and firms and in labor market conditions. A few of these members commented that there was an increasing risk that adjustments in the U.S. economy would proceed not only in inventory adjustments but also in a wider range of stock adjustments in such areas as capital stock and consumer durables.
Furthermore, some members referred to the effects of the intensifying adjustments in the U.S. economy on the global economy. One member said that the intensifying deceleration of the U.S. economy had led to a deterioration in the economic prospects of developing countries. A different member pointed out that a decrease in some Asian countries' exports had become more distinct.
Some members noted that (1) fiscal and monetary measures, such as tax cuts, an expansion in government spending, and the successive rate cuts by the Federal Reserve, had been adopted on a significant scale in the United States, and (2) stock prices worldwide were recovering recently despite an intensifying slowdown of the global economy, in particular the U.S. economy.
One of these members commented that the terrorist attacks were regarded as a downside risk to the U.S. economy at least in the short term, but the situation was highly fluid and there was a possibility that economic entities' sentiment might recover depending on political and military developments in the future. A different member pointed out that the decline in private consumption in the United States could be offset to some extent by an increase in government spending and tax cuts. On these grounds, these two members noted that the following would continue to require monitoring: (1) how the effects of the fiscal measures and monetary easing in the United States would affect the U.S. economy; and (2) what, in investors' outlook, was contributing to the recovery of stock prices worldwide.
Against the background of these developments in overseas economies, members discussed Japan's current economic situation and the economic outlook.
Regarding recent developments in the corporate sector, one member noted that (1) in manufacturing, the effects of adjustments in IT-related industries were spreading to other industries such as materials, and a recovery in the second half of fiscal 2001 was highly unlikely, and (2) a spreading of the effects of adjustments in manufacturing industries to nonmanufacturing industries, especially in corporate services, was becoming clear.
Another member said that a deterioration in business conditions was spreading to a wide range of industries, noting that (1) construction demand (for non-residential use) was likely to decline to levels last seen in around 1967, and (2) the automobile industry, which had remained relatively firm, was revising its production plans downward reflecting the weakness in car sales in Japan and a decrease in exports to the United States, due to the weak car sales in the United States since September. This member argued that amid the fall in both volume and prices, firms had to reduce costs to increase their profits, and, in line with this, the following movements would become more pronounced: (1) a decrease in the share of labor in income distribution through the introduction of a strategy of work-sharing; (2) a shift of production to overseas locations such as China; and (3) a reduction in costs due to cuts in the cost of infrastructure owing to deregulation.
A different member said that firms' moves to cut the number of employees were becoming conspicuous in other industries in addition to IT-related ones.
With regard to developments in the household sector, many members pointed out the following: (1) the effects of adjustments in the corporate sector were spreading to employment and income conditions in the household sector, mainly in special cash earnings and among part-time workers; (2) there were signs of a deterioration in consumer confidence; and (3) in this situation, private consumption remained at more or less the same level with some indicators showing somewhat weak developments.
Regarding employment conditions, one member noted that the number of full-time employees in the Labour Force Survey and self-employed decreased substantially, and said that the situation was likely to remain very severe for a while.
Another member remarked that private consumption remained at a normal level even though employment and income conditions were on a downtrend. This member continued that private consumption was likely to weaken in the future, because there were signs of weakness in consumption of durable goods, such as automobiles and electrical appliances, although consumption of services remained firm.
A few other members said that a decrease in production was gradually affecting employment and income conditions, and was likely to continue for a while. Given this situation, it was unlikely that private consumption would become the driving force of economic recovery.
With regard to price developments, one member made the following remarks from the viewpoint of firms' price setting. First, the prices of imported goods and domestic goods, which were competing with imported goods, continued to decline due to adjustment of domestic prices to an internationally competitive level, and adjustment pressure from overseas on domestic prices that would promote correction of the high cost structure of Japan's economy was likely to continue amid the fierce competition Japanese firms faced from firms in areas such as Asia. Second, price falls reflecting a rise in productivity and technological innovation continued. And third, a deterioration in the supply-demand balance in line with the deterioration in the economy was further spurring the current price falls. Although firms were trying to reduce production, these efforts had not borne much fruit due to prolonged inventory adjustments. A different member said that downward pressure on prices due to the deterioration in the supply-demand balance remained strong as many firms in the materials industries could not reduce their capacity utilization in order to maintain their cash flow.
Members then exchanged views about the outlook for the economy and prices viewed in a longer time frame.
Each member expressed the view that the key to Japan's economic outlook continued to be the degree of the adjustments in overseas economies and the timing of completion of these adjustments. On these grounds, some members noted the following as points that would require attention: (1) how long the global adjustments in IT-related industries would continue; and (2) to what extent consumption of durable goods, especially automobiles, would decrease in the United States.
Many members said that the following points would require attention on the domestic economic front. First, to what extent the adjustments in business fixed investment, which were currently occurring mainly in the IT-related industries, would spread to other industries. Second, to what extent private consumption would hold out given that the supply-demand balance of the labor market and consumer confidence were deteriorating. And third, how specific measures for structural reforms would be implemented and how this would affect the economy.
Given this situation, some members took a severe view of the outlook for the economy.
One member remarked that an economic recovery was unlikely at least before the first half of fiscal 2002. This member gave the following reasons: (1) a recovery in external demand was unlikely for a while, because adjustments in overseas economies, mainly IT-related industries, were generally continuing for longer than expected; and (2) it would take time to stimulate private domestic demand by means of structural reforms.
A different member said that the GDP growth rate for fiscal 2002 would remain very low and could be below zero. In addition, this member pointed out that considering the correlation between the output gap and prices, as seen in the short-term Phillips curve, the year-on-year decline in prices was unlikely to decelerate in fiscal 2002, given the weak aggregate demand and the expansion of the output gap where the real growth rate was lower than the potential one.
One member took a severe view that (1) the United States was facing one of the worst crises since World War II and the financial euphoria had ended, and (2) the Dow Jones Industrial Average was likely to hit a ceiling at the 9,370-9,533 U.S. dollar level and the U.S. Nasdaq composite index at the 1,655-1,721 level, after rising toward the year-end, and they were likely to decline further in 2002. This member contended that crude oil prices were likely to have hit bottom at around 21 U.S. dollars per barrel in mid-September, although this assessment depended on demand this winter. This member expressed the following view about Japan's economy. First, the economy was likely to follow a downtrend for about the next ten months, judging from the Indexes of Business Conditions. Second, both real and nominal GDP were likely to show negative growth in fiscal 2001 and fiscal 2002 second only to the negative growth in 1923 and 1998. And third, the economic situation was likely to be more severe than in 1998. This member added that given this situation the Reform Schedule should be converted into a crisis management program.
This member continued that in view of the medium- to long-term fundamentals of the Japanese economy, the global competitiveness of domestic industries, especially electrical machinery, was weakening partly due to competition from China, where personnel expenses were substantially lower than in Japan. On this point, a different member pointed out that a shift of production to overseas continued to exert downward pressure on production of electrical machinery in Japan.
B. Financial Developments
Many members commented on developments in the money market that liquidity seemed to be decreasing in the call market as there was an increasing tendency recently for foreign banks in Japan to hold a large amount of excess reserves.
Some members pointed out that central banks in the United States and Europe had provided ample funds to the markets in response to an increasing liquidity demand following the terrorist attacks in the United States, but this high liquidity demand subsided in about a week and the level of liquidity demand returned to normal thereafter. In Japan, on the other hand, liquidity demand remained high even after the interim book closings at the end of September, and the Bank continued to provide ample funds to the market. These members said that this was a very peculiar phenomenon.
These members explained the background to these developments as follows: (1) market participants had lost their incentive to invest since interest rates were virtually zero percent in Japan; and (2) they were becoming more risk averse following the terrorist attacks and the bankruptcy of a large Japanese retailer.
One of these members explained the background to the fact that foreign banks in Japan held a large amount of excess reserves as follows. First, almost all interest rates for investing and raising yen funds in the money market, even those on term instruments, were virtually zero percent under the current monetary easing. Second, as Japanese financial institutions were aggressively investing in U.S. dollar-denominated bonds with funds raised through currency swaps after the terrorist attacks, some foreign banks were taking advantage of the negative cost of funding yen in exchange for the U.S. dollar by responding to these currency swaps. This member continued that, with interest rates approaching much closer to zero percent after the change in the unit of rates for transactions to 0.001 percent, these foreign banks judged that they could not cover operational costs and risks related to investing funds in Japan. Therefore, these foreign banks deposited an enormous amount of yen in their accounts at the Bank.
Members next discussed the effects of the rise in risk premiums in international financial markets on the overall Japanese financial environment.
Many members commented on its effects on the Japanese financial system.
One member pointed out that in overseas financial markets an uptrend in risk premiums was widely observed, but in Japanese financial markets, it was only seen in some corporate bonds with low credit ratings and had not led to a rise in fund-raising costs of borrowers as a whole. This member said the background to these developments in Japan could be that indirect financing through financial intermediaries was still dominant in Japan and banks' lending rates did not fully reflect the increased risk premiums. This member continued that the increase in risk premiums worldwide was more likely to cause a deterioration in banks' assets than to increase fund-raising costs of borrowers, and whether or not these developments would negatively affect the financial system required careful monitoring.
Some members said that market participants' view of Japanese banks had already become severe.
One member pointed out that prices of bank stocks continued to follow a downtrend due to concern about the NPL problem while Japanese stock prices on the whole were recovering.
A few other members commented on the potential Japan premium. One member explained that the background to the negative yen-funding cost of foreign banks described earlier lay in the potential Japan premium.
A different member said that the credit default swap rates with five- to ten-year maturities suggested that the credit risk premium of Japanese banks was already on an increasing trend, similar to the situation in 1997-98, and therefore, this situation required careful monitoring.
Some members commented on the effects of developments in international financial markets.
These members said that the increasing tendency to risk aversion could cause problems in external financing for countries with a current account deficit and/or a cumulative debt, and this might have negative effects on Japan's economy through instability in the international financial system and fluctuations in the foreign exchange market. A few of these members noted that some developing countries had already experienced a fall in stock prices, currency depreciation, and a widening of yield spreads between their government bonds and U.S. Treasuries. A different member referred to the risk that capital flows to emerging markets might be reduced with the decrease in exports of Asian economies.
With regard to developments in corporate financing, some members pointed out that although credit contraction had not been observed widely, unlike the situation in 1997-98, fund-raising conditions for small firms had become tighter. This was because (1) the lending attitude of financial institutions toward small firms was cautious on the whole and (2) firms' cash flow had decreased in line with a fall in sales reflecting the deterioration of the economy.
One of these members said that some private banks claimed that they were in a dilemma between a requirement to increase loans in accordance with their plans for restoring sound management submitted to the Financial Reconstruction Commission and a requirement to maintain their financial soundness in accordance with the Financial Inspection Manuals for self-assessment of asset quality. This member continued that in order to improve banks' ability to take risks, it was necessary to (1) improve their profitability by securing appropriate lending spreads and restructuring and (2) solve the problems of their NPLs and of firms' excessive debt burden expeditiously. The member added that in order to solve the latter problem, it was necessary to set aside sufficient provision for loans to borrowers that "needed attention" and to remove loans to borrowers "in danger of bankruptcy" and "effectively bankrupt or bankrupt" borrowers completely from banks' balance sheets, for example, by using the planned new functions of the Resolution and Collection Corporation (RCC). For banks with insufficient financial strength to take such steps, another injection of public funds should be considered.
Based on the above discussion, many members said that one should pay due attention to the risk that the state of the financial environment would further dampen the economy, thereby causing the economy to fall into a spiral of deterioration. One of these members noted that the reduced risk-taking ability of the Japanese financial system had been impairing the effectiveness of the monetary easing, and this problem could be worsened further by the rise in risk premiums worldwide.
III. Summary of Discussions on Monetary Policy for the Immediate Future
Members discussed the monetary policy stance for the immediate future.
Most members shared the following view. First, adjustments in economic activity were becoming more severe since the previous meeting, as the decline in production had a negative influence on employment and income conditions. Second, the terrorist attacks in the United States had further heightened uncertainty about Japan's economy. These members pointed out that liquidity demand continued to fluctuate in financial markets.
These members expressed the view that, given the large fluctuations in liquidity demand, the stability of financial markets was likely to be impaired if the Bank conducted market operations aiming at a specific target for the outstanding balance of current accounts at the Bank. On this basis, these members concurred that the Bank should provide ample liquidity to the market in a timely manner while maintaining the flexible guideline for money market operations decided on September 18, 2001, which did not set an upper limit to the outstanding balance of current accounts at the Bank.
Some members said that the Bank's money market operations since September 12, 2001 could be regarded as a virtual zero interest rate policy and were effective in maintaining market stability. One of these members said that, given the current developments in financial markets, it would be desirable that (1) the staff provide ample liquidity to the market under the current guideline for money market operations, giving priority to ensuring the stability of the market, and that (2) if the outstanding balance of current accounts at the Bank fluctuated greatly as a result of such operations, the staff provide adequate explanation of its background to the Policy Board.
A different member expressed the opinion that it was appropriate to follow a guideline for market operations such as the current one, given the current market conditions that could be in a state of emergency.
One member said that the Bank should introduce a price level target and at the same time increase the outstanding balance of current accounts at the Bank to 10 trillion yen. This member added that (1) although the current guideline for money market operations did not set a specific target for the overnight call rate, the Bank's operations seemed to have been conducted aiming at a rate moving stably below 0.01 percent, and that (2) such a situation was not desirable since it had not been approved as a target at the meeting and it could make the introduction of the Lombard-type lending facility pointless.
At the request of some members, the staff provided the following explanation of the day-to-day money market operations.
First, the staff considered that the objectives of the current market operations were to ensure proper functioning of financial markets and enhance the effective permeation of monetary easing effects. Second, in examining the functioning of financial markets, it was necessary to take into account various factors, for example, market participants' perceptions at the time and change in the unit of rates for transactions. Third, the staff were carefully monitoring market conditions and striving to stabilize the market as much as possible to achieve the objectives of the current policy guideline. And fourth, the Lombard-type lending facility gave assurance to the market that interest rates would not rise greatly, regardless of whether it was actually utilized.
Members discussed the conduct of monetary policy in the future.
Members commented on the current liquidity demand, which remained high and fluctuating, as well as issues related to money market operations in such a situation.
Many members said that, with the current extremely low interest rates, market participants were not investing their excess funds in the money market but were keeping them as reserves, and this was the background to the current situation where (1) the outstanding balance of current accounts at the Bank remained high, while (2) funds were unevenly distributed and the availability of liquidity was lowered. These members pointed out that the relation between the quantity of funds and easing effects was becoming unclear.
One of these members commented that it was a natural consequence that, as the opportunity cost of holding excess reserves was close to zero due to the drastic easing measures, the outstanding balance of current accounts could fluctuate easily and that, as a result, the Bank might have to play a greater role in leveling the availability of funds.
Based on the above discussions, some members said that the gap was widening further between the reality of financial markets and the view that an increase in the monetary base or the outstanding balance of the Bank's current accounts itself was effective in stopping the current price decline.
Many members commented on the conduct of monetary policy in the future based on the assessment of the current monetary easing.
Many members expressed the view that (1) since the beginning of 2001, the Bank had been making every effort in its search for possible additional easing measures as it had exhausted orthodox monetary easing measures such as reducing interest rates, and (2) the limits of the effectiveness of the Bank's liquidity provision, the inherent role of a central bank, to deal with fundamental problems of Japan's economy, such as structural problems and weak aggregate demand, were becoming more evident from the experience of policy measures taken in August and September 2001.
One member summarized the effects of policy measures since March 2001 as follows. First, the aggressive provision of ample liquidity was effective in inducing a marginal decline in short-term interest rates, but effects could no longer be expected of an additional increase in the outstanding balance of current accounts at the Bank, as short-term interest rates had already reached their lowest possible level. Second, an increase in the outstanding balance of current accounts at the Bank only resulted in the increase in financial institutions' excess reserves rather than encouraging financial institutions to invest in various financial assets, namely rebalancing of financial institutions' portfolios. In other words, the high level of the outstanding balance of current accounts at the Bank was attributable to financial institutions holding excess reserves instead of rebalancing their portfolios. And third, an increase in the Bank's outright purchases of long-term JGBs gave cause for concern about fiscal discipline. On this basis, this member expressed the opinion that, theoretically, what monetary policy could do by itself in the future was limited to dealing with a possible surge in liquidity demand due, for example, to anxieties over the financial system.
A different member pointed out that since the adoption of the new policy framework for monetary easing in March 2001, the lending stance of private financial institutions had hardly changed, although the monetary base had been increasing significantly at about 15 percent year on year recently. This member added that this was evidence that the roles of policies other than monetary policy were essential in increasing broadly-defined money as well as boosting demand.
One member pointed out that many of the asset purchasing measures that were suggested by people outside the Bank as additional easing measures were, in fact, not a matter of monetary policy but fiscal policy.
Based on the above discussions, many members expressed a cautious view regarding the effectiveness of further increasing the target for the outstanding balance of current accounts at the Bank at that time. On this basis, these members commented that it was appropriate to examine the conduct of monetary policy in the future from the viewpoint of (1) how liquidity should be provided if there were problems in the financial system and in corporate financing toward the end of 2001 and fiscal 2001, and (2) whether there was still room for the Bank to take measures in line with those taken by the Government if the economy started to fall into a spiral of deterioration.
One of these members said that thorough discussion was necessary with regard to (1) fiscal measures that would be consistent with structural reforms to boost demand by improving the content of fiscal spending and (2) measures to enable drastic disposal of NPLs. On this basis, this member commented that it was reasonable to examine whether the Bank could make a contribution to such measures.
Members then discussed the conduct of macroeconomic policies for price stability.
Some members said that the continuous price fall was as undesirable as inflation, in that it would bring about fluctuations in the real value of debts and a rise in real interest rates. One of these members remarked that deflation would impede structural reforms, since it would hinder adjustments of real wages and relative prices. A different member said that the greatest tasks for Japan's economy were to achieve economic recovery and halt deflation.
On this basis, many members pointed out that discussion should focus on measures to stop the price fall.
One member pointed out that (1) as shown in the Phillips curve, price developments were greatly affected by the supply-demand balance, and that (2) therefore, it was important to examine measures to increase demand in order to stop the current price fall. This member also stated that it was not appropriate to say that both inflation and deflation were monetary phenomena and that quantitative expansion would be immediately effective in stopping the price fall by applying the equation for money and general price level, which could be applied only in the long term, to the short-term developments in prices. Further, this member remarked that the fact that prices continued to fall despite the fairly high growth in the monetary base and money stock was good evidence that the relation between price and monetary aggregates was very unstable in the short term.
A different member said that the greatest task for Japan's economy was to increase aggregate demand in a sustainable way, and that this would help stop the continuous price fall. On this basis, this member expressed the view that it was essential to (1) maintain the current powerful monetary easing framework and (2) restore the functions of the financial system through disposal of NPLs, while (3) conducting policy measures which would stimulate private demand efficiently. This member expressed the earnest hope that the Government would advance structural reforms that would gain public confidence at home and abroad and induce a sustainable growth of private demand.
Another member commented that in order to achieve economic recovery and halt deflation, a combination of efforts in fiscal policy, in monetary policy, and by the private sector, including firms and banks, was necessary. This member added that the Bank, as the authority in charge of monetary policy, should continue to demonstrate firm determination not to allow deflation.
In relation to this, some members stated that it was not appropriate to adopt inflation targeting at this time, given the current environment for prices and the limited scope for policy measures.
One member said that (1) the Bank should definitely not adopt a policy aimed at creating a certain level of inflation, which involved taking any and every measure to raise price levels regardless of other consequences, (2) inflation targeting adopted in some countries overseas was aimed at preventing inflation, and that (3) although it was necessary to set a numerical price target of either a level or a rate of change, it was necessary to discuss it only as a reference point for the goal, i.e., price stability. Having said this, this member expressed the view that, in the current situation where nominal interest rates were already close to zero percent and the economy was under structural adjustment pressure, there would not be any available and controllable measure to achieve the target with a certain time frame. This member added that setting a numerical price target was an issue to be discussed after deflation came to a halt and the environment for prices returned to normal levels.
Further, this member said that it was a dominant view in financial markets that the introduction of inflation targeting would lead to a fall in the price of long-term JGBs, and thus the introduction of inflation targeting required careful discussion taking into account this view.
A different member expressed the opinion that defining a medium- to long-term price stability by setting a numerical range could be a matter to examine. This member, however, expressed the opinion that inflation targeting could not be usefully discussed without considering plausible measures to achieve the goal.
IV. Remarks by Government Representatives
The representative from the Cabinet Office made the following remarks.
(1) The Government believed that the reforms laid out in the "Reform Schedule" would undoubtedly be realized, and that structural reforms were currently in the latter half of the first stage. In this stage, the Government would set aside necessary budgets and amend relevant laws.
Shortly after the turn of the year, structural reforms would enter the second stage where drastic institutional reforms regarding the core of the nation's system would have to be implemented. The foremost issue at this stage would be the taxation system.
(2) The reforms led by Prime Minister Koizumi did not contain any plans for taking additional fiscal measures in response to a mere deterioration in the economy. If fiscal measures were implemented, they would be based on a very difficult judgment of how the Government should react to a spiral of deterioration in a new crisis, the possibility of which could not be denied after the terrorist attacks, with a view to fulfilling responsibility for controlling the investment-savings balance.
(3) Regarding monetary policy, the Government understood well from discussions earlier in the meeting that the relation between quantity and price of money had entered a new phase. However, the Government would like to ask the Bank to give as much support as possible from the monetary side and discuss thoroughly various policy options based on its expertise.
The representative from the Ministry of Finance made the following remarks.
(1) In response to heightened liquidity demand after the terrorist attacks in the United States, the Bank took monetary easing measures on September 18 in order to ensure the stability of financial markets, in addition to its money market operation of providing ample liquidity to cause the outstanding balance of current accounts at the Bank to be about 8 trillion yen or more. As a result, the money market cleared the hurdle of the interim book closings at the end of September without any disruptions. The Government would like to ask the Bank to continue providing ample funds so that the outstanding balance of current accounts at the Bank would continue to be over 8 trillion yen, by continuing the money market operations which had been employed after the previous meeting, while closely monitoring the effects of the terrorist attacks on the economy and financial markets.
(2) The consumer price index (CPI) showed that prices continued to fall and the current continuous decline in prices was having a negative effect on various aspects of the economy, such as corporate activity and private consumption, and the Government would like to ask the Bank to further discuss measures to stop the price falls.
(3) The Bank had announced its determination to make the utmost effort as a central bank to stop the continuous price falls. However, as the downward trend in prices was unlikely to change, the Government would like to ask the Bank to conduct monetary policy in a timely manner to make its firm policy intention permeate into financial markets by way of working strongly on people's expectations, thereby making the policy intention effective.
Based on the above discussion, the majority of members considered it appropriate to maintain the procedures for money market operations decided on September 18, 2001.
One member, however, contended that the Bank should introduce a price level target and raise the outstanding balance of current accounts to around 10 trillion yen, and that, in order to achieve the target for the outstanding balance smoothly, it should remove the restriction that the amount of the Bank's long-term JGB holdings should not exceed the amount of banknotes issued.
This member gave the following reasons for this. First, the Bank should show its determination to prevent deflation by introducing a price level target. Second, if the Bank did not introduce a target for prices with a time frame, there was a risk that the Bank might eventually have to accept a target for prices with a time frame set by the Government. Third, the Bank should implement additional quantitative easing in response to the deterioration of the economy. And fourth, quantitative easing to date could be considered to have actually contributed to the recovery of stock prices since October and the maintenance of a tendency toward a weaker yen in the foreign exchange market. This member contended that the Bank should examine ways to purchase and manage foreign bonds, since the member considered that purchases of foreign bonds as a means of quantitative easing were possible within the framework of regular business of the Bank prescribed in Article 33 of the Bank of Japan Law.
As a result, the following proposals were put to vote.
Mr. N. Nakahara proposed the following procedures for money market operations:
The Bank of Japan will conduct money market operations, aiming at maintaining the CPI (excluding fresh food, on a nationwide basis) in the January-March quarter of 2003 at or raising it to a target of 99.1, which was the average of the CPI in the January-March quarter of 2001.
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:
The Bank of Japan will conduct money market operations, aiming at an outstanding balance of current accounts at the Bank of around 10 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 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, and will be made public by the attached statement (see Attachment).
The Bank of Japan will provide ample liquidity to the money market by aiming at maintaining the outstanding balance of current accounts held at the Bank at above 6 trillion yen.
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 for the following reasons. First, the current guideline, which did not set a specific numerical target, was unclear and would give the staff too much discretion. Second, the Bank should implement additional quantitative easing given the unstable economic situation following the terrorist attacks in the United States. Third, the lack of a specific numerical target in the guideline had been causing uncertainty among financial market participants. And fourth, if the Bank did not set a numerical target for prices of its own accord, there was a risk that the Bank might have to accept a target for prices with a time frame set by the Government.
VI. 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 October 15, 2001 in the Monthly Report of Recent Economic and Financial Developments (consisting of "The Bank's View" and "The Background").8
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 for the following reasons. First, the description of inventory adjustments of IT-related goods in "The Bank's View" was too optimistic. Second, the phrase "the decrease in the production of IT-related goods may eventually come to an end" was unclear and should be deleted. Third, considering the speed of the current adjustments in economic activity, to state that the adjustments would surely affect domestic demand "gradually" was not appropriate. Fourth, the judgment that prices were expected to follow a "gradual" declining trend for the time being was not appropriate. And fifth, it should describe the fact that the fall in public investment was having a large effect on economies in rural areas.
- 8The original full text, in Japanese, of the Monthly Report of Recent Economic and Financial Developments was published on October 15, 2001 together with the English version of "The Bank's View." The English version of "The Background" was published on October 16, 2001.
For immediate release
October 12, 2001
Bank of Japan
At the Monetary Policy Meeting held today, the Bank of Japan decided, by majority vote, to maintain the following guideline for money market operations for the intermeeting period:
The Bank of Japan will provide ample liquidity to the money market by aiming at maintaining the outstanding balance of current accounts held at the Bank at above 6 trillion yen.