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Minutes of the Monetary Policy Meeting

on November 15 and 16, 2001
(English translation prepared by the Bank's staff based on the Japanese original)

December 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 Thursday, November 15, 2001, from 2:00 p.m. to 3:38 p.m., and on Friday, November 16, from 9:01 a.m. to 12:31 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. Y. Kobayashi, Director General for Economic and Fiscal Management, 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. H. Yamaoka, Senior Economist, Policy Planning Office 4
Mr. S. Nagai, Senior Economist, Policy Planning Office 5

  1. The minutes of this meeting were approved by the Policy Board at the Monetary Policy Meeting held on December 18 and 19, 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 November 16 from 10:40 a.m. to 11:55 a.m.
  3. Mr. Kobayashi was present on November 15 for the whole of the session, and on November 16 from 9:01 a.m. to 10:39 a.m.
  4. Mr. Yamaoka was present on November 15.
  5. Mr. Nagai was present on November 16.

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 October 29, 2001. 7 The Bank provided ample liquidity to the money market as liquidity demand continued to be volatile against the background of the fact that foreign banks held a large amount of excess reserves in their current accounts at the Bank. As a result of these market operations, the uncollateralized overnight call rate was generally stable at 0.002-0.004 percent. An increasing number of lenders in the money market, such as regional banks, also seemed to be disinclined to invest in the money market recently, and thus a closer examination of demand for funds had become necessary.

  1. 6Reports were made based on information available at the time of the meeting.
  2. 7The guideline was as follows:
    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.

B. Recent Developments in Financial Markets

1. Developments in domestic financial markets

During the intermeeting period, Japanese stock prices were weak in contrast with U.S. and European stock prices, which were generally firm. The Nikkei 225 Stock Average fell by about 5 percent while the U.S. Nasdaq composite index rose by about 12 percent, showing that the co-movement of these stock market indices in these markets had become weaker. U.S. stock prices had been firm, partly in expectation of positive effects of the drastic fiscal and monetary policy measures, and more recently due to the progress regarding the situation in Afghanistan and the rebound in semiconductor prices. The weakness in Japanese stock prices reflected negative domestic factors, such as the nonperforming-loan (NPL) problem, rather than the effects of the rise in U.S. stock prices.

By industry, bank stocks fell to about 20 percent below the lowest level marked in 1998 after the bursting of the bubble. Real estate and construction stocks also fell markedly in anticipation of the negative impact of NPL disposal. As for the outlook, many market participants expected that Japanese stock prices would remain more or less at the same level, but concerns about the risk of further price falls remained strong.

Interest rates on term instruments remained almost level. Long-term interest rates moved around 1.3-1.4 percent, but they were on a slight downtrend reflecting (1) the fact that issuance of new Japanese government bonds (JGBs) was limited to 30 trillion yen in the budget for fiscal 2001 including the supplementary budget, and (2) the flow of funds into the JGB market with the start of the second half of the fiscal year. The market had been sensitive to information regarding the discussions about the initial budget for fiscal 2002 and the second supplementary budget for the current fiscal year, which would affect the supply-demand balance of JGBs, and it would continue to show mixed developments for a while due to both positive and negative factors.

Credit spreads, the yield differentials between private bonds and JGBs, remained level for bonds issued by firms with high credit ratings while those for bonds issued by firms with BBB/Baa or lower ratings were widening. The credit spreads for bonds issued by some banks were on a widening trend in line with the fall in the prices of bank stocks.

2. Developments in the foreign exchange market

The yen was in the range of 120-123 yen to the U.S. dollar, in spite of the fact that stock prices in the two countries moved in opposite directions, with Japanese stock prices weakening and U.S. stock prices rising, because, as a result of the aircraft accident in the United States and the fact that foreign investors reduced their short yen positions in short-term transactions, U.S. dollar purchases did not increase. The yen appreciated slightly against the euro.

C. Overseas Economic and Financial Developments

Features in overseas economies and financial markets in the intermeeting period were (1) a deterioration in consumer and corporate confidence and a worsening of employment conditions in the United States, (2) a significant weakening in inflationary pressure in various countries, and (3) a contrast between the current economic deterioration and market developments which factored in expectations for a recovery in the future.

In the United States, the real GDP for the July-September quarter declined at an annualized rate of 0.4 percent from the previous quarter, posting negative growth for the first time in eight and a half years. A breakdown by demand components showed that business fixed investment continued to decrease substantially for the second consecutive quarter and the positive contribution of private consumption and housing investment to GDP was much smaller. The U.S. real GDP growth rate for 2002 forecasted by private institutions was revised downward from 1.5 percent in October to 1.1 percent in November.

Developments in economic and financial indicators revealed the following. In the corporate sector, production continued to decline substantially. Inventories were decreasing, but the ratio of inventories to shipments remained high because shipments were contracting substantially. In this situation, corporate confidence was deteriorating, as evident from the sharp drop from the previous month in the National Association of Purchasing Management (NAPM) index for October, and firms were further reducing investment and adjusting employment. As for employment conditions, the unemployment rate rose, as nonfarm payroll employment had dropped by 420,000 in October, the largest decrease in about 20 years for a single month. The rate of increase in wages declined significantly.

In the household sector, consumer confidence was deteriorating rapidly. Retail sales excluding automobiles had grown at around 1 percent in October from the previous month, but they were not strong, as the level was below that in August. A weekly measure of sales at chain stores showed that sales were falling. Automobile sales for October marked a record high for a single month reflecting special sales promotion measures such as the zero-interest program for automobile loans offered by some automakers. However, this gave cause for concern that automobile sales might decrease in the future because future demand had been satisfied in advance. Many held a cautious view about Christmas sales. The Producer Price Index (PPI) for October fell by 1.6 percent from the previous month, the largest fall for a single month since the introduction of the index.

In this situation, the Federal Open Market Committee (FOMC) lowered its target for the federal funds rate from 2.5 percent to 2.0 percent on November 6. However, the FOMC remained concerned about the risk of a further weakening of the economy. U.S. federal funds rate futures factored in expectation of a cut of around 25 basis points in the federal funds rate by the end of 2001.

In major economies in Europe, such as Germany, production followed a downtrend, and business fixed investment also decreased due partly to a deterioration of corporate profits. Consumer confidence deteriorated due to a worsening of employment conditions, as evident in a rise in the unemployment rate, and the growth in private consumption seemed to be slowing. Inflationary pressure abated significantly. Against this background, the Governing Council of the European Central Bank (ECB) reduced the minimum bid rate on the main refinancing operations to 3.25 percent from 3.75 percent on November 8.

In NIEs and the ASEAN region, the economic deterioration starting from a fall in exports to the United States and Japan continued. In China, the growth in exports was slowing and, in addition to exports of IT-related goods, those of textile products seemed to be decreasing. However, the economy continued to record high growth reflecting strong domestic demand supported by an increase in fiscal spending and high levels of direct investment from abroad.

In Argentina, yield spreads between Argentine government bonds and U.S. Treasuries had further widened despite the Argentine government's announcement of a debt restructuring scheme on November 1. However, increasing tension in developments in Argentina had not had significant effects on other heavily indebted countries such as Brazil and Turkey.

D. Economic and Financial Developments in Japan

1. Economic developments

Adjustments in economic activity were becoming more severe, as the substantial decline in production was beginning to have an adverse effect on private consumption through decreases in employment and income.

With regard to final demand, exports continued to decline substantially reflecting the slowdown in overseas economies and sluggish demand worldwide for IT-related goods. Business fixed investment was also decreasing reflecting the deterioration in exporting conditions and corporate profits. Machinery orders, a leading indicator of business fixed investment, dropped sharply by 5.7 percent in July-September from the previous quarter, and were projected to decrease slightly in October-December. In contrast to the conspicuous weakness in manufacturing industries, activity in nonmanufacturing industries remained level on the whole. Thus, the economy did not deteriorate as rapidly as in 1998 when the economy last underwent adjustments. However, an increasing number of firms in nonmanufacturing industries, mainly construction and trading firms, had recently revised their earnings forecasts for the second half of fiscal 2001 significantly downward.

As for private consumption, weak indicators were increasing compared to the previous month. Passenger-car sales, which were previously relatively firm, decreased clearly in September and October, and travel, mainly to overseas destinations, decreased substantially. Consumer confidence was deteriorating further. Housing investment remained sluggish, and public investment continued to be on a downward trend.

Reflecting these developments in final demand, production continued to decline considerably. Industrial production was forecasted to fall substantially in October-December, after the 4.3 percent decline in July-September from the previous quarter. The inventory cycle of manufacturing industries suggested that adjustments were still necessary in electronic parts, although their inventories had decreased considerably as a result of significant cuts in production. The increase in inventories of materials was finally coming to a halt due to the full-scale reduction in production, but the ratio of inventories to shipments remained high. Inventories of final goods such as construction materials, consumer goods, and capital goods were beginning to build up, and the adjustments in economic activity starting from the decrease in exports were having a negative influence on domestic demand.

Regarding employment conditions, the ratio of job offers to applicants was on a moderate downtrend, and the number of regularly employed workers and nominal wages also continued to decrease. In this situation, the unemployment rate surged to 5.3 percent in September from 5.0 percent in August, due mainly to a sharp fall in the number of employees, which had been on an uptrend. Monthly fluctuations in statistics should be taken into account to some extent, but the risk of a further deterioration in employment and income conditions should be kept in mind.

Some slightly positive signs could be observed regarding adjustments in IT-related industries. Adjustments in excessive inventories of IT-related goods were progressing steadily worldwide, for example in the United States. According to anecdotal information from some IT-related manufacturers, orders and shipments were recovering. July-September results for worldwide shipments of semiconductors were slightly higher than projected in October in the forecast for the quarter. DRAM (dynamic random access memory) spot prices, an indicator sensitive to supply-demand balance in the semiconductor markets, were rebounding recently. However, final demand for IT-related goods still seemed to be decreasing and would continue to require close monitoring as it might decline further due to the effects of the terrorist attacks.

Regarding the economic outlook, exports were likely to continue to show a clear decline, reflecting not only the sluggish demand for IT-related goods but also the continued slowdown in overseas economies. With respect to domestic demand, private consumption would weaken further while employees' income continued to decline. In addition to the weak developments in final demand, adjustment pressure on inventories remained strong especially in materials, and therefore, industrial production was likely to follow a downtrend at least until the end of fiscal 2001.

With regard to prices, the rate of decline in import prices from three months earlier was expanding recently. This was mainly due to the fall in international commodity prices, such as those of nonferrous metals and crude oil. The rate of decline in domestic wholesale prices from three months earlier was also expanding slightly as (1) prices of electronic parts, steel, and nonferrous metals fell reflecting an easing of supply-demand balance at home and abroad; and (2) the effects of high crude oil prices to date and the yen's depreciation had peaked out. The CPI was weakening owing mainly to the decline in prices of imported products and their substitutes. As for the outlook for prices, the rate of decline in various price indexes would remain unchanged or slightly accelerate for some time as the balance between supply and demand in the domestic market was likely to exert downward pressure on prices gradually.

2. Financial environment

Major developments in the financial environment were as follows: (1) in the corporate bonds and CP markets, the issuing conditions were deteriorating particularly for firms with low credit ratings; (2) conditions for indirect financing were becoming slightly more severe as evident in the lending attitude of banks and the fund-raising conditions for small firms; and (3) the number of corporate bankruptcies increased sharply in October.

The amount outstanding of private bank lending decreased by around 2 percent year on year and showed no significant change. Banks remained keen to increase lending to blue-chip firms, but were becoming cautious about lending to firms with higher credit risk. Major banks' lending plans for the latter half of fiscal 2001 showed a further decrease in lending, in contrast to their plans for the first half of fiscal 2001. This was basically due to the weakness in funds demand, but partly also to a change in the banks' attitude to one that placed less emphasis on the volume of lending instead of equal emphasis on volume and spreads as in the past.

Spreads on loans were widening with some fluctuations, and in the past few months, spreads on long-term lending had been widening clearly, albeit marginally.

The lending attitude of banks as perceived by small firms had become more cautious from September to October. The percentage share of firms perceiving their financial position as tight had increased slightly. Fund-raising conditions for small firms were becoming more severe, even though not as rapidly as in 1998 when there was widespread concern about the stability of the financial system.

In the corporate bond market, the year-on-year growth rate of the amount outstanding of bonds issued slowed. Issuance of corporate bonds by firms with high credit ratings, such as electric power companies, continued to be steady, but issuance by firms with a BBB/Baa or lower rating remained difficult partly in view of the effects of the failure of a large retailer. The share of BBB/Baa-rated corporate bonds in the total amount issued declined in October.

The amount outstanding of CP issued continued to expand by about 30 percent year on year, and the volume of CP issuance had not been depressed by the effects of the failure of a large retailer. However, according to some sources, interest rates on CP maturing beyond the year-end and issued by firms with low credit ratings were rising slightly due to the effects of the failure.

Monetary aggregates such as the monetary base and money stock continued to show a relatively high growth. The year-on-year growth rate of the monetary base was 14-15 percent in October for the second consecutive month. The year-on-year growth rate in M2+CDs was 3.6 percent, almost unchanged from September. In detail, the growth rate of deposit money, a component of M1 (cash currency + deposit money), had been increasing.

The number of corporate bankruptcies rose significantly to 1,843 cases in October from the previous level of about 1,500 cases per month until September. This was the fourth highest level in a single month. In detail, the share of small firms in the total number of bankruptcies increased from the previous month. The number of bankruptcies due to the termination of special guarantee systems for the financial stabilization of small and medium-sized enterprises also increased.

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

A. Current Economic Situation

Most members concurred that it was appropriate to make the judgment on the current state of the economy more cautious than in previous months, because adjustments in economic activity were becoming more severe, as the substantial decline in production was beginning to have an adverse effect on private consumption through decreases in employment and income. One member said that the Japanese economy was experiencing deflation but had not yet fallen into a deflationary spiral. Another member pointed out that (1) the Indexes of Business Conditions showed the rapid deterioration of the economy, (2) the Leading Index of the above indicated that the economic deterioration was not likely to stop at least for the next eight to ten months, and (3) the pace and the extent of the current economic adjustments were similar to those after the oil crises and the bursting of the bubble. This member continued that it was clear, given the rise in the unemployment rate, the increase in the number of corporate bankruptcies, and worsening indicators of corporate financing, that the economy had entered an even more severe phase.

Many members said that activity in the corporate sector continued to deteriorate and adjustments were still in progress. Regarding production and inventories, a few members pointed out that inventory adjustments were progressing in some industries such as electronic parts, and pulp and paper, but on the whole, they were lagging despite the rapid pace of production adjustments.

Some members pointed to the impact on corporate activity of excess supply due to a delay in structural adjustments and of increased global competition pressure. One member cited the fact that the figure for construction starts (nonresidential) for fiscal 2001 was expected to be below that for 1967 against the background of a concentration of economic activity in the Tokyo metropolitan area, and pointed out that (1) prices of construction orders to major contractors were falling by almost 30 percent from the previous year; and (2) fabricators of parts had been forced to shift their production base to China, and as a result, such fabricators and materials manufacturers were experiencing a fall in prices, orders, and earnings. This member continued that automobile production would inevitably be less than previously projected because domestic sales of automobiles were falling and exports to the United States were expected to level off in the near future when the effects of the sales promotion measures for automobiles in the United States subsided. This member was concerned about the decline in automobile production because it would have a large effect on economic developments. Another member, referring to the difference in wages of manufacturers in China, Japan, and other Asian countries, pointed out that (1) low-priced exports from China were a threat to manufacturers not only in Japan and but also in other Asian countries; and (2) in this situation, Japanese manufacturers were being forced to cut fixed costs substantially particularly by reducing the number of employees.

A few members expressed the view that business fixed investment was decreasing further due to the decline in corporate profits. One member referred to the fall in machinery orders, pointing out that the decrease in business fixed investment was spreading from manufacturers of IT-related goods to their users.

With regard to activity in the household sector, members generally agreed that the judgment on private consumption had to be revised downward, which was a change from their previous judgment that it had remained flat so far. Many members pointed out that employment and income conditions were deteriorating as evident in the rise in the unemployment rate and that consumer confidence had weakened. In addition, they noted that indicators of consumption such as outlays for overseas travel and passenger-car sales, which had been fairly firm, had started to decline. One member said that consumers were becoming more thrifty and a decrease in expected future income was restraining present consumption.

B. Economic Outlook

With regard to the economic outlook, members shared the view that adjustments in economic activity, starting from the decline in exports since the beginning of the year, would surely dampen domestic demand further. On this basis, members pointed out that the following required monitoring for the time being: (1) the risk that a simultaneous deceleration in the world economy, especially the United States, would lead to a substantial decline in Japan's exports; (2) the risk that private consumption would start declining clearly due to a deterioration in employment and income conditions; and (3) the risk that the economy's vulnerability on the financial front would negatively affect economic activity.

With regard to developments in overseas economies, members generally shared the view that, a simultaneous slowdown was becoming more pronounced as evident in the further weakness in indicators relating to the household sector in the United States and Europe, which had been firm, in addition to a slowdown in the activity of the corporate sector. One member, citing the decline in the composite leading indicators in OECD countries, said that a recovery in the world economy could not be expected at least until the end of March 2002, since the economy was already in a downward phase before the terrorist attacks and had been further damaged by them.

A few members commented on the U.S. economy that (1) production adjustments were expected to be prolonged further because orders received by manufacturers had declined significantly; (2) income conditions and consumer confidence deteriorated rapidly after the terrorist attacks and the effect they had on consumption was cause for concern; (3) the negative wealth effect stemming from the fall in some housing prices, which had been firm, more or less offset or slightly exceeded the positive effect of the reduction in tax and interest rates; and (4) business fixed investment was not likely to recover while consumption continued to be fairly firm.

In response to the above views, one member said that a sharp economic deceleration, such as the one observed in the United States from late 2000 to date, was unlikely to be repeated because economies worldwide were already slowing down practically simultaneously. This member added, however, that there was strong uncertainty about the U.S. economic outlook, for example future developments in the personal saving rate, which rose sharply in September, and the sustainability of the effects of the zero-interest program for automobile loans.

Some members commented on developments in IT-related industries worldwide and pointed out that (1) some indicators were starting to show changes in the trend, for example an increase in sales of electronic parts manufacturers in Asia and a rise in the spot prices of semiconductors but (2) the severe situation would continue since there were no signs yet of a recovery in final demand of IT-related goods, and shipments and orders continued to decrease in IT-related industries in the United States.

Based on these overseas economic developments and the conditions for exports, members generally agreed that the corporate sector in Japan would remain in a severe situation for a while. One member said that the ratio of inventories to shipments remained high because shipments were decreasing concurrently with the decrease in inventories, and adjustments in production would inevitably be prolonged. Another member said that corporate activity would not start recovering unless firms' profits recovered, and in the second half of fiscal 2001, the environment for corporate profits would become more severe. This member also expressed concern that the recent weakness in stock prices was causing the shortfall in reserves for pension benefits and this shortfall was exerting downward pressure on corporate profits. One member pointed out that, with the introduction of mark-to-market accounting, the consequences of the level of stock prices at the end of the fiscal year in March 2002 for corporate management would warrant attention.

One member pointed out problems in Japan's corporate sector for the medium to long term and the adjustment pressure stemming from these problems. This member explained the problems as follows: (1) income distribution between households and firms was distorted significantly as financial assets of households had increased by slightly less than three times while firms' capital bases had been impaired in the past 17 years; (2) the net amount of corporate taxable income for fiscal 1999 was only 2 trillion yen and the corporate sector as a whole had earned little profit; (3) it was therefore necessary for firms to reduce costs and assets to raise their return on assets (ROA); and (4) the rates of increase in product and service prices and in real wages were higher in industries with low productivity that depended heavily on demand in the public sector and that had been protected by regulations, for example construction, services, and real estate, compared to other industries. The member added that such problems would start to be resolved in the future.

Members were concerned about the effects of the deterioration in employment and income conditions on private consumption in the future. A few members cited the fact that employment adjustments were spreading to various industries and expressed the view that a cut in "scheduled cash earnings," or regular payments, and use of work-sharing could spread during fiscal 2002. These members continued that employment and income conditions would deteriorate further and were expected to have a negative impact on private consumption.

With these economic developments, members shared the view that it was highly likely that downward pressure on prices stemming from weak demand would intensify. One member said that the risk of a deflationary spiral emerging warranted careful monitoring. A few members pointed out that, with the simultaneous slowdown of the world economy, a fall in the inflation rate worldwide and in international commodity prices would also push down prices in Japan. One member summarized the situation as follows: (1) price falls that were due to increased productivity and technological innovation and that would help to correct the high cost structure of Japan's economy were inevitable and consistent with economic growth; whereas (2) price falls due to a deterioration in the supply-demand balance would lead to a cycle of contraction of the economy by damaging firms through excessive price competition and forcing adjustments in business fixed investment and employment. This member concluded that the current price falls were damaging firms in terms of flow and stock by squeezing corporate profits and increasing the real debt burden, and this had become firms' major problem.

C. Financial Developments

Members shared the view that the financial environment in Japan remained extremely easy in terms of financial market conditions and interest rate levels, but private banks and investors were becoming slightly cautious about taking credit risks and fund-raising conditions of firms with higher credit risk were apparently becoming severe. On this basis, the discussion of members centered on the risk that the economy might become more vulnerable due to factors from the financial side such as heightened uncertainty about the stability of the financial system and a more cautious lending attitude of financial institutions.

Most members expressed concern that market participants' view of Japanese banks' soundness was becoming extremely severe. A few members pointed out that (1) prices of bank stocks were at their lowest since the bursting of the bubble, and (2) spreads between bank bonds and JGBs and those between subordinated bank bonds and JGBs remained large and banks' credit default swap rates continued to be high even after the interim book closings. In relation to this, one member said that the fall in the prices of bank stocks could be a warning from the market, which demanded progress in disposal of NPLs and an early confirmation of the final amount of losses.

On these grounds, one member remarked that if concerns about banks' soundness heightened, the viability of banks would come into question through the decline in stock prices, and also economic activity could be negatively affected through a deterioration in conditions for corporate financing. Many other members said that attention should be paid to the risk that the financial system and the economy could deteriorate spirally before the termination of measures to fully protect bank deposits in case of bank failure. Based on this, one member insisted that a credit contraction like that of 1997-98 should definitely be avoided, and developments in stock prices, financial institutions' capital bases, liquidity management conditions, and shifts of deposits should be monitored carefully. A different member expressed the opinion that the Bank was expected to make efforts to restore the public's confidence in the financial system in cooperation with the Financial Services Agency, and that injection of public funds would be inevitable if banks' financial strength could not be sustained.

In this situation, most members noted that banks' lending attitude was becoming cautious. A few members expressed the view that firms' demand for funds had been weak and there was no sign of the supply-demand balance of funds tightening rapidly. Members including these members shared the view that banks were likely to attach increasing importance to widening interest margins and to differentiating between borrowers, and these developments would require close monitoring.

Members generally shared the view that fund-raising conditions for firms were gradually polarizing. One member raised the surge in the number of corporate bankruptcies in October as cause for concern. A few other members said that firms' demand for funds was increasing because they needed more working capital and funds for restructuring due to sluggish sales and a decline in their cash flow, and banks were becoming severe in their assessment of asset quality and were becoming more selective about their borrowers, and as a result, there was a risk that small firms and some firms in industries that were showing weak performance would face difficulty in financing toward the end of December 2001 and March 2002. One of these members continued that if corporate financing actually became difficult, banks, firms, and households would become even more risk averse and financial markets as a whole might become unstable.

Regarding the financial intermediary function of financial institutions, one member said that monetary easing effects were frequently described as unlikely to spread outside the financial system due to the NPL problem, and that this explanation was right for the medium to long term but might be simplistic to apply for the short term. This member continued that (1) banks' lending activity showed that they were competing to increase lending to firms with high creditworthiness; (2) they were cautious about making new loans to firms with lower creditworthiness, while they continued to hold a large amount of loans to these firms, made in the past with low interest margins; (3) potential NPLs were increasing because banks continued such unreasonable lending behavior, and therefore; (4) the sluggishness in lending was not attributable to NPLs but the excessive amount of lending, which should have been adjusted. This member added that (1) based on this understanding, it could be considered that banks' loans outstanding in the economy would decrease when disposal of NPLs was in progress, but sufficient funds would be provided to financially sound borrowers and promising business projects; and (2) in such a situation, financial institutions' demand for reserves at the Bank might not always increase.

One member said that in domestic financial markets, stock prices, interest rates, and foreign exchange rates were not in a situation to move significantly because there were many unclear factors in the markets. Members acknowledged that long-term interest rates had generally been stable recently due to the global disinflationary trend and the ample provision of liquidity by the Bank, but fluctuated briefly reflecting discussions about the outcome of the second supplementary budget for fiscal 2001 and the amount of issuance of new government bonds in fiscal 2002. One member pointed out that (1) while overseas stock prices rose by 20 to 30 percent after hitting bottom following the terrorist attacks, Japanese stock prices rose only marginally; (2) the background to these Japanese stock price developments was the weakness in stock prices of banks and of firms with excessive debts in industries such as construction, real estate, and distribution; and (3) in this situation, the Japanese stock market demanded progress in structural reforms, particularly accelerated disposal of NPLs and the establishment of new business models for the future. A few other members said that a delay in disposal of NPLs was the primary cause of the weak stock prices.

With regard to overseas financial markets, members mainly discussed the background to the recent developments in stock prices overseas, which were fairly firm despite the simultaneous slowdown of the world economy.

One member pointed out the following. First, the firmness in U.S. stock prices and in the U.S. dollar's exchange rate was consistent with the market's view that the U.S. economy would start recovering in the first half of 2002. And second, a rise in stock prices in Korea and Taiwan since the end of September was related to signs of changes in Asian economies, for example, a slowdown in the decrease in exports and a bottoming out of semiconductor prices. A different member, on the other hand, said that the U.S. stock market was in a state of euphoria against the background of (1) expectations for the effects of fiscal measures and the monetary easing and (2) positive developments in Afghanistan, and that there might be negative consequences in the future when the euphoria faded. This member added that the recent rise in long-term interest rates in the United States could be reflecting concerns about the possibility that the country might become involved in international conflicts in the long run.

Another member commented on developments in the U.S. corporate bond market as follows. First, credit spreads between U.S. Treasuries and bonds issued by firms with high credit ratings returned to the level before the terrorist attacks, while the spreads between U.S. Treasuries and bonds issued by firms with lower ratings remained high and the amount of issuance of such bonds decreased. Second, the extent to which indirect financing would cover the decrease in direct financing would determine the future of the U.S. economy. And third, although U.S. banks could be expected to make up for the decrease in direct financing since they had smaller NPLs and a larger core capital than Japanese banks, the credit extension of U.S. banks might contract along with the decrease in direct financing since U.S. banks were said to include stock prices of borrowers as a factor in assessing their creditworthiness in the banks' credit risk models. Thus, future developments required close monitoring.

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

Members discussed the monetary policy stance for the immediate future.

Most members agreed that, given that liquidity demand had continued to be volatile in the money market, the Bank should provide ample liquidity to the market in a timely manner while maintaining the current guideline for money market operations, which did not set an upper limit to the outstanding balance of current accounts at the Bank.

Many members pointed out that liquidity demand continued to be volatile against the following background. First, there was a possibility that precautionary demand for liquidity had been heightened reflecting market anxiety due to the fall in the prices of bank stocks. And second, there was a deterioration of the functioning of the money market as lenders were reluctant to lend in the market at the current extremely low interest rates. These members concurred that for the time being liquidity demand in current accounts at the Bank would remain difficult to predict.

With regard to the first point, the heightened precautionary liquidity demand, a few members expressed the view that the Bank should maintain the current guideline in view of the possibility that, if liquidity demand increased due to a heightened concern about the stability of the financial system, it might need to provide liquidity to meet such demand under the current guideline.

Concerning the second point, the deterioration of the functioning of the money market, a few members pointed out that, in addition to foreign banks in Japan holding a large amount of excess reserves, other financial institutions such as regional banks were also becoming markedly reluctant to invest in the money market recently. These members shared the view that the amount of excess reserves held by foreign banks could fluctuate significantly depending on the duration and extent of Japanese investment in foreign bonds, because the excess reserves held by foreign banks were basically the result of Japanese investors' funding of foreign currencies in exchange for yen.

One member stressed the seriousness of the deterioration in Japan's economy, saying that (1) the economy was deteriorating further; (2) in this situation there was gloom regarding effective policy measures as progress in structural reforms had been so slight, and yet no measures were being taken to stimulate the economy; and (3) there was a risk of the economy falling into a deflationary spiral or of a critical situation developing in terms of the financial system in the future.

On this basis, this member expressed the view that it was inappropriate for the Bank to be passive, i.e., maintain the current guideline, and that the Bank should take active steps to halt deflation. The member said that the member would like to propose, as in the previous meeting, that the Bank should introduce a price level target and adopt a guideline for money market operations aiming at an outstanding balance of current accounts at the Bank of around 10 trillion yen. This member continued that at this meeting the member would not make the same proposal as at the previous meeting--that the Bank should remove the restriction that the amount of the Bank's long-term JGB holdings should not exceed the amount of banknotes issued--but instead officially would propose that the Bank should start purchasing foreign bonds. The member added that the above mentioned outstanding balance of current accounts at the Bank of around 10 trillion yen could be achieved without purchasing foreign bonds in the current financial conditions, but purchases of foreign bonds were necessary with a view to diversifying the Bank's means of funds provision.

Members then discussed the conduct of monetary policy in the future. Many members concurred that they needed more time to examine the effects of the current policy framework for monetary easing, although expected effects of the monetary easing such as rebalancing of financial institutions' portfolios had not been clearly observed so far. One member said that the current measures contributed significantly to maintaining conditions where firms could raise funds at extremely low interest rates. A different member expressed the view that it was important that the Bank maintain the policy framework for monetary easing adopted in March 2001 to provide ample liquidity and to keep its commitment in terms of policy duration in order to maintain the stability of financial markets. This member added that one could not rule out the possibility that, as a result of maintenance of the current monetary easing measures, other quantitative effects of monetary easing besides its effects on interest rates would permeate into the economy followed by changes in economic entities' sentiment and in the environment in the future.

With regard to the duration of the current guideline for market operations aiming at maintaining the outstanding balance of current accounts held at the Bank at above 6 trillion yen, a few members commented that it was desirable to consider reinstating a guideline with a specific target for the outstanding balance of the current accounts in the future. One of these members expressed the following opinion. First, the member considered that the current guideline was merely temporary. Second, there was the stockpile of foreign banks' holdings of excess reserves but given that this was a result of rational behavior based on the market mechanism, the Bank should take the presence of this stockpile of excess reserves as given in setting the target for money market operations. And third, it was difficult to express at this point the extent of monetary easing in absolute terms of the outstanding balance of current accounts at the Bank, and adoption of a specific target for the outstanding balance of the current accounts, merely confirming the current situation, would not have a positive effect, but it might be effective, in the event a downside risk to the economy materialized, to raise the target for quantitative easing in a package with other measures such as an increase in purchases of JGBs. Another member commented that it seemed unlikely that the factors causing volatile liquidity demand would subside soon, and thus in the future it would be necessary to examine the way in which money market operations were conducted, taking the volatile liquidity demand into account.

In response to this, one member said that it was necessary to recognize the fact that it was becoming more difficult to judge the extent of monetary easing by the outstanding balance of current accounts at the Bank because the functioning of the money market had deteriorated.

Many members expressed the view that it was necessary to examine the issue of diversifying the Bank's measures for liquidity provision, including purchases of foreign bonds, from the viewpoint of their effects, feasibility, and problems, so that the Bank would be prepared to respond to possible further deterioration of the economy. One member commented that in examining purchases of unconventional assets, it would be important to consider them from the perspective of whether these measures would coordinate and be consistent with policy measures the Government might take in the future. A different member said that as there was not much room left for conventional monetary policy measures, there might come a time when the Bank should examine the types of assets to be purchased in market operations from the viewpoint of coordination with other economic policies such as the Government's fiscal and foreign exchange policies. The member continued that, while the Bank's credibility as the central bank and public confidence in its banknotes must be maintained when diversifying the types of assets purchased, such credibility and confidence could be strengthened in the changing economic environment if the diversification was conducted within the context of the coordination of monetary, fiscal, and foreign exchange policies, compared to a situation where purchases were made under monetary policy alone.

Regarding purchases of foreign bonds by the Bank, a few members said that there was no need to adopt such a measure at the moment, because the Bank did not have any difficulty in providing ample liquidity, and this view was generally shared by members. Some members other than the member who had said that the member would propose purchases of foreign bonds concurred that such purchases had certain advantages as a means of liquidity provision. One member clarified the advantages of the Bank purchasing foreign bonds as follows. First, the purchases would improve the Bank's ability to provide liquidity because foreign bonds had low substitutability for funds in current accounts at the Bank. Second, such purchases would not cause concern for fiscal discipline in the market, unlike an increase in the Bank's outright purchases of JGBs. And third, they would have only a limited effect on neutrality of allocation of resources unlike purchases of corporate bonds and stocks. This member continued that the following points should be examined. First, whether purchases of foreign bonds were necessary for smooth provision of ample funds. Second, there was a risk that purchases of foreign bonds by the Bank might lead to misunderstanding that the pursuit of price stability, the objective of monetary policy, included foreign exchange rate stability, despite the fact that the following principle was made clear in the report released by the central bank study group in preparation for the 1997 revision of the Bank of Japan Law: the Government was solely responsible for foreign exchange intervention, in which the Government would buy and sell foreign currencies with the aim of affecting foreign exchange rates, since the objective of the Bank's monetary policy was to maintain domestic price stability, which did not include foreign exchange rate stability. Third, the Bank might find itself in a difficult position if the situation called for it to sell foreign currencies as an agent of the Government and at the same time to purchase foreign bonds for market operation. And fourth, for the Bank to start purchasing foreign bonds, it would be vital to gain the understanding of foreign countries through the Japanese Government. Finally, the member added that great caution was required to avoid misunderstanding that there was a confrontation between the Bank and the Government regarding purchases of foreign bonds by the Bank.

However, a few members, including this member, pointed out that the relation between the Government's foreign exchange policy and the Bank's purchases of foreign bonds could be a key issue. In response to a request from a member, the representative from the Ministry of Finance commented as follows.

(1) The Government had not yet examined this issue in detail, but it could be recognized that the Bank could legally buy and sell foreign exchange according to Article 40 of the Bank of Japan Law where it was stated that the Bank of Japan, when necessary, may buy and sell foreign exchange on its own account.

(2) In Article 40, Paragraph 2, however, it was prescribed that the Bank should buy and sell foreign exchange as an agent of the Government on the basis of instructions from the Ministry of Finance when its purpose was to stabilize the exchange rate of the national currency.

(3) Purchases and sales of foreign exchange to achieve price stability through a weaker yen would naturally fall under Article 40, Paragraph 2, and in that event, the Bank would act as an agent of the Government. Given that it was confirmed in the report of the central bank study group that the Government should be solely responsible for foreign currency intervention in the current international currency system, it seemed that various issues regarding purchases of foreign bonds by the Bank needed to be examined from a legal point of view.

In response to this, the member who had said that the member would propose purchases of foreign bonds by the Bank commented that the member was well aware of the issue concerning Article 40 of the Bank of Japan Law, and said that the Bank should adopt means to distinguish such purchases from foreign exchange interventions by, for example, purchasing a fixed amount per month on a regular basis. The member also commented that it would be meaningful to reexamine purchases of foreign bonds by the Bank because the present economic situation was very different from that at the time the report was prepared by the study group. A few other members expressed the view that if the Bank purchased foreign bonds to ensure smooth provision of yen funds, this would not be in contravention of Article 40 of the Bank of Japan Law.

Some members commented on the importance of other economic policies from the viewpoint of encouraging permeation of the effects of monetary easing. One member expressed the view that (1) there was a limit to what monetary easing measures alone could do to stop the continuous decline in prices and to establish a basis for sustainable growth of Japan's economy; (2) in this regard, the greatest task for Japan's economy was to increase aggregate demand in a sustainable way; and (3) to this end, it was important to revitalize the functions of the financial system through disposal of NPLs and carry forward structural reforms in a way that would stimulate private demand efficiently. The member expressed the earnest hope that the Government would take drastic measures to advance structural reforms that would gain public confidence at home and abroad and induce a sustainable growth of private demand.

A different member emphasized 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. The member continued that the following measures were important. First, in the short term the most important task was to halt deflation, and it was vital to stimulate private demand through government spending with a higher multiplier effect in a supplementary budget for fiscal 2001 and the budget for fiscal 2002. Second, restoring the soundness of the financial system through progress in disposal of NPLs would also improve the confidence of firms and households. And third, in the medium to long term it was important to implement government spending effectively, for example focusing on items such as revitalization of urban areas, the environment, welfare, and investment in IT-related infrastructure, while giving due consideration to fiscal consolidation. In addition, the member noted that tax reforms, deregulation, and provision of a safety net for the unemployed, all of which would encourage economic activity, were also essential.

IV. Remarks by Government Representatives

The representative from the Cabinet Office made the following remarks.

(1) Slightly more than six months had passed since the formation of the Koizumi Cabinet. Throughout that period, the Government had been asking the Bank at Monetary Policy Meetings to conduct monetary policy in an appropriate and timely manner to stop deflation, while the Bank had been pointing out to the Government the necessity of creating demand by, for example, deregulation, and disposing of NPLs. Both the Bank and the Government had been fully aware of the necessity to achieve both of these aims, but each party had been facing its own difficulties.

(2) According to the economic outlook estimated and released by the Cabinet Office on November 9, 2001, the GDP for fiscal 2001 would show a negative growth of 0.9 percent, a postwar record low, mainly due to the fall in overseas demand. The Government expected that the positive growth of private consumption would contribute to prevent a spiral of deterioration, but it revised its assessment of the economy downward in the Monthly Economic Report released on November 14, 2001 due mainly to the weakness in private consumption. Thus, the conduct of economic policy was becoming very difficult. The authorities might, in some cases, have to tolerate a deterioration of the economy, but it was their duty to take drastic measures against the continued and accelerated economic deterioration.

(3) The supplementary budget for fiscal 2001 passed by the Diet on November 16 gave a high priority to the safety net for the unemployed and apportioned part of the budget to the "Advanced-Reform Program" in the severe budgetary conditions, while maintaining fiscal discipline by limiting the issuance of new government bonds in fiscal 2001 to less than 30 trillion yen. The Government acknowledged that it should make a fresh start by thoroughly reexamining its policy, given that the supplementary budget had been passed by the Diet. The Council on Economic and Fiscal Policy had started intensive discussions from the viewpoint of thoroughly reviewing various economic policy measures.

(4) The Government was fully aware of the seriousness of the NPL problem and considered it was necessary to review and reinforce measures to deal with the problem in view of the termination of measures to fully protect bank deposits in case of bank failure. In relation to this problem, the Government would like to ask the Bank to come up with new ideas to deal with deflation.

(5) The Government was determined to take unconventional measures, and would like to ask the Bank to widen the range of monetary policy options and conduct monetary policy in an appropriate and timely manner to stop deflation.

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

(1) The supplementary budget for fiscal 2001, compiled based on the "Advanced-Reform Program," had been passed by the Diet on November 16, 2001. The Bank had continued to provide ample funds since the previous meeting with the result that the outstanding balance of current accounts at the Bank was generally at above 9 trillion yen. The increase in the outstanding balance of current accounts at the Bank was expected to support the economy through alleviation of the market's concerns, and therefore, the Government would like to ask the Bank to continue providing ample funds, giving due consideration to economic and financial developments.

(2) The 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 do its utmost as a central bank to stop the continuous price falls. As the downward trend in prices was still unlikely to change, the Government would like to ask the Bank strongly 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.

(4) The effects of the Bank's conventional market operations using mainly short-term financial assets were limited as short-term interest rates were virtually zero, and the Government would like the Bank to discuss monetary policy that would be more effective in relation to the economy considering a wide variety of options, for example adoption of new measures for market operations in order to dispel deflationary concerns.

V. Votes

Based on the above discussion, the majority of members considered it appropriate to maintain the current guideline for money market operations.

One member, however, proposed that the Bank should (1) introduce a price level target, (2) start purchasing foreign bonds in order to provide funds smoothly, and (3) raise the target for the outstanding balance of current accounts at the Bank to around 10 trillion yen.

This member gave the following reasons. First, the Bank should make clear to the public its strong determination to prevent price falls below the current level by setting a price level target and a specific time frame so that the Bank's policy would be clearly evaluated. Second, the Bank should improve its ability to provide funds by diversifying its means of doing so through purchases of foreign bonds. And third, the phrase in the current guideline, "maintaining the outstanding balance of current accounts held at the Bank at above 6 trillion yen," was ambiguous and insufficient, and the Bank should provide a clear quantitative target for the outstanding balance of current accounts at the Bank above the current balance of around 9 trillion yen. This member added that foreign bonds would be purchased continuously and steadily, and this was clearly different from foreign exchange intervention by the Government. This member said that, as it did for JGB purchases, the Board would entrust to the staff the decision on the actual methods of purchasing foreign bonds.

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, aiming at maintaining the average of the CPI (excluding fresh food, on a nationwide basis) in the January-March quarter of 2003 at or raising it to or above a target of 99.1, which was that in the January-March quarter of 2001.

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

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

The Bank of Japan will start to purchase foreign bonds as soon as all arrangements are made. Foreign bonds will be purchased when judged necessary to increase the outstanding balance of current accounts at the Bank smoothly.

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

Further, this member 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.

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 target for the outstanding balance of current accounts at the Bank, was virtually the same as an interest rate target policy and was not consistent with the framework for money market operations decided in March 2001. Second, the Bank's current provision of funds was merely accommodating demand in the money market and was far from showing the Bank's decisive stance of achieving further quantitative easing. Third, the proposal was insufficient in that it did not sufficiently recognize the current severe economic situation where the rate of price falls was accelerating. And fourth, given its responsibility as a monetary authority, the Bank should set a specific target for prices with a specific time frame of its own accord.

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 November 19, 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 "Bank's View" should refer to the pace of economic deterioration and should use the word "deterioration" instead of "adjustments" when describing the state of the economy. Second, the judgment that "prices were expected to follow a gradual declining trend" was inadequate given the possibility that the pace of price falls might accelerate further. Third, it should refer to the increase in corporate bankruptcies and the rise in the unemployment rate in October. And fourth, it should mention the fact that the fall in public investment was having a very large effect on economies in rural areas.

  1. 8The original full text, in Japanese, of the Monthly Report of Recent Economic and Financial Developments was published on November 19, 2001 together with the English version of "The Bank's View." The English version of "The Background" was published on November 20, 2001.

VII. Approval of the Minutes of the Monetary Policy Meeting

The Policy Board approved unanimously the minutes of the Monetary Policy Meeting of October 11 and 12, 2001 for release on November 21, 2001.


Attachment

For immediate release

November 16, 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.