Minutes of the Monetary Policy Meeting

on January 15 and 16, 2002
(English translation prepared by the Bank's staff based on the Japanese original)

March 5, 2002
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 Tuesday, January 15, 2002, from 2:00 p.m. to 3:51 p.m., and on Wednesday, January 16, from 9:00 a.m. to 12:39 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. T. Taniguchi, Senior Vice Minister of Finance, Ministry of Finance²
Mr. H. Fujii, Deputy Vice Minister for Policy Planning and Coordination, Ministry of Finance³
Mr. Y. Kobayashi, Vice Minister for Economic and Fiscal Policy, Cabinet Office

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. T. Wada, Associate Director, Policy Planning Office⁴
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. T. Umemori, Chief Manager, Planning Division 2, Policy Planning Office⁴
Mr. S. Nagai, Senior Economist, Policy Planning Office
Mr. S. Shimizu, Senior Economist, Policy Planning Office
Mr. M. Osawa, Chief Manager, Financial Markets Department⁴
Mr. T. Kurihara, Manager, Financial Markets Department⁴

1. The minutes of this meeting were approved by the Policy Board at the Monetary Policy Meeting held on February 28, 2002 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. Taniguchi was present on January 16.
3. Mr. Fujii was present on January 15.
4. Messrs. Wada, Umemori, Osawa, and Kurihara were present on January 16 from 9:00 a.m. to 9:30 a.m.

I. Summary of Staff Reports on Economic and Financial Developments⁵

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 December 18 and 19, 2001.⁶

The Bank conducted market operations so as to gradually increase the outstanding balance of current accounts held at the Bank to around 15 trillion yen toward the end of December 2001, and maintained the outstanding balance at that level into early January 2002. As a result of these operations, the weighted average of the uncollateralized overnight call rate moved at 0.001-0.002 percent, a historic low level, in the intermeeting period including the last business day of December 2001.

Since January 11, 2002, undersubscription, where bids fell short of the Bank's offers, had been observed in some of the Bank's market operations such as the borrowing of Japanese government bonds (JGBs) against cash collateral (JGB repos) and purchases of CP under repurchase agreements. This was because market participants' incentive to bid in market operations maturing within the fiscal year 2001 declined substantially as they considered that this overabundance of funds in the market would continue until the end of the fiscal year. The Bank would continue efforts to supply ample funds smoothly by carefully selecting the types and maturity of market operations.

1. 5Reports were made based on information available at the time of the meeting.
2. 6The guideline was as follows:
   The Bank of Japan will conduct money market operations, aiming at the outstanding balance of the current accounts at the Bank at around 10 to 15 trillion yen.
   Should there be a risk of financial market instability, such as a surge in liquidity demand, the Bank will provide more liquidity irrespective of the guideline above.

B. Recent Developments in Financial Markets

1. Developments in domestic financial markets

Domestic financial markets were generally stable in the intermeeting period.

Interest rates on term instruments were declining on the whole reflecting widespread confidence in financial institutions' funding beyond the end of the calendar and fiscal year due to the Bank's additional monetary easing measures decided at the previous meeting. Three-month Euro-yen rates maturing beyond the fiscal year-end were extremely low at around 0.1 percent, although they strengthened slightly.

Stock prices rebounded somewhat toward the start of the year, but were weakening recently. By industry, export-related stocks responded favorably to the depreciation of the yen, and were relatively firm. Bank stocks rebounded due partly to market speculation about a possible re-injection of public funds. More recently, however, bank stocks were under selling pressure again because it was forecasted that the cost of nonperforming-loan (NPL) disposal would increase.

Yields on JGBs were declining for those with up to two years remaining to maturity, partly reflecting the additional monetary easing measures decided in December 2001. Meanwhile, yields on JGBs with three years or more remaining to maturity were rising slightly due to financial institutions' adjustment of their positions before the auction of new JGBs. However, few market participants were expecting a surge in long-term interest rates since the Ministry of Finance's Planned Bond Issuance for fiscal 2002 turned out to be within the expectations of the market and given the fact that the economic situation was still deteriorating.

Credit spreads, the yield differentials between corporate bonds and JGBs, had been on a widening trend recently especially for bonds issued by firms with low credit ratings. Credit spreads for bonds issued by firms with BBB/Baa ratings increased to the levels recorded in early 1998 when concerns about credit risk intensified. Credit risk premiums on bonds issued by banks were expanding on the whole.

2. Developments in the foreign exchange market

The yen declined to the 133-134 yen level against the U.S. dollar from the 127-128 yen level due to the fact that some economic indicators in the United States were better than expected and heightened market speculation that the Japanese currency authority was tolerating a depreciation of the yen. However, market sentiment did not seem to be expecting a straight decline of the yen. This was because the U.S. economic outlook was still subject to uncertainty, and the officials of some Asian economies were starting to make comments signaling that they were against a further depreciation of the yen.

C. Overseas Economic and Financial Developments

Overseas economies continued to decelerate on the whole. Recently, adjustment pressures on production and inventories in the United States were easing, and the pace of decline in exports of Asian economies was slowing, but the outlook for overseas economies remained uncertain.

In the U.S. economy, inventory adjustments progressed considerably as a result of continuous cuts in production, and indexes compiled by the Institute for Supply Management (ISM) and the consumer confidence index were improving. Christmas sales seemed to have turned out to be fairly brisk, showing some firmness in private consumption. Given these developments, the U.S. economy could be expected to hit bottom in the first half of 2002 and to recover moderately from the middle of the year. However, the U.S. economic outlook remained uncertain because there were still downside risks to the economy that required monitoring. These risks were that a further deterioration in employment conditions could cause consumption to fall off, and adjustments in business fixed investment could be prolonged by a deterioration in corporate profits.

As for the U.S. financial markets, stock prices had been firm reflecting expectations of an economic recovery in the future, but recently they had been weakening slightly as cautious views about corporate profits became widespread. It seemed that stocks had been overvalued for some time, and recently the tendency was strengthening judging from valuation indexes such as price-earnings ratios and yield spreads (government bond yields minus expected earnings on stocks).

In Europe, economies on the whole continued to decelerate due to slower growth in exports and business fixed investment, and in Germany the economy had already entered a recessionary phase. Recently, however, there were signs that the pace of production cuts was moderating, as seen in the improvement in the Purchasing Managers' Index (PMI) for the euro area manufacturing sector for December for the second consecutive month, partly due to progress in inventory adjustments following the production cuts. As for prices, the annual percentage increase in the overall index in the Harmonised Index of Consumer Prices (HICP) was recently on a downtrend.

NIEs and ASEAN economies also continued to decelerate on the whole. Recently, the pace of decline in exports was slowing due mainly to the slowdown in the decrease in exports of IT-related goods reflecting progress in inventory adjustments such as in semiconductors.

The situation in Argentina was worsening considerably with political and social turmoil, and the government had recently announced a temporary suspension of payments of external public debt and a currency devaluation. Given this situation, yield spreads between Argentine government bonds and U.S. Treasuries remained wide. The economic outlook for Argentina was highly uncertain, and attention must be paid to the future course of the economy together with the effects on other emerging economies.

D. Economic and Financial Developments in Japan

1. Economic developments

There were no new factors to change the Bank's assessment of the economy made in December 2001 that "Japan's economy is deteriorating broadly." The pace of decline in exports and production, which had been the first to deteriorate from the beginning of 2001, had started to slow somewhat. It was possible that inventory adjustments would be completed and production would bottom out at around the middle of 2002 if these adjustments progressed smoothly and the risks mentioned later did not materialize. On the other hand, adjustments had been delayed in employment and income conditions and consumption, and they were starting to spread recently.

With regard to final demand, exports would basically continue on a downtrend despite a small increase in October and November 2001 brought about by temporary factors such as the increase in exports of automobiles to the United States. However, the pace of decline in exports of IT-related goods was slowing considerably. The decrease of Japan's exports would moderate in the future, given the considerable progress in worldwide inventory adjustments of IT-related goods and the effect of the yen's depreciation.

Business fixed investment continued to decrease. Given developments in machinery orders and in investment conditions such as the level of corporate profits, business fixed investment was very likely to decrease not only in IT-related manufacturers, which had shown a considerable decline, but also in a wider range of industries including nonmanufacturers.

Private consumption was weak on the whole, although some specific sales data showed firm developments. Consumer confidence continued to become more cautious. Employment and income conditions, which underpinned private consumption, were becoming increasingly severe. The unemployment rate continued to rise, and the ratio of job offers to applicants was falling slightly faster due to the increase in the number of job applicants. Furthermore, the weakness in employees' income was becoming distinct. In view of these factors, private consumption would continue to be weak.

Reflecting the above developments in final demand, production continued to decline considerably. However, the decrease in production was beginning to moderate somewhat, mainly in electrical machinery, as inventory adjustments progressed, and this reduction in the pace of decline was expected to continue into the future.

Prices continued to follow a gradual declining trend, but domestic wholesale prices seemed to be declining at a slightly slower pace than before. This was partly because (1) international commodity prices such as those of crude oil and nonferrous metals were rebounding, (2) some domestic commodity prices were showing signs of rising, and (3) the depreciation of the yen was expected to support import prices. On the other hand, consumer prices were declining faster recently in a wide range of goods, including petroleum products. With regard to service prices, the effects of the weakness in wages warranted attention.

In viewing the outlook for the economy and prices, the following risks should be kept in mind particularly: (1) the fact that there was still considerable uncertainty about future overseas economic developments including in the United States; and (2) in Japan, concern that an increase in large-scale bankruptcies could negatively affect consumer sentiment and corporate financing.

2. Financial environment

Private banks' lending continued to decline at about 2 percent on a year-on-year basis. Financial institutions were expecting a further decline in funds demand toward the end of March 2002.

Regarding fund-raising through the markets, although the amount outstanding of CP issued was at a record high in December 2001, the year-on-year growth rate continued to decline. In the corporate bond market, the amount of bonds issued by firms with low credit ratings was falling significantly.

Summarizing the above, the year-on-year decrease in the total amount of funds raised by the private sector was on an expanding trend.

With regard to monetary aggregates, the year-on-year growth rate of the monetary base (currency in circulation plus current account balances at the Bank) rose further in December due primarily to a substantial increase in the outstanding balance of current accounts at the Bank. The year-on-year growth rate of M2+CDs also rose to 3.4 percent from 3.2 percent in the previous month due to the shift of funds from money management funds (MMFs) to deposits including ordinary deposits. The rate was projected to slow somewhat from January to March 2002, as funds demand in the private sector was expected to decline further and the shift of funds from postal savings was peaking out.

Funding costs for firms continued to be at extremely low levels on the whole. However, the long-term prime lending rate rose for the second consecutive month because spreads between interest-bearing bank debentures and JGBs had been expanding. Issuance rates on CP had been on an uptrend until the middle of December, but the rates, especially those on CP issued by firms with high credit ratings, declined slightly thereafter due to additional monetary easing measures taken in December. Meanwhile, issuance rates on CP issued by firms with low credit ratings did not show any notable decline.

As outlined above, the financial environment remained fairly easy on the whole. However, the lending attitude of financial institutions as perceived by small firms was gradually becoming more severe, and fund-raising conditions for firms with low creditworthiness tended to deteriorate. As for the future, developments in financial institutions' behavior and corporate financing required close attention.

II. Decisions concerning Amendments to the Guidelines on Eligible Collateral, the Principal Terms and Conditions for the Outright Purchase/Sale of JGBs, and the Selection Procedure for Counterparties in Bill Purchasing Operations

A. Staff Proposal

1. Expansion of the range of eligible assets and collateral with a view to strengthening money market operations

Following the Policy Board's decision at the Monetary Policy Meeting on December 19, 2001, the Bank's staff proposed, with a view to broadening the range of eligible assets and collateral, amending the guidelines including the Guidelines on Eligible Collateral in order to be able to take the following measures: (1) accepting asset-backed commercial paper (ABCP) as eligible collateral and as eligible assets for CP purchasing operations under repurchase agreements; (2) broadening the range of eligible asset-backed securities (ABS) by accepting ABS backed by mortgage loans and cash flows generated from real estate as eligible collateral; and (3) accepting as eligible collateral bonds whose principal balance might decrease due to prepayments before the final maturity date, such as pass-through bonds, which included ABS and Fiscal Investment and Loan Program (FILP) Agency bonds, both of which were backed by mortgage loans. As for the timing of the implementation, measure (1) would take effect no later than February 28, and measures (2) and (3) no later than the middle of March 2002.

2. An amendment to the Principal Terms and Conditions for the Outright Purchase/Sale of JGBs

Since the start of the Bank's outright purchases of JGBs in 1967, JGBs issued within the previous twelve months had been excluded from those eligible to be purchased by the Bank (the "one-year rule") in order to avoid causing a perception that the central bank was practically underwriting JGBs. However, given the recent improvements in the primary and secondary markets for JGBs, the staff proposed amending the Principal Terms and Conditions for the Outright Purchase/Sale of JGBs and the rules for conducting the Bank's business, both of which prescribed the "one-year rule," to expand the range of JGBs eligible to be purchased. Specifically, the Bank would exclude only the latest two issues of each maturity which had been issued within the previous twelve months.

3. Revision of the Selection Procedure for Counterparties in Bill Purchasing Operations

The staff proposed, with a view to further facilitating money market operations, revising the Selection Procedure for Counterparties in Bill Purchasing Operations: (1) the frequency of selection of counterparties for bill purchasing operations conducted at all the Bank's offices, namely the head office and all branches, would be changed from once a year to any time; and (2) the criteria for selecting counterparties in bill purchasing operations conducted at the Bank's head office would include successful bids in the bill purchasing operations conducted at all the Bank's offices. The revised procedure (1) would apply from early February 2002, and the revised criterion (2) from the next selection in around May 2002.

B. Members' Discussion and Votes

Most members expressed approval of the staff's proposal based on the view that money market operations would be facilitated further and the Bank's provision of funds would be improved. One of these members expressed the view that the revision of the "one-year rule" for the outright purchases of JGBs reflected the recent improvements in the primary and secondary markets for JGBs, and the Bank should be extremely careful in explaining the revision to the public to avoid market speculation that it would continue increasing the outright purchases of JGBs. Another member opposed the staff's proposal on expansion of the range of eligible assets and collateral, one of the three proposals mentioned above, because the member considered that the Bank should not step too far into the area of corporate financing.

By majority vote, members approved the proposal on expanding the range of eligible assets and collateral with a view to strengthening money market operations. By unanimous vote, members approved the proposal on amending the Principal Terms and Conditions for the Outright Purchase/Sale of JGBs and revising the Selection Procedure for Counterparties in Bill Purchasing Operations. It was then decided to make the decision public.

The Vote on the Staff's Proposal Regarding Expansion of the Range of Eligible Assets and Collateral

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, as he had advocated in the previous meeting, the Bank should not, without careful consideration, step into the area of corporate financing, and monetary easing should be done with conventional measures. And second, the staff's proposal would have only a limited effect, as the market size for ABS and other instruments concerned was small.

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

A. Current Economic Situation and the Outlook

On the current state of Japan's economy, most members concurred that it was appropriate to maintain the assessment at the previous meeting that "Japan's economy is deteriorating broadly, as private consumption is weakening in addition to a decline in exports and business fixed investment."

On this basis, some members pointed out that the pace of decline in exports and production was recently slowing somewhat, especially in IT-related industries. Many members including these members, however, expressed the view that the outlook for Japan's economy remained uncertain given that (1) there was still much uncertainty about the outlook for the world economy including the U.S. economy, and (2) there was a concern that private consumption could weaken further due to factors such as a deterioration in employment and income conditions.

The first topic of discussion was overseas economic developments.

Many members pointed out that the following positive factors were starting to be observed: (1) reflecting the steady progress in the adjustment of excessive inventories in IT-related industries, the pace of decrease in shipments of semiconductors worldwide had slowed and semiconductor prices showed signs of bottoming out; and (2) a large decrease was avoided in the results of Christmas sales in the United States, which had been a focus of attention. One member added that aggressive monetary and fiscal policy measures in the United States and the decline in crude oil prices continued to support the U.S. economy's progress toward a recovery. Some members commented that they supported the scenario that the U.S. economy would start to recover from the middle of 2002, and pointed to the fact that the U.S. financial markets were increasingly anticipating its materialization.

The members who pointed out the above positive factors shared the view, however, that the outlook for the U.S. economy remained highly uncertain because the recovery of final demand in the United States had not been confirmed yet on the following grounds. First, it was cause for concern that sales might fall in the future in reaction to various discount sales such as those of automobiles. Second, the deterioration in employment and income conditions and excessive debts of consumers could restrain the growth of private consumption. And third, business fixed investment was unlikely to increase given the fact that the momentum for a recovery in corporate profits was weak. One member who held a more cautious view of the U.S. economy than other members commented that it would be difficult for the scenario of a U.S. economic recovery from the middle of 2002 to materialize, judging from such factors in the United States as the quasi-bubble situation of stock prices, the rise in the unemployment rate, the peaking out of business fixed investment, and the decrease in imports.

One member added that possible negative effects of the situation in Argentina on other countries continued to require monitoring as a risk factor to the world economy, although no such effects had been observed so far.

Members then discussed the current situation and the outlook for Japan's economy.

Some members expressed the view that in the corporate sector, although exports remained on a downtrend, the pace of decline was slowing slightly. One of these members pointed out that exports of electrical machinery to the United States and East Asia seemed to have stopped decreasing. Given such developments in exports, many members expressed the view that inventory adjustments, mainly in electronic parts, were showing steady progress, and the pace of decrease in production was slowing. One member, however, commented that it would take more time for production to stop decreasing because inventory adjustments in some types of goods would take longer to complete and this would affect the outlook for production, and furthermore, the shift of firms' production to overseas was expected to continue.

A few members said that business fixed investment was still on a downtrend. One of these members expressed the view that business fixed investment could start to decrease in a wider range of industries including nonmanufacturers in addition to IT-related manufacturers, where it had already been decreasing. One member commented that corporate profits were being significantly affected by the decline in prices and sales.

Regarding developments in the household sector, many members expressed the view that employment and income conditions were deteriorating and private consumption was weakening.

However, a different member referred to various indicators and pointed out that, while sales of automobiles and electrical appliances were declining, some indicators were firm, such as the performance of businesses in food services and domestic travel, and sales at department stores, and therefore it could be considered that private consumption was still at a normal level. This member continued that it was also important to rejuvenate the economy while private consumption was holding out.

With regard to prices, one member said the decrease in some domestic wholesale prices seemed to have stopped partly due to the recent depreciation of the yen. This member also pointed out that there were some cases where suppliers tried to raise prices for goods whose supply-demand balance had started to improve due to the progress in inventory adjustments.

Another member pointed out that crude oil prices were testing the market's floor, due to the fact that the upward pressure on crude oil prices stemming from the further reduction in oil production was being offset or more than offset by the downward pressure from the weakness of the world economy.

With regard to Japan's economic situation as described above, a few members expressed the view that the economy had not deviated significantly from the standard scenario in the "Outlook and Risk Assessment of the Economy and Prices" released in October 2001 which forecasted that Japan's economy would stop deteriorating toward the second half of fiscal 2002. However, these members added that downside risks to the economy continued to require monitoring.

As factors posing a risk to the economic outlook, many members cited developments in the world economy including those in the U.S. economy. Furthermore, these members stressed that due attention should be paid to developments in the financial system and corporate financing and their effects on the economy. One member added that attention should be paid to the increasing severity of the deterioration in regional economies, as seen in the deterioration in the fiscal condition of local governments, the further widening of the economic gap between the rural areas and the metropolitan areas, and the increase in the number of bankruptcies of small firms.

One member expressed a more cautious view than other members on Japan's economic situation. This member gave the following reasons. First, the Indexes of Business Conditions showed that the current economic deterioration was as severe as the worst previous situation, which was after the first oil crisis, and there was still no sign of an economic recovery. Second, business fixed investment was on a downtrend in a medium-term economic cycle judging from the level of the supply-demand balance, the rates of return on investment, and the ratio of investment to GDP, and investment related to construction was falling to the lowest level in a long-term economic cycle. This member continued from a longer-term perspective that the problems of excessive debts, capital stock, and employee numbers that had been left unsolved would have to be dealt with in the next few years at the latest, but thereafter the outlook would become somewhat brighter. This member pointed out that one of the reasons for this view was that the adjustment of over-lending in Japan was likely to be completed by a further reduction of banks' lending outstanding by about 25 trillion yen, taking the ratio of banks' lending outstanding to nominal GDP in the early 1980s before the bubble as an indication of the appropriate level of their lending outstanding.

B. Financial Developments

Members discussed the recent developments in financial markets from the viewpoint of the effects of the additional monetary easing decided in December 2001. Many members shared the view that its effects were gradually appearing, mainly in the money market, pointing to the following developments. First, there had not been any significant disruption in the money market at the turn of the calendar year, and confidence about the availability of funds was increasing toward the fiscal year-end. Second, interest rates on term instruments, which were on a moderate uptrend in early December, had started to decline again. And third, in the CP market, issuance rates were declining, especially for CP issued by firms with high credit ratings.

A few members noted that developments in credit spreads on corporate bonds and stock prices showed a further tendency to polarization between firms with high and low credit standings despite the Bank's ample funds provision. One of these members said that strong concerns over availability of liquidity and fund-raising conditions as seen in 1997-98 had been prevented to a considerable extent due to the current strong monetary easing, but the market's concern about credit risk was mounting. Another member said that there was a limit to the extent to which the Bank's liquidity provision could deal with problems related to credit in the market.

One member summarized the Bank's conduct of monetary policy and its effects after the introduction of quantitative targeting. This member pointed out that the Bank had been able to increase the outstanding balance of current accounts at the Bank to a level which was initially considered difficult to reach, because (1) there had been concerns about the stability of the financial system since autumn 2001, (2) liquidity demand surged in preparation for funding beyond the calendar and fiscal year-end, and (3) the intermediary functions of the money market declined due to the extremely low interest rates. The member continued that as a result of the Bank's additional funds provision since the previous meeting, market confidence about the availability of funds increased and interest rates on term instruments had become lower, but no significant effects on medium- to long-term interest rates, stock prices, or foreign exchange rates had been observed. The member stated that these developments needed to be examined in the future because neither the effects of the rebalancing of financial institutions' portfolios nor the effects on market participants' expectations of the drastic increase in the outstanding balance of current accounts at the Bank to around 15 trillion yen had appeared clearly so far.

Many members exchanged views on the recent developments in foreign exchange markets where the yen was depreciating. Some members remarked that given the difference between Japan's economic situation and that of other countries, the yen's weakness was consistent with economic fundamentals, together with the weakness of stock prices and the stability of long-term interest rates at low levels in Japan. One of these members said that the weak yen might reduce firms' incentive to restructure and improve their productivity, but in the short term it could have positive effects on corporate profits and prices.

Another member, however, said that the recent weakness in the yen was mainly due to the difference between the growth in the monetary base in Japan and the United States, and the yen was still considerably overvalued in view of the differences in labor productivity and the unit labor cost between the two countries, and the level of purchasing power parity. A different member expressed the view that a depreciation of the yen would be necessary in the process of combating deflation while maintaining the stability of the real exchange rate, which reflected changes in prices.

In response to this, one member pointed out that concern was being expressed about a further depreciation of the yen in some economies such as those in Asia, and the member thus considered that a further weakening of the yen amid concerns over the financial system would adversely affect the markets' view of Japan's overall economy.

Based on the above discussion, some members emphasized that the authorities should refrain from making remarks about the foreign exchange rate, as it tended to fluctuate reflecting various speculations.

Regarding other developments in financial markets, one member noted that long-term interest rates were moving at levels close to the upper end of the recent range, and said that upward pressure on the rates might emerge reflecting cautiousness about risks on JGBs. Another member pointed out that prices of JGB futures had been declining after recording high levels from the middle of 2001 to the autumn, and also a technical analysis showed that market developments warranted attention. This member also remarked that the risk that stock prices could fall to record lows should be kept in mind.

Members exchanged views on developments in corporate financing, which many members considered as one of the risk factors for the time being. Some members said that it was natural for financial institutions to set lending spreads according to the credit risk of borrowers, and this was also important in restoring the soundness of the financial system. These members, however, added that recently fund-raising conditions of small firms and firms with low creditworthiness were deteriorating, due mainly to the fact that the lending attitude of banks as perceived by small firms was becoming more severe and that the tendency to polarization in credit spreads on corporate bonds was intensifying. One member remarked that it was essential to ensure smooth financing for small firms toward the fiscal year-end, and therefore use of financing through government financial institutions would be one option. Another member commented that inter-company credit contracted significantly judging from the flow of funds accounts in January-September 2001.

Views were exchanged on the current state of the financial system. Some members expressed the view that the weakness in prices of bank stocks and the widening trend of credit spreads of bonds issued by banks and of bank debentures indicated that the market's view of the financial system remained severe. A few members said that it was necessary that financial institutions set aside sufficient provision for NPLs or write them off, and then, re-injection of public funds would have to be considered for financial institutions if they could not strengthen their capital bases by themselves.

On the other hand, another member expressed the view that financial institutions' lending could not be expected to increase immediately even if public funds were injected, because financial institutions' risk-taking ability seemed to be declining. In addition, this member said that in order to ease the excessive cautiousness over credit risk, the excess capacity in the corporate sector needed to be reduced and a sustainable recovery path for corporate profits would have to come into prospect. A different member said that public funds would have to be injected, but that it was uncertain whether this would immediately improve the market's view regarding banks.

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

Members discussed the monetary policy stance for the immediate future.

Most members shared the view that the economy was deteriorating broadly, as private consumption was weakening in addition to a decline in exports and business fixed investment. Further, members generally agreed that developments in the Japanese financial system and corporate financing conditions, as well as in overseas economies such as that of the United States, would require close monitoring for the time being.

On this basis, most members expressed the view that, given that the Bank had taken additional monetary easing measures in December 2001 fully taking into account economic and financial developments, the Bank should (1) maintain the current guideline for money market operations and promote stability of financial markets through provision of ample funds, and (2) examine how the significant increase in the outstanding balance of current accounts at the Bank would affect developments in financial institutions' behavior and financial markets. Some of these members contended that it was important to give the market confidence in the availability of liquidity, particularly toward the end of the fiscal year in March 2002. A different member added that the member strongly hoped that the Government and the private sector would advance structural reforms steadily as the Bank continued to make every effort to maintain easy monetary conditions.

Members also discussed how the Bank should conduct money market operations. A few members expressed the view that within the guideline's target range of "at around 10 to 15 trillion yen" the Bank should maintain the current stance of aiming at the upper end of the range as much as it could. With regard to the fact that undersubscription in the Bank's money market operations had started to be observed, one member said that this was proof that the Bank was providing liquidity to its utmost. A few members including this member shared the view that they would like to examine how the Bank's efforts to provide liquidity in a situation of continuing undersubscription would affect financial markets and economic activity.

Members then discussed measures to deal with concerns about the financial system. One member expressed the view that in the event the market's concerns about availability of liquidity heightened due to downside risks related to the financial side, the Bank needed to provide ample funds flexibly, which was possible under the contingency clause in the guideline for money market operations. A few members commented that presentation of concrete measures to deal with a financial crisis could give confidence to the market, and in this regard it would be important that the Bank and the Government addressed problems related to the financial system in a coordinated manner toward the end of the fiscal year. A different member summarized the discussion in the following way. First, in its monetary easing as a macroeconomic policy, the Bank had been doing its utmost through the provision of ample liquidity and the "Lombard-type" lending facility. Second, it was possible and also appropriate for the Bank to provide additional liquidity to deal with event risk. And third, to address systemic risk, measures outside the framework of monetary policy would be necessary, and in such a case the Bank should appropriately implement measures it could take as a central bank.

A few members commented that developments in long-term interest rates also warranted close monitoring. One of these members said that given that the role of fiscal policy could become increasingly important depending on future economic developments, it was essential to secure market confidence in the conduct of fiscal policy, and this would require presentation of a forecast indicating that the medium-term fiscal condition would be sustainable.

One member who took a more cautious view of the economy than other members said that the Bank was not doing enough by being passive and taking a "wait and see" stance, and therefore the member would like to propose 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 15 trillion yen.

V. Remarks by Government Representatives

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

(1) The Government had compiled the budget for fiscal 2002, which strongly reflected its commitment to reforms. The principle of the budget was to improve the efficiency of government expenditures and shift funds boldly to priority areas. Prior to the budget for fiscal 2002, the Government submitted the second supplementary budget for fiscal 2001 to the Diet, and it was determined to deal with the current economic situation flexibly and decisively to advance structural reform through these two budgets.

(2) The Bank decided to take additional monetary easing measures at the previous meeting, and as a result, there were no disruptions in the money market at the turn of the year. The Government hoped that the Bank would continue providing ample funds giving due consideration to developments in the economy and financial markets, and further, consider providing a few trillion yen of additional funds in view of developments in liquidity demand toward the end of the fiscal year.

(3) The consumer price index (CPI) showed that prices continued to fall. The Government would like to ask the Bank to further discuss measures to prevent the economy from sliding into a deflationary spiral and to conduct monetary policy that would be more effective in relation to the economy, looking at a wide variety of options. The Government hoped that measures to strengthen money market operations discussed at this meeting would enhance the effectiveness of the Bank's monetary easing.

The representative from the Cabinet Office made the following remarks.

(1) With regard to the assessment of the current state of the Japanese economy, the Government judged that the economy was in a severe situation as seen in the negative growth of real GDP for the second consecutive quarter and the record high unemployment rate. The Government's Fiscal 2002 Economic Outlook forecasted that real GDP growth would be flat at around 0.0 percent and consumer prices would decline by 0.6 percent from the previous fiscal year.

(2) The Government would cooperate closely with the Bank, and achieve an economic recovery and stabilize prices as soon as possible. The Government would like to ask the Bank to implement monetary policy in an appropriate and timely manner to stop deflation.

VI. Votes

Based on the above discussions, 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 15 trillion yen. The target under the current guideline for money market operations was, in the member's opinion, insufficient to deal with the current situation of the economy, which had deteriorated further and was in the early stages of a deflationary spiral.

This member gave the following reasons for the proposals. First, the Bank should make clear its determination to stop deflation. Second, the Bank should diversify its means of providing funds and avoid relying heavily on operations using JGBs. Third, purchases by the Bank of a fixed amount of foreign bonds on a regular basis would not be in contravention of Article 40, Paragraph 2 of the Bank of Japan Law. And fourth, the Bank should reinstate a policy with a specific target for the outstanding balance of current accounts at the Bank.

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 July-September quarter of 2003 at or raising it to or above a target of 99.2, which was that in the July-September 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:

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 15 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 on the Guideline for Market Operations:

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 conduct money market operations, aiming at the outstanding balance of the current accounts at the Bank at around 10 to 15 trillion yen.

Should there be a risk of financial market instability, such as a surge in liquidity demand, the Bank will provide more liquidity irrespective of the guideline above.

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, at 10 trillion yen, the lower end of the range was insufficient to have a quantitative effect. Second, the range of 10 to 15 trillion yen gave the staff too much discretion. And third, the economy had deteriorated further and was in the early stages of a deflationary spiral, and in this situation, it was not appropriate to maintain the current guideline for money market operations because this might delay a monetary policy response.

VII. Discussion on the Bank's View of Recent Economic and Financial Developments

The Policy Board discussed "The Bank's View" of recent economic and financial developments, and put it to the vote. By majority vote, the Board decided to publish "The Bank's View" on January 17, 2002 in the Monthly Report of Recent Economic and Financial Developments (consisting of "The Bank's View" and "The Background").⁷

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, corporate bankruptcies, and the unemployment rate. Second, Japan's economy was already in the early stages of a deflationary spiral. Third, it should mention the fact that the fall in public investment was having a large effect on economies in rural areas. And fourth, the judgment that prices were expected to follow a "gradual" declining trend for the time being was not appropriate.

1. 7The original full text, in Japanese, of the Monthly Report of Recent Economic and Financial Developments was published on January 17, 2002 together with the English version of "The Bank's View." The English version of "The Background" was published on January 18, 2002.

VIII. Approval of the Minutes of the Monetary Policy Meetings

The Policy Board approved unanimously the minutes of the Monetary Policy Meetings of November 29, 2001, and December 18 and 19 for release on January 21, 2002.

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Attachment

For immediate release

January 16, 2002
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 conduct money market operations, aiming at the outstanding balance of the current accounts at the Bank at around 10 to 15 trillion yen.

Should there be a risk of financial market instability, such as a surge in liquidity demand, the Bank will provide more liquidity irrespective of the guideline above.