Minutes of the Monetary Policy Meeting

on June 11 and 12, 2002
(English translation prepared by the Bank's staff based on the Japanese original)

July 19, 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, June 11, 2002, from 2:00 p.m. to 3:53 p.m., and on Wednesday, June 12, from 9:00 a.m. to 12:12 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. K. Ueda
Mr. T. Taya
Ms. M. Suda
Mr. S. Nakahara
Mr. H. Haru
Mr. T. Fukuma

Government Representatives Present
Mr. H. Fujii, Deputy Vice Minister for Policy Planning and Coordination, Ministry of Finance²
Mr. Y. Ninomiya, Counselor of the Minister's Secretariat, Ministry of Finance³
Mr. Y. Kobayashi, Vice Minister for Economic and Fiscal Policy, Cabinet Office

Reporting Staff
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. S. Kushida, Chief Manager, Planning Division I, Policy Planning Office
Mr. K. Yamamoto, Director, Financial Markets Department
Mr. H. Hayakawa, Director, Research and Statistics Department
Mr. K. Monma, Senior Manager, Research and Statistics Department
Mr. W. Takahashi, Associate Director, International Department

Secretariat of the Monetary Policy Meeting
Mr. Y. Hashimoto, Director, Secretariat of the Policy Board
Mr. Y. Nakayama, Advisor to the Governor, Secretariat of the Policy Board
Mr. K. Ishida, Chief Manager, Global Economic Research Division, International Department⁴
Mr. H. Onobuchi, Manager, Secretariat of the Policy Board
Mr. H. Yamaoka, Senior Economist, Policy Planning Office
Mr. S. Shimizu, Senior Economist, Policy Planning Office

The minutes of this meeting were approved by the Policy Board at the Monetary Policy Meeting held on July 15 and 16, 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.
Mr. Fujii was present on June 11.
Mr. Ninomiya was present on June 12.
Mr. Ishida was present on June 11 from 2:00 p.m. to 2:50 p.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 decided at the previous meeting on May 20 and 21, 2002.⁶ The Bank conducted market operations, aiming at an outstanding balance of current accounts at the Bank of around 15 trillion yen.

As a result, the weighted average of the uncollateralized overnight call rate was stable at 0.001-0.002 percent.

5Reports were made based on information available at the time of the meeting.
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

The money market continued to be stable in the intermeeting period, with Euro-yen rates and yields on short-term Japanese government securities (JGSs) remaining at low levels. The yield differentials between short-term JGSs and Euro-yen rates or CP rates expanded during February and March, but since April they had been contracting to the levels of early January as market participants became more willing to take risks.

Developments in the foreign exchange and domestic capital markets reflected market participants' close attention to the outlook for Japan's economy and changes in the international flow of funds. The U.S. dollar generally depreciated against major currencies due partly to concern about the possibility of a recurrence of terrorist attacks and a possible slowdown in the inflow of funds into the United States. Against this background, the yen appreciated more rapidly against the U.S. dollar from mid-May. Thereafter, the yen stayed in the range of 123-125 yen after the media reported that the Japanese currency authority had conducted yen-selling intervention against the U.S. dollar in late May. Compared to weak stock prices in the United States and Europe, Japanese stock prices were generally firm, underpinned by expectations for economic recovery and for improvement in corporate profits and by the inflow of foreign investors' funds. Long-term interest rates stayed mainly in the range of 1.3-1.4 percent. Although a foreign credit rating agency had announced a downgrading of Japanese government bonds (JGBs), the JGB market did not seem to have reacted much to it.

Credit spreads, the yield differentials between JGBs and corporate bonds or bank bonds in the secondary market, continued to contract, especially for bonds issued by firms with high credit ratings because institutional investors gradually became more willing to take risks.

C. Overseas Economic and Financial Developments

The U.S. economy continued to be on a recovery trend. In particular, private consumption was firm due partly to the improvement in consumer confidence. As for the corporate sector, indexes compiled by the Institute for Supply Management (ISM) for May improved from the previous month for the manufacturing sector, particularly the new orders index, and thus production was projected to expand for the time being. Nondefense capital goods orders, a leading indicator of business fixed investment, seemed to have stopped declining. However, no clear indication of recovery in business fixed investment had been observed yet, reflecting firms' excessive debts and capital stock and uncertainty in the outlook for corporate profits. With regard to employment, downward pressure was gradually abating as seen in the increase in private nonfarm payroll employment for the second consecutive month.

U.S. stock prices were weak, falling to the lowest levels recorded since the autumn of 2001. This was attributable to concern about the possibility of a recurrence of terrorist attacks, the growing tension between India and Pakistan, and increasing skepticism about firms' accounting information, in addition to the fact that the heightened expectation for U.S. economic recovery had been dampened.

In the euro area, GDP for the January-March quarter of 2002 increased from the previous quarter due mainly to the increase in exports, and there were clearer signs of bottoming out of the economy led by external demand. Regarding prices, the increase in the Harmonised Index of Consumer Prices (HICP) had remained generally steady so far, but the effects of the increase in crude oil prices and the agreements in negotiations on a fairly large increase in wages in Germany were a matter of concern. The money stock continued to mark high growth although the pace had slowed slightly.

In East Asian economies, exports and production increased and domestic demand was showing signs of a recovery. By destination, exports to countries within the region as well as to the United States were increasing markedly.

D. Economic and Financial Developments in Japan

1. Economic developments

With regard to developments in demand components, exports increased markedly in April compared with the average of the January-March quarter of 2002. A breakdown of exports by goods showed that capital goods and parts, and also intermediate goods, continued to mark high growth, and IT-related goods, which had been decreasing, recorded a sizable increase. Recently, demand for semiconductors worldwide was recovering rapidly. However, since this was due mainly to restocking by their users, the growth in demand was projected to slow somewhat from the second half of 2002. Imports continued to decrease, but were expected to stop declining due to the recovery in domestic production.

Business fixed investment, particularly in manufacturers, recorded a substantial decline according to the Financial Statements Statistics of Corporations by Industry, Quarterly. However, machinery orders from manufacturers, a leading indicator, seemed to be bottoming out. In addition, with regard to corporate profits, the ratio of current profits to sales had almost stopped decreasing in manufacturers and the pace of decline had greatly moderated in nonmanufacturers. These developments were expected to underpin business fixed investment.

Private consumption remained weak as a whole. However, as seen in the pick-up in passenger-car sales, private consumption seemed to be holding up relative to the weakness in household income. This might reflect the fact that consumer sentiment had improved somewhat from its worst.

Industrial production was picking up reflecting the above developments in demand components. The growth rate of production for the April-June quarter of 2002 was projected to be relatively high, although it would not be as high as the 4.3 percent in the production forecast survey. Inventories had fallen significantly, suggesting that, overall, inventory adjustment had almost been completed. As for shipment by goods, however, while producer goods were increasing considerably due mainly to the restocking of inventories of IT-related goods worldwide, final demand goods remained on a downtrend reflecting the weakness in domestic final demand.

The rebound in production was beginning to influence employment and income conditions, albeit marginally, with an increase in overtime working hours and in new job offers for part-time workers. The ratio of job offers to applicants had almost stopped declining. However, the decline in household income continued to be significant due to the moderate expansion of the pace of decline in wages and the general downtrend in the number of employees.

With respect to prices, the month-on-month growth rate of domestic wholesale prices for each of the last four months had been either unchanged or slightly positive. Import prices had increased due to upward pressure from the rise in crude oil prices in early spring, but recently they were stable because the upward pressure had been offset by the recent appreciation of the yen. The consumer price index continued to decline.

With regard to the outlook for prices, import prices were likely to start falling, and domestic wholesale prices, which were sensitive to import prices, would edge down. Consumer prices were expected to stay on a declining trend for the time being at the current gradual pace. This was partly because, while the slower growth in imports of consumer goods was expected to alleviate the downward pressure on prices to some extent, the decline in wages might possibly reinforce the ongoing decline in service prices.

2. Financial environment

With regard to corporate finance, private banks' lending continued to decline by 2-3 percent on a year-on-year basis. The amount outstanding of corporate bonds and CP issued was above the previous year's level, but the year-on-year growth rate was slowing. However, issuance conditions for corporate bonds and CP were improving, as evident in the fact that issuance of corporate bonds with single A ratings and CP with A-2/P-2 or lower credit ratings, which had been somewhat sluggish until recently, had started to increase.

The monetary base continued to increase substantially by around 30 percent from the previous year's level in May, although the growth rate slowed slightly due partly to the abatement of liquidity demand prompted by a system failure of a major bank group.

The year-on-year growth rate of the money stock remained around 3.5 percent. In detail, M1 (cash currency plus deposit money) continued to mark high growth, but quasi-money such as time deposits remained on a downtrend. As for other financial assets, investment trusts continued to decrease while recently the growth rate of safe financial assets, such as JGSs, had increased further.

The average contracted interest rates on new loans and discounts remained stable, but financial institutions were gradually becoming eager to increase their interest margins. Meanwhile, small firms' perception of their funding situation had almost stopped deteriorating, and this seemed to reflect the recent improvement in economic activity.

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

A. Economic Developments

On the current state of Japan's economy, members concurred that it showed signs of stabilizing with a distinct increase in exports and a pick-up in production, although domestic private demand remained weak. They agreed to again revise the assessment of the economy slightly upward following the upward revision of the previous month.

Many members expressed the view that there were an increasing number of indicators suggesting improvement in the economy, in particular those relating to exports and production. Members generally held the same view, however, that the economy had not stopped deteriorating as a whole, as there were no clear signs that the effects of the increase in exports and production were spreading into domestic final demand. As for the outlook, many members expressed the view that the economy was expected to stop declining as a whole, but that it was necessary to continue examining carefully the pace of the recovery in overseas economies and the effect of the recovery in exports and production on nonmanufacturers and households.

With regard to developments in the corporate sector, most members pointed out that exports were increasing markedly due to the recovery in overseas economies. A few members commented that the increase in exports would be sustained by the following factors: (1) exports of IT-related goods had started to increase; (2) domestic demand in Asian economies was recovering; and (3) Asian economies could be becoming more interdependent and thus less influenced by developments in the U.S. economy.

Many members said that production was picking up, reflecting the increase in exports and completion of inventory adjustment. Some members, however, expressed the view that, since the recent increase in exports and production reflected restocking, mainly of IT-related goods, the pace of the increase might slow as the effects of restocking dissipated.

Many members commented that there was no evidence of a recovery in business fixed investment. Some members expressed the view, however, that it could gradually stop decreasing in the near future, given that machinery orders and building construction starts (private, nondwelling use), both of which were leading indicators of business fixed investment, were higher for April than the average for the January-March quarter of 2002.

One member pointed out that the business condition of all sizes of firms was improving, according to the Business Outlook Survey compiled by the Ministry of Finance. Another member said that a survey by the Japan Finance Corporation for Small Business indicated that small firms' view on sales, profits, and employment was improving, and therefore positive developments in the economy could be spreading to small firms.

Members then discussed the household sector. Some members pointed out that there were signs of a marginal improvement in the supply-demand balance in the labor market reflecting the increase in production, as was evident in an increase in overtime working hours and new job offers. One of these members said that corporate restructuring had been progressing and the deterioration in employment conditions would come to a halt in the near future. Many members, however, expressed the view that employment and income conditions of households overall remained severe because the share of labor in income distribution was still high and firms were still keen to reduce personnel expenses.

Some members commented that, although sales were flat on balance according to various statistics, private consumption was holding up relatively well despite the deterioration in income. One of these members explained that this was because there were some improvements in employment conditions and consumer confidence. On the other hand, a few members said that they would like to examine more data before judging the trend of private consumption because wages and household income were declining.

As for prices, a few members said that domestic wholesale prices were almost flat reflecting the improvement in the supply-demand balance in the manufacturing sector at home and abroad, in addition to the depreciation of the yen and the rise in crude oil prices in the past. Some members said that, although consumer prices were expected to stay on a declining trend at the current pace for the time being, they would like to carefully examine changes in firms' low price strategy, changes in consumers' expectations for deflation, and the extent to which the effects of the decline in wages were spreading to service prices. One of these members said that the possibility could not be ruled out that developments in consumer prices might not be in line with developments in the economy. In response to this, a different member expressed the view that, given that the trend in consumer prices was determined by the output gap and wages, the outlook for consumer prices was unpredictable because it was unclear whether domestic demand was recovering.

A few members expressed the view that the above developments in the economy and prices were still within the range of the standard scenario in the "Outlook and Risk Assessment of the Economy and Prices" released in April 2002. A few members commented that, examined together with supply-side statistics, the preliminary GDP data for the January-March quarter of 2002 were in line with the standard scenario, which forecasted that the economy would lack strength in domestic demand while exports would show high growth.

Many members noted the following risks for the near future: (1) developments in overseas economies including the United States and changes in international capital flows; and (2) the effects of structural adjustment pressures on Japan's economy and concern about the stability of the financial system.

Regarding overseas economic developments, many members commented that the pace of recovery of the world economy, particularly the U.S. economy, remained highly uncertain. One member expressed the view that private consumption in the United States could not be expected to become the driving force of economic recovery because income conditions of households were not especially firm, and the growth in business fixed investment was likely to be low. These members added that it was cause for concern that U.S. stock prices had been weak recently, reflecting the following: (1) increased cautiousness about the outlook for corporate profits; (2) the situation in the Middle East; (3) concern about the possibility of a recurrence of terrorist attacks; and (4) skepticism about firms' accounting information. A few of these members referred to the expansion of the U.S. fiscal deficit and pointed out the risk that the decrease in capital inflows to the United States might change the direction of international capital flows. In relation to this, some members expressed the opinion that due attention should be paid to the effects of the surge in the yen against the U.S. dollar on the Japanese economy.

Some members commented on the effects of structural adjustment pressures on the economy. One member pointed out that firms' balance-sheet problems were relatively concentrated in the nonmanufacturing sector and that firms were still keen to reduce personnel expenses, which could prevent the improvement in the economy from spreading to nonmanufacturers and households. Another member expressed the view that further analysis should be made of the relationship between the ongoing improvement in the economy led by the manufacturing sector, developments in the nonperforming-loan (NPL) problem, and the adjustment in asset prices such as land prices after the bursting of the bubble. A different member commented on the Japanese financial system since the removal of blanket deposit insurance and said that it remained unstable although financial institutions had disposed of a huge amount of NPLs in fiscal 2001. This member added that the high growth of banknotes in circulation and M1 was also evidence that concern about the stability of the financial system was still strong, and therefore developments in such liquid assets continued to require close monitoring.

B. Financial Developments

A few members pointed out that credit spreads for corporate bonds, especially those with high credit ratings, contracted due to the improvement in Japan's economy, and that Japanese stock prices remained fairly firm despite weak stock prices overseas and the surge in the yen against the U.S. dollar. A different member said that market expectations for a recovery of Japan's economy might not be so strong given that (1) the recent developments in stock prices were merely due to buybacks after excessive selling, and (2) long-term interest rates were either generally level or were declining slightly. This member continued that similar developments were also observed in financial markets of major industrial countries such as the United States, and thus the view of the world economic outlook for the medium to long term seemed to be becoming slightly cautious. Another member said that so far no effects of the downgrading of JGBs were observed, but there was concern about a possible negative effect on firms' financing conditions in the future.

Some members commented on developments in foreign exchange markets. These members expressed the view that the recent market intervention by the Japanese currency authority had been meaningful, considering the possible effects on the economy of the surge in the yen against the U.S. dollar in late May. One of these members, however, said that there might be limits to the extent to which the depreciation of the U.S. dollar against the yen could be curbed solely by market intervention.

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

Members first discussed the monetary policy stance for the immediate future. All members expressed the view that it was appropriate to maintain the current guideline for money market operations and continue providing ample funds to the money market. This was because, although the assessment of the economy had been revised upward, it was still under structural adjustment pressure, and it was necessary to underpin it by continuing the Bank's decisive monetary easing measures in order to return it to a sustainable recovery path.

A few members remarked that the Bank should make clear its intention to continue the current monetary easing stance because it was important to stabilize the expectations of private economic entities and market participants.

Regarding the level of the outstanding balance of current accounts at the Bank, some members commented that it was appropriate to continue aiming at the upper limit of the current target range of "around 10 to 15 trillion yen." Members discussed the reason why the Bank had been able to provide funds relatively smoothly to maintain the outstanding balance at around 15 trillion yen, even after concern about the financial system had abated. Some members explained that this was against the background of the increase in financial institutions' bids for the Bank's market operations with relatively long maturity and operations utilizing treasury bills (TBs) and financing bills (FBs) reflecting the following factors. First, market function was weakening as seen in the decline in the outstanding volume of the call market. And second, the supply-demand balance in the TB and FB market had eased. A few of these members said that market participants were becoming more dependent on the Bank's market operations, and the Bank was increasingly in effect intermediating funds transactions between lenders and borrowers in the market. These members expressed the view that careful monitoring was required of developments in market interest rates and in the liquidity demand in current accounts at the Bank in order to analyze the effect of the Bank's provision of ample liquidity on the market.

Regarding the fact that the growth of broadly-defined money stock was sluggish while that of the monetary base was high, one member referred to an argument outside the Bank that financial institutions should extend loans directly to the Government. Against this argument, this member commented that the growth of the money stock would not change even if the channels for supplying funds to the Government were shifted from purchasing of JGSs by financial institutions to loans. This member continued that if the money stock were increased through financing of the Government by financial institutions, expansion of the fiscal deficit would be inevitable. This member further said that market participants' preference for liquid assets and/or risk-free assets had changed little in a situation where the monetary base had been increasing considerably, and thus it was important to strengthen the risk-taking capacity of economic entities in order to increase policy effects. In response to this view, a different member said that the Bank's ample liquidity provision had contributed to alleviating concern about liquidity, and this was considered to have stabilized the medium- to long-term zone of the yield curve and to have positively affected stock prices and economic activity. Another member added that strong monetary easing measures were making it easier for firms to proceed with balance-sheet adjustment, for example, through the decline in credit risk premiums since April 2002.

In addition, some members commented on other economic policies. One member attached importance to completion of the disposal of NPLs as soon as possible because there would still be a risk that concern about the stability of the financial system could rekindle in the rest of 2002 or in 2003. A few other members hoped that concrete measures regarding economic revitalization strategies and tax reform would stimulate the economic activity of the private sector.

IV. Remarks by Government Representative

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

(1) The preliminary GDP data for the January-March quarter of 2002 confirmed that the economy had bottomed out. With the aim of fostering the bottoming out of the economy to sustainable private demand-led growth, the Government would continue to take decisive actions for structural reform, and was firmly resolved to stop deflation in close cooperation with the Bank.

(2) In this regard, the Government would compile by the end of June new basic policies for economic and fiscal policy management which would include the following: economic revitalization strategies including, for example, regulatory reform; tax reform; and reform of the structure of government expenditure.

(3) With regard to the conduct of monetary policy, the Bank was providing funds aiming at an outstanding balance of current accounts at the Bank of around 15 trillion yen, the upper limit of the current target range. The Government would like the Bank to continue to give due consideration to developments in the economy and financial markets and conduct monetary policy in a flexible manner should there be a rapid surge in liquidity demand. It was necessary that the Bank continue to conduct appropriate monetary policy to overcome deflation and ensure a full-fledged economic recovery at the present time when the economy had bottomed out. The Government would also like the Bank to consider a variety of options in devising additional monetary policy measures and to take drastic measures.

The representative from the Cabinet Office made the following remarks.

(1) GDP returned to positive growth, increasing 1.4 percent in the January-March quarter from the previous quarter after declining for three consecutive quarters. The economic growth rate was pushed up principally because the contribution of external demand to GDP rose due mainly to the increase in exports. These developments were mostly in line with the Government's view of the economic situation.

(2) Given that Japan's economy was still experiencing deflation, it was essential to achieve self-sustained economic growth in order to overcome deflation through implementation of structural reform focusing on increasing private demand and employment, as well as of measures from the monetary side. The Government's Council on Economic and Fiscal Policy would compile the "Basic Policies for Economic and Fiscal Policy Management and Structural Reform 2002" (the "Basic Policies No. 2"), which would include tax reform and economic revitalization strategies drawn up from a medium- to long-term perspective. On June 7, 2002, the Prime Minister presented a comprehensive set of directions to be followed by the members of the Council on Economic and Fiscal Policy as the basis for compiling the "Basic Policies No. 2."

(3) As for the monetary side, the Government was firmly resolved to stop deflation in cooperation with the Bank, and in this regard, the Government would continue promoting further disposal of NPLs and establish a vigorous financial system that could support a reinvigorated economy. The Government would like the Bank to continue deliberating on monetary policy measures which were effective in overcoming deflation and implementing them.

V. Votes

Based on the above discussions, members considered that it was appropriate to maintain the current guideline for money market operations.

To reflect this 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. K. Ueda, Mr. T. Taya, Ms. M. Suda, Mr. S. Nakahara, Mr. H. Haru, and Mr. T. Fukuma.

Votes against the proposal: None.

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 unanimous vote, the Board decided to publish "The Bank's View" on June 13, 2002 in the Monthly Report of Recent Economic and Financial Developments (consisting of "The Bank's View" and "The Background").⁷