Minutes of the Monetary Policy Meeting

on June 26, 2002
(English translation prepared by the Bank's staff based on the Japanese original)

August 14, 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 Wednesday, June 26, 2002, from 9:00 a.m. to 12:44 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. T. Taniguchi, Senior Vice Minister of Finance, Ministry of Finance
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. E. Hirano, Executive Director
Mr. M. Shirakawa, Adviser to the Governor, 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, Adviser to the Governor, Secretariat of the Policy Board
Mr. H. Onobuchi, Manager, Secretariat of the Policy Board
Mr. S. Nagai, Senior Economist, Policy Planning Office
Mr. H. Yamaoka, Senior Economist, Policy Planning Office

The minutes of this meeting were approved by the Policy Board at the Monetary Policy Meeting held on August 8 and 9, 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.

I. Summary of Staff Reports on Economic and Financial Developments²

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 June 11 and 12, 2002.³ 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.

2Reports were made based on information available at the time of the meeting.
3The 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

Short-term interest rates remained low and stable in the intermeeting period, as many market participants felt that there was an excess of liquidity in the market due to provision of ample funds by the Bank. Three-month Euro-yen rates followed a downtrend, partly because investors were becoming more willing to take risks. The rates were 0.02 percent currently, the lowest level ever. The yield differentials between treasury bills or financing bills and Euro-yen rates had been contracting.

Developments in the Japanese stock and the foreign exchange markets, on the other hand, continued to reflect market participants' nervousness in response to the fall in U.S. stock prices.

Japanese stock prices remained generally firm until early June 2002, reflecting expectations of an improvement in corporate profits, while U.S. stock prices had been on a downtrend since March this year. However, Japanese stock prices had increasingly tended to follow the downtrend in U.S. stock prices since the middle of June. The recent fall in U.S. stock prices seemed to reflect, in addition to skepticism about firms' accounting information and concern about the possibility of a recurrence of terrorist attacks, anxiety about the outlook for a recovery in the U.S. economy. This anxiety seemed to have led to concern over the momentum of a recovery in the Japanese economy in the future.

The yen appreciated against the U.S. dollar, as the U.S. dollar depreciated further against major currencies due mainly to the fall in U.S. stock prices and concern about the possibility of a recurrence of terrorist attacks. As the dollar's depreciation was particularly marked against the euro, the yen depreciated slightly against the euro.

Reflecting the fall in stock prices and the appreciation of the yen against the U.S. dollar, long-term interest rates had inched down, and were around 1.3 percent currently. Credit spreads, the yield differentials between corporate bonds or bank bonds and Japanese government bonds in the secondary market, continued to contract.

C. Overseas Economic and Financial Developments

Most U.S. economic indicators confirmed that the country's economy continued to be on a recovery trend. Industrial production for May rose by 0.2 percent from the previous month, increasing for the fifth consecutive month.

In the U.S. household sector, retail sales had decreased in May and consumer confidence had weakened. The decrease in retail sales, however, seemed to be attributable to a fall in gasoline prices and unseasonable weather. Automobile sales and sales at chain stores seemed to be recovering since the beginning of June. Judging from these developments, private consumption remained firm on the whole.

Housing starts in the United States remained at high levels. The risk that housing investment would decrease considerably in the near future seemed marginal, as the housing inventory level remained low and long-term interest rates were declining.

Regarding the U.S. balance of payments, the deficit in the external balance was expanding further due mainly to an increase in imports.

In U.S. financial markets, stock prices, especially in IT-related industries, continued to fall. In this situation, market expectations that the target for the federal funds rate would be raised in the near future had subsided.

The continuing fall in U.S. stock prices in a situation where the nation's economy remained generally on a recovery course seemed to reflect the following factors. First, skepticism about firms' accounting information. Second, U.S. stock prices, which had factored in excessively high expectations for economic growth compared to the actual state of the economy since the end of 2001, had been adjusted downward. And third, the fall in stock prices seemed to partially reflect the market's anxiety that the factors that were the basis for the U.S. economic prosperity in the 1990s, such as the fiscal surplus and the "peace dividend," might have started to weaken due to the change of fiscal balance to a deficit and concern about the possibility of a recurrence of terrorist attacks.

As for economies in the euro area and East Asia, various economic indicators generally confirmed that they had bottomed out or were tending to recover.

Among financial markets in emerging economies, those in Asia generally remained stable. However, the markets in Brazil and Turkey had become unstable recently, in addition to those in Argentina, which were already unstable. In these countries, yields of their government bonds and their spreads against U.S. Treasuries increased, their currencies depreciated sharply against foreign currencies, and stock prices plummeted.

D. Economic and Financial Developments in Japan

1. Economic developments

Trade statistics for May and results of private institutes' surveys regarding summer bonus payments, corporate profits, and business fixed investment were released in the intermeeting period. These economic indicators were generally in line with the assessment of the economy at the previous meeting that Japan's economy showed signs of stabilizing with a distinct increase in exports and a pick-up in production, although domestic private demand remained weak. The increase in exports was becoming more noticeable.

Exports were increasing significantly recently, especially in IT-related goods. A decrease in imports was coming to a halt.

The results of surveys regarding corporate profits conducted by various private institutes suggested that corporate profits would start to increase substantially in fiscal 2002 from the previous year.

On the other hand, summer bonus payments in 2002 were forecasted to decrease considerably from the previous year, according to survey results of various private institutes.

The economic indicators relating to private consumption remained weak as a whole amid the severe income conditions. The overall sales of electrical appliances for May, however, increased from the previous year with the surge in sales of television sets due to the World Cup soccer tournament.

2. Financial environment

Only a few economic indicators relating to financial developments were released in the intermeeting period. The issuing environment for corporate bonds and CP had been improving, and the credit spreads continued to narrow. Against this background, there was a slight increase in the share of corporate bonds and CP with relatively low credit ratings in the total amount issued, specifically corporate bonds with single A ratings and CP with A-2/P-2 or lower credit ratings.

Banknotes in circulation and the monetary base continued to mark high growth in June.

The number of corporate bankruptcies remained at high levels. A breakdown showed that the bankruptcies in accordance with the procedure laid down in law had accounted for more than 30 percent of the total number of bankruptcies for five consecutive months. This reflected the following factors. First, an increasing number of firms were deciding to discontinue business. Second, financial institutions were pressing forward with removal of nonperforming loans (NPLs) from the balance sheet. Third, an increasing number of creditors preferred transparent bankruptcy proceedings. And fourth, a new law regarding corporate bankruptcies, the Civil Rehabilitation Law, had been established.

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

A. Current Economic Situation and the Outlook

Many members expressed the following view on the current state of Japan's economy. First, economic indicators released in the intermeeting period were in line with the economic assessment made at the previous meeting on June 11 and 12 and the standard scenario in the "Outlook and Risk Assessment of the Economy and Prices" (hereafter the Outlook Report) released in April 2002. The economic assessment at the previous meeting was that the economy showed signs of stabilizing with a distinct increase in exports and a pick-up in production, although domestic private demand remained weak. And second, there were slightly stronger-than-expected economic indicators, particularly in exports.

Regarding U.S. economic developments, many members pointed out that most economic indicators confirmed that the country's economy was on a recovery trend. However, developments in U.S. financial markets were not in line with the economic developments, as evident in the fall in stock prices and the depreciation of the U.S. dollar.

These members considered that, although the U.S. economy was expected to remain on a recovery trend, the following required close monitoring. First, factors behind the weak developments in U.S. financial markets, especially in the stock market, where prices fell sharply. And second, effects of the weak financial developments on the economy in the near future. Some members said that the possibility that the fall in U.S. stock prices might affect international financial markets through changes in international capital flows needed to be watched closely.

Members then discussed developments in Japan's economy.

Many members commented that corporate profits were improving, reflecting an increase in exports and a pick-up in production. On the other hand, summer bonus payments were expected to decrease considerably. Some members expressed the view that these developments were in line with the standard scenario in the Outlook Report, in which the corporate sector recovered and downward pressure on household income persisted.

With regard to developments in exports and production, many members expressed the view that the pace of the increase in exports was likely to slow as inventories overseas approached adequate levels. This was because the current increase in exports, which was greater than expected, was probably due to restocking of IT-related goods worldwide. A few of these members pointed out that another factor behind the high growth in exports was a significant increase in exports of materials from Japan to other Asian countries, reflecting the firm recovery supported by strong domestic demand and increased intra-regional trade in those economies.

One of these members mentioned that some manufacturers had already become cautious about ordering IT-related goods, given that producers of these goods were increasing their inventories sharply. A different member said, on the other hand, that the recent significant increase in exports should at least be having positive effects on current production and corporate profits in Japan.

Many members pointed out that survey results of various private institutes suggested that corporate profits were expected to increase substantially in fiscal 2002. On this basis, these members expressed the view that the mechanism described in the Outlook Report in April 2002, whereby an increase in exports would induce a recovery in production which would in turn lead to an improvement in corporate profits, was gradually starting to operate.

One member, however, said that the improvement in the corporate sector had been concentrated mainly in exporting manufacturers and was not spreading to nonmanufacturing industry, judging from the following. First, the index of tertiary industries' activity had not stopped declining. And second, the breakdown of the index revealed conspicuous weakness in industries providing services for the nonmanufacturing sector. A different member supported this view by referring to figures for aggregate electricity demand and the Report on the Current Survey of Selected Service Industries.

Regarding the household sector, many members commented that summer bonus payments were expected to decrease considerably, and that income conditions of households remained severe as firms continued with corporate restructuring.

One of these members said that it was not particularly surprising that income conditions of households remained severe, for the following reasons. First, the decrease in nominal wages was in line with the increased pace of downward adjustment in labor input that was observed recently. And second, bonus payments generally tended to be affected by past rather than present corporate profits. A different member pointed out that firms' policy of reducing personnel expenses and their forecasts of an increase in corporate profits were two sides of the same coin. Therefore, it was necessary to consider the overall effects of these two movements on private demand as a whole.

B. Financial Developments

Many members pointed out the following two developments. First, Japanese stock prices were being negatively affected by the continued decline in U.S. stock prices and had been declining since the middle of June. And second, the yen had appreciated against the U.S. dollar, reflecting the depreciation of the U.S. dollar against major currencies. A few of these members summarized the current situation by saying that downside risks, stemming from developments in financial markets, to the scenario for a recovery of the Japanese economy had increased slightly.

On this basis, these members said that the following two points required close monitoring: first, the view of market participants that lay behind these developments in financial markets; and second, their effects on the economy both in Japan and abroad and on the financial environment.

Members discussed the background to the fall in stock prices in Japan and the United States.

Many members expressed the view that the following factors led to the recent fall in stock prices in Japan and the United States. First, in the United States, market participants' uncertainty about the outlook for the U.S. economy and corporate profits persisted, in addition to skepticism about firms' accounting information and concern about the possibility of a recurrence of terrorist attacks. Second, recovery in the Japanese economy seemed to be still heavily dependent on exports, since there were structural problems.

A few members cited the following as other factors behind the fall in U.S. stock prices. First, market participants' view was that there was delay in the shift in the driving-force of demand from household spending to business fixed investment. And second, the expected growth rate of the U.S. economy in the medium term had been revised downward. One of these members commented that Japanese stock prices might not necessarily follow the downtrend in U.S. stock markets if the downward revision of the medium-term expected growth rate was causing investors to restructure their portfolios in global terms.

Many members said that the effects of the fall in Japanese stock prices on corporate and household sentiment, corporate financing, and the financial system in Japan required close monitoring. A few members said that attention should be paid to the effects of the fall in stock prices on the financial strength of banks and life insurance companies. One of these members said that it was important to make progress in securing the stability of the Japanese financial system while foreign investors generally maintained an active stance toward investment in Japanese securities.

One member pointed out that the magnitude of the fall in the Nasdaq composite index was comparable with that of the fall in Japanese stock prices when the bubble in the stock market burst. This member said that the direct effects of the fall in the Nasdaq composite index on the U.S. economy, however, would be limited compared to the impact of the fall in Japanese stock prices at that time. The member cited the following reasons. First, the U.S. economy was twice the size of Japan's economy. Second, prices of real estate were firm. Third, loss stemming from the fall in stock prices was unlikely to be concentrated in the banking sector, as it was in Japan. And fourth, the fall in the Dow Jones Industrial Average was much smaller than that in the Nasdaq composite index. This member continued that for a full-fledged recovery of the U.S. economy, it was important that business fixed investment recovered while private consumption remained firm. For this, a recovery in corporate profits was a precondition. The member added, however, that attention should be paid to the fact that market participants had a cautious view of the outlook for corporate profits implied by the fall in U.S. stock prices.

A few other members agreed that the U.S. economic system had a structure in which the effects of a fall in asset prices were unlikely to be concentrated in the banking sector. However, the fall in stock prices might have been negatively affecting the financial condition of nonfinancial firms and households through various channels, and skepticism about U.S. corporate accounting might reflect these possible negative effects.

As the background to the depreciation of the U.S. dollar, a few members cited the following, in addition to uncertainty about the outlook for the U.S. economy and corporate profits and concern about the possibility of a recurrence of terrorist attacks, which were also affecting U.S. stock prices. First, the widening of the U.S. current account deficit. Second, a decrease in foreign direct investment in the United States. And third, a decrease in foreign portfolio investment in the United States. One of these members said that careful monitoring was needed of the effect of a change of fiscal balance to a deficit on market sentiment at a time when the excessive debts of firms and households had not been reduced.

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

Based on the above assessment of economic and financial developments, members agreed on the monetary policy stance for the immediate future that it was appropriate to maintain the current target for the outstanding balance of current accounts at the Bank of around 10 to 15 trillion yen.

A few members pointed out the possibility of a decline in the function of the call market due to the Bank's provision of ample liquidity. Financial institutions' willingness to invest in the market had been reduced, and transactions between financial institutions in the market were being replaced with bilateral transactions between financial institutions and the Bank. One of these members mentioned specifically that there was a risk that market participants might not be able to obtain liquidity swiftly in the call market when they needed it. This member also pointed out the possibility that demand for liquidity might increase due to concern over availability of liquidity as the removal of blanket deposit insurance for demand deposits in April 2003 approached, since the problems related to the financial system had not yet been fully resolved.

In response to this, a few other members argued that given the current economic situation, the positive effects of maintaining the monetary stance of providing ample liquidity would outweigh the side effects such as a decrease in the willingness of financial institutions to invest in the call market. These members added that if there were a surge in demand for liquidity, it would be reflected in interest rate developments. Therefore, it was appropriate to continue to conduct market operations with a quantitative target with due attention to developments in interest rates.

IV. Remarks by Government Representatives

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

(1) The Cabinet approved the "Basic Policies for Economic and Fiscal Policy Management and Structural Reform 2002" (hereafter the Basic Policies 2002) on June 25, 2002 to steadily advance structural reform and realize sustainable growth led by private demand. In the "Present Economic Revitalizing Policies," a recent agreement between the Government and the ruling parties, it was stated that the Basic Policies 2002 would serve as the foundation for Japan's deflation countermeasures. The Government would make efforts to examine which items in the Basic Policies 2002 could be selected for early implementation, then realize them at the earliest possible date. In the Basic Policies 2002, the Government expressed its hope that the Bank would continue to conduct effective monetary policy to overcome deflation.

(2) The Government would like the Bank to deliberate further on various policy measures and to take drastic measures to overcome deflation in line with the Government's policies. The Bank's assessment of the economy at the previous meeting was that Japan's economy showed signs of stabilizing. Monetary policy measures would be particularly effective in dispelling deflationary concern at this stage. The Government would like the Bank to continue providing ample funds to the money market as it had done so far, and 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.

The representative from the Cabinet Office made the following remarks.

(1) In the June issue of its Monthly Economic Report, the Government maintained its assessment of the economy from the previous month as follows: "While the economy continues to be in a difficult situation, it has bottomed out." As for the short-term prospects, an increase in exports and the near completion of inventory adjustment were expected to bring about a recovery of the economy. However, there were concerns over the downward pressure on final demand that might be exerted by such factors as the severe employment and wage situation. It was therefore necessary to continue to pay close attention to economic developments.

(2) The Government would press ahead with structural reform focusing on increasing private demand and employment in order to achieve self-sustained economic growth. As a part of this process, the Cabinet approved the Basic Policies 2002, which included economic revitalization strategies, tax reform, and reform of the structure of government expenditure, on June 25, 2002. The Prime Minister had presented policies concerning the economic revitalization strategies on June 17, 2002, and the policies had been approved by the leaders of the three ruling parties. The Government would make efforts to implement the Basic Policies 2002 as soon as possible.

(3) The Government considered it important that the Government and the Bank cooperate continuously and implement powerful and comprehensive measures in order to overcome deflation. The Government would swiftly compile a report with a view to restructuring the financial sector in the medium-term so as to establish a vigorous financial system, in addition to promoting further disposal of NPLs. 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 1).

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. Approval of the Minutes of the Monetary Policy Meeting

The Policy Board approved unanimously the minutes of the Monetary Policy Meeting of May 20 and 21, 2002 for release on July 1, 2002.

VII. Approval of the Scheduled Dates of the Monetary Policy Meetings in July-December 2002

At the end of the meeting, members approved the dates of Monetary Policy Meetings to be held in the period July-December 2002, for immediate release (see Attachment 2).

Attachment 1

For immediate release

June 26, 2002
Bank of Japan

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