Minutes of the Monetary Policy Meeting

on December 16 and 17, 2002
(English translation prepared by the Bank's staff based on the Japanese original)

January 27, 2003
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 Monday, December 16, 2002, from 2:00 p.m. to 3:32 p.m., and on Tuesday, December 17, from 9:01 a.m. to 1:14 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 Finance²
Mr. H. Fujii, Deputy Vice Minister for Policy Planning and Coordination, Ministry of Finance³
Mr. H. Takenaka, Minister of State for Economic and Fiscal Policy, Cabinet Office⁴
Mr. Y. Kobayashi, Vice Minister for Economic and Fiscal Policy, Cabinet Office⁵

Reporting Staff
Mr. S. Nagata, Executive Director
Mr. M. Shirakawa, Executive Director
Mr. H. Yamaguchi, Adviser to the Governor, Policy Planning Office
Mr. T. Wada, 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. A. Horii, 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. N. Yoshioka, Chief Manager, Planning Division II, Policy Planning Office⁶
Mr. M. Ohsawa, Chief Manager, Money and Capital Markets Division, Financial Markets Department⁶
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

1. The minutes of this meeting were approved by the Policy Board at the Monetary Policy Meeting held on January 21 and 22, 2003 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 December 17.
3. Mr. Fujii was present on December 16.
4. Mr. Takenaka was present on December 17 from 10:58 a.m. to 12:42 p.m.
5. Mr. Kobayashi was present on December 16 for the whole of the session, and on December 17 from 9:01 a.m. to 10:57 a.m.
6. Messrs. Yoshioka and Ohsawa were present on December 17 from 9:01 a.m. to 9:31 a.m.

I. Summary of Staff Reports on Economic and Financial Developments⁷

A. Money Market Operations in the Intermeeting Period

The Bank conducted market operations aiming at the highest possible amount within the target range in accordance with the guideline decided at the previous meeting on November 18 and 19, 2002.⁸ In the intermeeting period, the Bank gradually increased the outstanding balance of current accounts at the Bank to around 20 trillion yen by the end of the final week of November, and then maintained it at around that level.

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

1. 7Reports were made based on information available at the time of the meeting.
2. 8The guideline was as follows:
   The Bank of Japan will conduct money market operations, aiming at the outstanding balance of current accounts held at the Bank at around 15 to 20 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 above target.

B. Recent Developments in Financial Markets

In the money market, developments in the uncollateralized overnight call rate suggested that participants were feeling very strongly that there was excess liquidity, reflecting ampler liquidity provision by the Bank. Developments in the outstanding balance of current accounts held at the Bank showed a conspicuous increase for city banks, long-term credit banks, foreign banks, and tanshi companies (money market broker-cum-dealers). Interest rates on term instruments continued to show nervous developments given weak bank stock prices. They temporarily rose somewhat reflecting a rise in bid rates on the Bank's bill purchasing operations. However, both interest rates on term instruments and bid rates on the Bank's market operations generally declined moderately from the beginning of December. This was because the funding situation of some city banks eased further, due partly to their selling of treasury bills and financing bills, and lenders in the market such as regional banks and investment trusts started to invest in relatively long-term instruments in the money market. The prevailing view in the market was that there would not be any significant disruption in the money market at the turn of the calendar year.

In the stock market, the Nikkei 225 Stock Average temporarily recovered to the 9,200-9,300 yen level, but had fallen again thereafter and was currently moving at around 8,500 yen.

In the bond market, yields on ten-year Japanese government bonds (JGBs) in the secondary market moved at around 1.0 percent and those on five-year JGBs at around 0.3 percent. Banks' and institutional investors' demand for JGBs remained strong. The yield differentials between corporate bonds and JGBs remained generally unchanged. However, market participants seemed cautious about the credit risk of some Japanese banks, as seen in the fact that yield differentials between bank bonds and JGBs and the risk premium of Japanese banks in the credit default swap market varied from bank to bank.

The yen had depreciated temporarily to the 125.5-126.0 yen level against the U.S. dollar, due to increasing speculation about the Japanese authority's stance on the foreign exchange rate, in addition to a recovery in some U.S. economic indicators. However, the yen was currently appreciating against the U.S. dollar at the 120-122 yen level, reflecting speculation arising from the resignation of the Secretary of the Treasury in the United States and geopolitical developments. The euro appreciated against the U.S. dollar to the highest level in almost three years.

C. Overseas Economic and Financial Developments

Regarding the U.S. economy, indicators related to private consumption and business fixed investment, two components of final demand, such as retail sales, automobile sales, and new orders for nondefense capital goods, improved slightly. However, the pace of the cyclical improvement of the economy was slowing, as the recovery in production was sluggish and there was a conspicuous decrease in private nonfarm payroll employment and a pronounced rise in the unemployment rate. Nevertheless, it seemed that the slowdown in the pace of improvement of the economy was unlikely to give immediate cause for concern about a decrease in production to adjust the level of inventories, given their current low level.

In U.S. financial markets, amid economic indicators showing mixed signs, both long-term interest rates and stock prices rose steadily in late November, but from the beginning of December, long-term interest rates had fallen again and stock prices had been weak. Developments in U.S. federal funds rate futures suggested that the majority of market participants expected that the target for the federal funds rate would be kept unchanged for the time being. In relation to corporate financing, the risk-averse stance of investors seemed to have eased somewhat, as was evident in a slight increase in issuance of corporate bonds from the previous month and a narrowing trend of the yield differentials between corporate bonds and U.S. Treasuries.

In the euro area, the possibility that the economy might decelerate again was increasing, as domestic demand was sluggish and there were also signs of a slowdown in exports. In European financial markets, long-term interest rates remained virtually level. Stock prices had risen temporarily through the end of November, but had fallen from the beginning of December due partly to the weakness in U.S. stock prices. Judging from developments in EURIBOR futures, expectations persisted that the European Central Bank (ECB) would reduce its key interest rates further, despite the fact that they had been cut on December 5, 2002.

NIEs and ASEAN economies remained on a recovery trend, as domestic demand, particularly private consumption and business fixed investment, remained firm, although there were signs of a marginal slowdown in the pace of the increase in exports. In China, domestic and external demand remained strong, and in South Korea, the growth in domestic demand remained relatively high. In economies such as Taiwan and Singapore, however, production seemed to be peaking out, reflecting a slowdown in the pace of the increase in exports.

In financial markets in emerging economies, yield differentials between sovereign bonds issued in these economies and U.S. Treasuries were narrowing. This was because the inflow of funds to these economies continued, given that overseas investors had somewhat eased their risk-averse stance owing to the rise in stock prices through the end of November in Europe and the United States.

Private institutes' forecasts for overseas economies in 2003 were as follows. For the United States, the forecast for the annual economic growth rate for 2003 had been revised downward from three months earlier, but economic growth for the second half of 2003 was expected to recover to the 3.5-4.0 percent level. On the other hand, the forecasts for economies in the euro area were revised downward considerably. As for East Asian economies, the forecasts were revised slightly downward, but steady growth was expected on the whole.

D. Economic and Financial Developments in Japan

1. Economic developments

Exports had recently been virtually level. By type of goods, exports of capital goods and parts, particularly to East Asia, were increasing. However, the growth in IT-related exports had declined to close to zero percent, and exports of intermediate goods and automobile-related goods, both of which had been increasing, started to decrease due partly to the effects of China's safeguard measures on steel imports and the lockout at U.S. West Coast ports. As for the outlook, the momentum for a recovery in worldwide IT-related demand was expected to be very weak, and exports as a whole were expected to be more or less unchanged. Imports were also expected to be virtually unchanged, reflecting developments in domestic demand and production.

Both the December Tankan (Short-Term Economic Survey of Enterprises in Japan) and the results of private institutes' surveys suggested that corporate profits would increase throughout fiscal 2002 as had been projected. Firms were cautious about the outlook for their business condition, although it had been improving recently.

With regard to corporate finance, which had been a focus of attention, the December Tankan showed that there was no major change in firms' perception of their financial position. Small firms' perception of the lending attitude of financial institutions remained unchanged, but that of large firms deteriorated slightly. This suggested that some industries burdened with excessive debts might have been affected by the acceleration of nonperforming-loan (NPL) disposal.

The decline in business fixed investment had almost come to a halt due partly to the increase in corporate profits. However, signs of recovery in business fixed investment were still not observed, as was evident in the weakness in fixed investment of large manufacturers, whose corporate profits had recovered relatively clearly. Small firms' fixed investment was revised upward slightly in the December Tankan, although there had been concern that small firms' financing situation might exert downward pressure on it.

Production had recently been virtually unchanged after a deceleration in the pace of increase in the July-September quarter of 2002. It was expected to remain more or less unchanged in the January-March quarter of 2003, although it might be affected by the results of holiday sales in the United States. As for inventories, adjustment had been completed, and their levels continued to be low.

Private consumption remained weak, although it was holding up relatively well considering the weakness in household income. Overall, there was no distinct change in the underlying trend of private consumption, although various sales statistics showed monthly fluctuations and mixed movements. Consumer confidence had recovered somewhat and was level at present, but careful monitoring was necessary to see whether it deteriorated again.

The unemployment rate, which marked a historical high of 5.5 percent in October, had been generally unchanged in the previous several months. The pace of increase in new job offers had been decelerating since summer 2002, and the pace of improvement in the ratio of job offers to applicants was slowing. As for wages, regular payments were expected to continue decreasing, and winter bonuses were likely to decline significantly, although not as much as summer bonuses had.

On the price front, import prices were on the rise reflecting the increase in crude oil prices and the depreciation of the yen during summer and autumn 2002. Domestic wholesale prices turned up slightly due to the increase in import prices and the improved supply-demand balance in materials industries. Domestic corporate goods prices, the new price indicator which would replace domestic wholesale prices from December 2002, were expected to be virtually level for a while reflecting the increase in the weight of IT-related goods. Consumer prices were expected to stay on a declining trend for the time being at the current gradual pace.

As for domestic supply-demand conditions, the December Tankan revealed that firms perceived the supply-demand conditions for products and services as continuing to improve due to the completion of inventory adjustment, but recently the improvement had stopped.

2. Financial environment

The total amount of funds raised by the private sector continued to follow a downtrend. The pace of decline in banks' lending slowed slightly in November. This might partly reflect firms' raising of necessary funds in advance, given the uncertainty of the prospects for the financial environment due to factors such as the possible effects of an acceleration of NPL disposal. Thus, future developments required careful monitoring.

The year-on-year growth rate of the monetary base increased slightly in November due to an increase in the outstanding balance of current accounts at the Bank following the Bank's additional monetary easing measures decided on October 30, 2002. The year-on-year growth rate of the money stock remained at around 3.0-3.5 percent. Meanwhile, the preliminary figure for the year-on-year growth rate of broadly-defined liquidity showed a fairly considerable decline, although it could be revised later.

As for developments in corporate financing, the December Tankan showed that there was no major change, particularly for small firms, in the perception of their financial position and the lending attitude of financial institutions. On the other hand, according to a survey by the Japan Finance Corporation for Small Business (JFS), the proportion of firms perceiving the lending attitude of financial institutions as "severe" had increased, and the diffusion indexes for their perception of financial institutions' lending attitude had declined to the lowest level since July 1999. The results of these two surveys differed because small firms surveyed by the JFS were mostly located in the metropolitan areas, and thus the results of its survey could reflect changes in the lending stance of major banks more strongly than the Tankan.

The Japan premium had been increasing very marginally as the year-end approached, partly because bank stock prices had fallen by around 30 percent compared with early October 2002. CP issuance rates had been stable on the whole. However, banks seemed to have become slightly cautious about underwriting CP, and credit spreads on six-month CP maturing beyond the fiscal year-end were expanding slightly.

Financial institutions' behavior and the corporate financing situation, and how both were influenced by the Government's measures to accelerate NPL disposal and to revitalize industries and firms, required close monitoring. Financial institutions' behavior and the corporate financing situation, and how both were influenced by the Government's measures to accelerate NPL disposal and to revitalize industries and firms, required close monitoring. Financial institutions' behavior and the corporate financing situation, and how both were influenced by the Government's measures to accelerate NPL disposal and to revitalize industries and firms, required close monitoring.

II. Amendments to Guidelines on Eligible Collateral and Establishment of Temporary Rules of Eligibility Standards for Asset-Backed Commercial Paper (ABCP)

A. Staff Proposal

Financial institutions had been striving to resolve the NPL problem, and they were currently being more cautious about extending loans to firms with high credit risks. Considering this situation, the Bank should take the following measures to secure smooth corporate financing. First, various collateral value ratios should be introduced and a broader range of loans on deeds should be accepted as eligible collateral. And second, as a temporary measure effective until the end of March 2005, the ABCP guaranteed by the Bank's counterparty financial institutions should be accepted as eligible collateral. With the former measure, collateral value ratios would be raised for loans on deeds with original maturity of three years and less, and loans on deeds with original maturity of more than five years and up to ten years would be accepted as eligible collateral. And with the latter measure, of the current overall ABCP program size, which was 18 trillion yen, nearly 90 percent would be accepted as eligible collateral.

In addition, the Bank should include book-entry STRIPS government securities as eligible collateral in line with the introduction of STRIPS government securities in January 2003.

B. Members' Discussion and Vote

Some members remarked that they expected that the above measures would make it easier for financial institutions to refinance ABCP and loans on deeds to firms, thereby facilitating smooth corporate financing as well as the development of the ABCP market. A few members said that since some aspects of the above measures were technical, it was vital to explain them clearly to the public.

Members voted unanimously to approve the proposal.

III. 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 was appropriate to maintain unchanged from the previous month the assessment that "Japan's economy has stabilized as a whole, but there is still substantial uncertainty toward recovery." The uncertainty about the prospects for a recovery was due mainly to developments in overseas economies and effects of the disposal of NPLs. This was confirmed in the December Tankan.

One member commented that pessimism, which had increased in the early fall, was subsiding slightly among top management due partly to the following factors. First, the improvement in corporate profits had been confirmed by data. Second, the schedule for implementing measures in the Government's "Program for Financial Revival" had been released. Third, it had been decided that a supplementary budget for fiscal 2002 would be compiled. And fourth, details of the tax-cut plan for fiscal 2003 had been announced.

With respect to the economic outlook, some members commented that the scenario of a modest recovery of the economy for fiscal 2003 presented in the "Outlook and Risk Assessment of the Economy and Prices" released in October 2002 remained valid. Some other members expressed the view that, judging from the current levels of corporate profits and inventories, downside risks were not increasing. Many members including these members, however, agreed that signs of a recovery would not become clear for the time being, as domestic demand was expected to remain weak and the recovery of the economy would continue to depend on external demand.

A few members commented that exports and production remained virtually unchanged as previously forecasted, and this trend was likely to continue for a while. One of these members pointed out that the strength of exports to Asian economies was becoming pronounced as domestic demand in Asian economies remained firm. However, another member cautioned that, given the situation of the U.S. economy, developments in exports and production in the first half of fiscal 2003 required monitoring, although the scenario of an eventual recovery in both of them remained intact.

Many members pointed to the fact that corporate profits of manufacturers in particular had increased significantly in the December Tankan. One member commented that downward pressure on wages was leading to an increase in corporate profits, while sales remained generally unchanged. Another member said that an expansion of economic activity in terms of quantity, in addition to the decline in wages, was contributing to the increase in corporate profits to some extent. A different member's assessment was that firms' efforts to improve their business management, including restructuring efforts to adapt to deflation, were achieving results.

A few members commented that the decline in business fixed investment had almost come to a halt, but its momentum for a recovery was not increasing. This was because, as the December Tankan suggested, large manufacturers, whose corporate profits were improving, were cautious about increasing business fixed investment. A few other members noted that large firms were increasing their business fixed investment overseas. In addition, a few members commented that small firms' business fixed investment was revised slightly upward in the December Tankan, as there had not been any substantial downward pressure from their financing situation, which had been cause for concern.

A few members said that households' employment and income situation continued to be generally severe, and attention should therefore be paid to future developments including how winter bonuses turned out. A few members noted that private consumption continued to be relatively firm considering the weakness in income, and whether this tendency continued would be an important factor in determining the economic outlook.

As factors posing a risk to the economic outlook, most members pointed out developments in the United States and other overseas economies, and the possible effects of an acceleration of NPL disposal on corporate financing and Japanese stock prices.

Of these risk factors, members spent much time on the discussion of developments in the U.S. economy. Many members expressed the view that pessimism about the U.S. economy had become weaker than before. This was because some economic indicators recently released, such as private consumption, the consumer confidence index, and new orders for nondefense capital goods, confirmed that the gradual recovery of the economy was continuing. However, these members added that the pace of improvement in production, employment, and income was slowing, and a recovery in final demand including business fixed investment had not been observed yet.

Some members commented on the outlook for the U.S. economy that concern that the moderate recovery trend might stall was abating. Many members including these members, however, expressed the view that the downside risks to the economy were still on balance greater than the upside, and that there were no new factors to change their cautious view of the outlook. Some of these members said that they would like to follow developments in private consumption closely, including the results of holiday sales. They also pointed out factors to bear in mind regarding private consumption, such as deterioration in the employment and income situation, effects of changes in stock prices and housing prices, and households' accumulation of debt. A few members expressed the view that attention should also be paid to economic policies of the U.S. government, including plans for tax cuts. A different member said that it was considered in the United States that risks related to geopolitical factors would persist for some time and have a profound effect worldwide, and thus there was a view that they could cause costs to increase in the medium to long term. Another member said that crude oil prices were rising recently, and their effects on the U.S. economy also required careful monitoring.

Some members commented on prices. A few members expressed the view that the fall in prices was not accelerating on the whole, although wages were recently decreasing noticeably. One of these members said that problems facing Japan's economy, including the NPL problem, were closely linked to the fall in asset prices rather than that in general prices, although the deflationary trend of general prices must be overcome. This member presented an analysis that, according to data by industry, the fall in goods and services prices was smaller in industries burdened with a more serious NPL problem.

B. Financial Developments

Many members commented on corporate finance in relation to the economy. These members pointed out that firms' perception of their financing situation, especially that of small firms, was virtually unchanged in the December Tankan, and this suggested that the acceleration of NPL disposal had not affected corporate finance. A few of these members, however, said that it was clear from the results of a survey by the JFS that financial institutions were being more selective about borrowers. They added that this could be because the survey was mainly of firms in the metropolitan areas, and thus it could reflect changes in major banks' lending stance more strongly. One member said that a situation where credit contraction came to involve all types of firms, even viable firms, must be avoided, although changes in financial institutions' lending attitude were inevitable to some extent in the process of strengthening their financial soundness. A few other members agreed with this view, saying that changes in banks' activities were expected to become more evident by the end of fiscal 2002. Further, a different member expressed concern that the market mechanism might not function properly if banks and firms increased their ties within their traditional business groupings in the process of corporate restructuring and efforts to strengthen the soundness of the financial system.

Members then discussed financial market developments. Many members commented on the money market that interest rates on term instruments and bid rates in the Bank's market operations had temporarily risen somewhat, but short-term interest rates became stable again even with the year-end approaching, due partly to ampler funds provision by the Bank. Some of these members said, however, that there was a risk that financial institutions might suddenly experience difficulty in their funding triggered by some particular event, because market liquidity seemed to be decreasing, as seen for example in the decline in the volume of transactions in term instruments. One member said that calls by financial institutions for the Bank to devise further ways of supplying funds through its operations seemed to be becoming stronger than before.

Many views were put forward regarding developments in capital markets. One member noted that, in capital markets worldwide, stock prices were becoming stable, credit spreads were contracting, and international capital transactions were increasing, mainly reflecting improvements in the world economy and corporate profits, and policy actions taken in each country. These factors suggested that investors had gradually become more willing to take risks. A few members including this member continued that Japanese stock prices were unstable even in this situation and the reason for this was unclear, but clearly they were vulnerable to various negative factors. Many members said that various factors, such as the financial system problem, geopolitical developments, unwinding of cross-shareholdings, and the effects of changes in the tax system for stocks, were exerting downward pressure on stock prices, particularly bank stocks. These members agreed that, as a result of these factors and the expansion of the Japan premium and credit spreads on private bonds issued by firms in industries with poor performance and those issued by some banks, the market remained cautious about credit risk.

One member commented on the foreign exchange rate that the U.S. dollar had been depreciating against the yen due to speculation about the replacement of U.S. government officials in charge of economic policy in addition to geopolitical issues. The member continued that a surge in the yen was not desirable, and therefore further developments in the market should be watched closely. A different member agreed with this view. In addition, one member noted that households were recently increasing their holdings of foreign currency-denominated assets, and commented that households were starting to change their portfolios.

Based on the above discussion, members concurred that monitoring was required of the behavior of financial institutions, the corporate financing situation, and developments in the financial and capital markets, and how these were influenced by the Government's measures to accelerate the disposal of NPLs and to revitalize industries and firms, especially through the end of fiscal 2002.

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

On the monetary policy stance for the immediate future, most members agreed that it was appropriate to maintain the current guideline for money market operations, given that there was no significant change in economic and financial developments and that there was stability in financial markets as a whole. Many members added that close attention should be paid to future developments in corporate financing and financial markets. One member pointed to the fact that the outstanding balance of current accounts at the Bank had reached a level of around 20 trillion yen in a very short period of time, and expressed concern that this reflected tension in the money market.

Some members said that it was appropriate for the Bank's daily market operations to be conducted aiming at the upper end of the target range of "around 15 to 20 trillion yen." Some other members said that the Bank needed to respond in a timely manner by utilizing the contingency clause of the guideline for money market operations if liquidity demand increased in the money market. One of these members added that the Bank could provide additional funds in a timely manner, judging from the amount of collateral that had been submitted by financial institutions to the Bank.

There were several issues taken up in the discussions on the future conduct of monetary policy. Some members said that the Bank would need to consider the possibility of additional monetary easing if the economy deteriorated due, for example, to significant fluctuations in financial markets. One of these members raised the following examples of policy measures that had been put forward as ways of ensuring the stability of the money market: introducing a higher target for the outstanding balance of current accounts; increasing the Bank's outright purchases of JGBs; devising further ways in which the Bank could supply funds through its operations; and enhancing the supplementary lending facility, also known as the Lombard-type standby lending facility. A different member attached importance to achieving monetary easing effects through low and stable long-term interest rates, and said that the Bank should reconsider the role of outright purchases of JGBs in the monetary policy framework and the rule that placed a ceiling of the amount outstanding of banknotes issued on the Bank's holding of JGBs. This member continued that, if this ceiling on the Bank's holding of JGBs were to be removed, an agreement would have to be reached between the Bank and the Government in order to secure fiscal discipline and the financial soundness of the Bank.

However, the member who referred to the idea of increasing the Bank's outright purchases of JGBs commented that there would be adverse effects on financial institutions' profit opportunities and risk management if the yield curve flattened rapidly. In response to this view, one member said that it was unlikely that financial institutions would reallocate their assets given that their risk-taking capacity was declining. Moreover, a further decline in yields on JGBs could not be expected to have a strong stimulative effect on the economy. Another member said that if the Bank tried to directly influence long-term interest rates, this could distort proper market function, and there was a risk that long-term interest rates would surge abruptly at a certain point in time if inflationary expectations emerged for some reason. This member added that, for stabilizing long-term interest rates by making use of the function of the market, the Bank's commitment to continue the current framework of quantitative easing was more effective. In addition, a different member said that the Bank had been increasing its outright purchases of JGBs in order to provide funds smoothly to the money market, and this had already influenced long-term interest rates to some extent.

Based on these discussions, some members expressed the view that due consideration should also be given to the situation of the JGB market when deliberating whether to increase the Bank's outright purchases of JGBs in the future. One of these members added that long-term interest rates were stable at low levels with the market mechanism functioning properly because not only fiscal discipline but also confidence in the Bank's conduct of monetary policy had been maintained. It was important to maintain such discipline and confidence.

Members discussed the relationship between revitalizing the economy and overcoming deflation. One member expressed the view that, although the disposal of NPLs and implementation of fiscal consolidation were exerting downward pressure on the economy and prices in the short term, they were vital in the long term to revitalize the economy. That was why the Government was currently implementing these measures. This member emphasized that when the economy returned to sustainable growth after going through the above process, deflation would be overcome as a result. A different member expressed a similar view that, during the period of adjustment, some degree of downward pressure on prices would have to be tolerated as a natural consequence of structural reforms. Another member pointed out that the Bank's monetary policy had been playing a crucial role in preventing deflation from accelerating, and the Bank should continue its efforts. The member continued, however, that it was important to acknowledge that these efforts alone could not solve the problems prevailing in Japan's economy, and thus it was necessary to generate further positive momentum in economic activity by means of NPL disposal and structural reforms in order to bring the economy back to a full-fledged recovery.

In relation to the above discussions, members exchanged views on inflation targeting. One member expressed the view that adopting inflation targeting would be reckless and inappropriate for the following reasons. First, it was difficult to increase expectations of inflation by merely announcing an inflation target without sufficient and credible policy tools. And second, if inflationary expectations increased at a time when there had been a loss of confidence in the central bank and Japan's economy, this would put the chances of the economy overcoming deflation and achieving sustainable growth in serious jeopardy. Many other members agreed with the above view, and said that, even if a price target were set, the Bank would not be able to achieve it alone. A few of these members remarked that prices could increase if the Government drastically expanded fiscal spending and implemented tax cuts in order to narrow the output gap, but such policies had not been and should not be adopted in the current situation.

On the other hand, another member expressed the following view. Inflation targeting could only be adopted on the basis of the Government and the Bank sharing responsibility. The Bank and the Government could agree that setting a specific inflation rate would be appropriate, if the Government made an explicit commitment to maintain continuous fiscal discipline and if the Bank's flexibility and freedom in conducting monetary policy without setting a specific time frame for achieving the inflation rate were guaranteed. This member continued that the current commitment to continue quantitative easing might have been causing market participants' expectations of deflation to strengthen because they felt that it was extremely difficult to overcome deflation with the Bank's commitment alone.

Against this view, a different member cautioned that the question whether a target range of prices should be set needed to be considered very carefully. This was because price developments could become unstable if a price target were set within a narrow range and any means were employed regardless in order to achieve the target in the current situation. Another member agreed with this view.

Based on these discussions, one member expressed the view that it was important to show a clear recovery path for Japan's economy so that it could eventually return to sustainable growth, and if people's expectations of economic growth heightened due to this, there would be positive effects on the spending of households and firms as well as asset prices. This member further emphasized that it was thus most important to increase expectations of economic growth and not those of inflation.

V. Remarks by Government Representatives

The representative from the Cabinet Office made the following remarks.

(1) The Government's assessment of the economy for November was as follows: "Movements towards an incipient recovery continue to be seen in the economy, though its pace has become more gradual." The Government considered it necessary to present a more cautious view for its December assessment.

(2) In fiscal 2003, the public sector would exert downward pressure of around 1 percent of GDP on the private sector, due to increases in various forms of burdens on the public and the fact that the effects of the second supplementary budget for fiscal 2001, which made themselves felt in fiscal 2002, had played themselves out. However, the Government expected that the supplementary budget for fiscal 2002 and the advanced implementation of tax cuts in the fiscal 2003 tax revision would offset this downward pressure. On the other hand, it was important to pave the way for budget consolidation. The Government therefore intended to firmly maintain the goal of ensuring a surplus in the primary balance early in the 2010s. Tax reform measures, the content of which was expected to bear fruit, had been compiled, and the Government would continue to make efforts to promote such reforms, as it regarded fiscal 2003 as the first year of fundamental tax system reforms.

(3) It was very difficult to stop the vicious circle of deflation and the NPL problem, as there was a strong correlation between the nominal economic growth rate and the emergence of new NPLs. In this situation, much would inevitably be expected of monetary policy in dealing with deflation. The Government would like the Bank to discuss how deflation could be overcome.

(4) The Government and the Bank should work together to overcome deflation, and strive to make the inflation rate positive as soon as possible. The Government would like the Bank to implement further effective monetary policy measures.

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

(1) The Government and the Bank should continue to implement powerful and comprehensive measures to overcome deflation, since it was the most important task for Japan's economic policy. To complement and reinforce the "Comprehensive Measures to Accelerate Reforms" released on October 30, 2002, the Government had drawn up the "Program to Accelerate Reforms" on December 12, 2002 and would also compile the supplementary budget for fiscal 2002.

(2) The Bank was currently providing ample liquidity to financial institutions, but deflationary concern remained and could intensify in the process of an acceleration of NPL disposal. The Government would like the Bank to consider a variety of options in devising effective monetary easing measures that would improve both the quality and quantity of liquidity provision and to implement them, in order to show a firm resolution to dispel deflationary concern.

(3) The Government would like the Bank to provide more liquidity in the approach to the year-end in order to accommodate a possible surge in liquidity demand since it was likely that corporate financing conditions would become severer. The Government hoped that the Bank would start implementing the measures to secure the smooth functioning of corporate financing, which were discussed earlier in meeting, as soon as possible.

(4) As stated in the previous meeting, the Government would like the Bank to deliberate on not sterilizing foreign exchange intervention. Unsterilized foreign exchange intervention would result in an increase in the outstanding balance of current accounts held at the Bank, and thus the Government would like the Bank to incorporate such an increase in the contingency clause in the guideline for money market operations.

(5) The representative stated his personal view that the Bank's outright purchases of JGBs should be increased to 2 trillion yen per month to rebalance financial institutions' portfolios. The representative continued that, for example, the Bank could consider removing, until the end of fiscal 2003, the ceiling of the outstanding amount of banknotes issued on its holding of JGBs.

(6) The Government would like the Bank to consider a variety of policy options designed to simultaneously implement effective monetary easing measures and secure the smooth functioning of corporate financing for small firms. For example, the Government would like the Bank to consider underwriting Fiscal Investment and Loan Program (FILP) Agency bonds issued by government financial institutions. In this way, the Bank could supply the economy with funds through government financial institutions.

Policy Board members commented on the above remarks regarding the treatment of funds supplied through foreign exchange intervention. One member was of the opinion that there was no reason to treat funds movement accompanying foreign exchange intervention in the same way as the usual payment and receipt of treasury funds, because in an intervention the Government conducted foreign exchange transactions with a particular policy aim. The member added that, within the contingency clause of the guideline for money market operations, the Bank could in effect not sterilize the funds supplied through foreign exchange intervention, assuming that providing funds through unsterilized intervention would lead to depreciation of the yen. In response to this, one member said that not sterilizing foreign exchange intervention was inconsistent with the objective of the contingency clause because it had been devised as a temporary measure to deal with a surge in liquidity demand. This member continued that, given that the Bank was supplying and absorbing funds in daily money market operations by making use of various types of funds, including funds provided through foreign exchange intervention, making a distinction between sterilized and unsterilized intervention was in practice pointless. A different member expressed the view that the Bank had judged that the current level of the target for the outstanding balance of current accounts at the Bank was appropriate taking into account the effects of the yen's fluctuations on economic and financial developments, and therefore, even after yen-selling intervention, it was not necessary to immediately raise the target for the outstanding balance of current accounts at the Bank by the amount of the intervention. Another member agreed with this view, pointing out that there was no clear causal relationship between changes in the outstanding balance of current accounts at the Bank and the fluctuations in the foreign exchange market.

VI. 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 current accounts held at the Bank at around 15 to 20 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 above target.

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 above target.

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.

VII. Discussion on the Public Statement

In line with the Bank's decision to amend the Guidelines on Eligible Collateral and to establish temporary rules concerning eligibility standards for ABCP, the staff prepared a draft public statement regarding measures to facilitate smooth corporate financing. Members discussed the draft and it was put to the vote. By unanimous vote, the Board approved "Measures to Facilitate Smooth Corporate Financing" and decided to release it on December 17 (see Attachment 2).

VIII. 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 December 18, 2002 in the Monthly Report of Recent Economic and Financial Developments (consisting of "The Bank's View" and "The Background").⁹

1. 9The original full text, in Japanese, of the Monthly Report of Recent Economic and Financial Developments was published on December 18, 2002 together with the English version of "The Bank's View." The English version of "The Background" was published on December 19, 2002.

IX. Approval of the Minutes of the Monetary Policy Meetings

The Policy Board approved unanimously the minutes of the Monetary Policy Meetings of October 30, 2002, and November 18 and 19 for release on December 20, 2002.

X. Approval of the Scheduled Dates of the Monetary Policy Meetings in January-June 2003

At the end of the meeting, members approved the dates of Monetary Policy Meetings to be held in the period January-June 2003, for immediate release (see Attachment 3).

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Attachment 1

For immediate release

December 17, 2002
Bank of Japan

Measures to Facilitate Smooth Corporate Financing

1. At the Monetary Policy Meeting (MPM) held today, the Bank of Japan decided to take the following measures to secure smooth corporate financing. These are the outcome of the deliberations to follow up the discussion at the MPM on October 30.
   1. a) Acceptance of a broader range of loans on deeds as eligible collateral
      Loans on deeds with original maturity of more than five years and up to ten years will be accepted as eligible collateral. In addition, collateral value ratios will be raised for loans on deeds with original maturity of three years and less.
   2. b) Relaxation of standards for ABCP as eligible collateral
      As an exceptional and temporary measure effective until the end of March 2005, the asset-backed commercial paper (ABCP) guaranteed by the Bank's counterparty financial institutions will be accepted as eligible collateral and be eligible for Bank's market operations to purchase commercial paper under the repurchase agreement.
2. By providing markets with ample funds, the Bank removes concern about liquidity financing, thereby contributing to the promotion of a favorable environment for financial institutions to extend loans. In addition, the Bank is playing its part in securing smooth corporate financing by accepting corporate debts as eligible collateral and conducting market operations to purchase commercial paper under the repurchase agreement.
3. The Bank expects that today's decision will make it easier for financial institutions to refinance ABCP and loans on deeds to business firms, thereby facilitating smooth corporate financing as well as the development of the ABCP market. The Bank also expects that various institutional frameworks will be reviewed to promote the development of markets for securitized products, such as ABCP and asset-backed securities.
4. The Bank will continue to closely monitor developments in corporate financing including the impact of acceleration in the disposal of the non-performing loans.

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Attachment 2

For immediate release

December 17, 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:

The Bank of Japan will conduct money market operations, aiming at the outstanding balance of current accounts held at the Bank at around 15 to 20 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 above target.

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Attachment 3

For immediate release

December 17, 2002
Bank of Japan

Scheduled Dates of Monetary Policy Meetings in January-June 2003

1. Outlook and Risk Assessment of the Economy and Prices (April 2003) will be published on Wednesday, April 30, 2003.