Minutes of the Monetary Policy Meeting

on January 21 and 22, 2003
(English translation prepared by the Bank's staff based on the Japanese original)

February 19, 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 Tuesday, January 21, 2003, from 2:00 p.m. to 3:46 p.m., and on Wednesday, January 22, from 8:59 a.m. to 12:25 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. Tsuda, Deputy Vice Minister for Policy Planning and Coordination, Ministry of Finance³
Mr. Y. Kobayashi, Vice Minister for Economic and Fiscal Policy, Cabinet Office

Reporting Staff
Mr. E. Hirano, Executive Director
Mr. M. Shirakawa, Executive Director
Mr. A. Yamamoto, Executive Director
Mr. H. Yamaguchi, 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. 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. H. Onobuchi, Manager, Secretariat of the Policy Board
Mr. K. Etoh, 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 February 13 and 14, 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.
Mr. Taniguchi was present on January 22.
Mr. Tsuda was present on January 21.

I. Summary of Staff Reports on Economic and Financial Developments⁴

A. Money Market Operations in the Intermeeting Period

The Bank conducted market operations in accordance with the guideline decided at the previous meeting on December 16 and 17, 2002.⁵ It aimed at the highest possible amount, around 20 trillion yen, within the target range of the outstanding balance of current accounts at the Bank. As a result, the weighted average of the uncollateralized overnight call rate remained at 0.001-0.002 percent. In the money market, participants were feeling very strongly that there was excess liquidity, and undersubscription had occurred in the Bank's CP purchasing operations under repurchase agreements whose term would end before March 31, 2003, the fiscal year-end.

The Bank was providing ample funds by using instruments that would mature beyond the fiscal year-end at an unprecedented pace. As of January 15, 2003, the outstanding balance of such funds provided by the Bank through operations, including outright purchases of treasury bills (TBs) and financing bills (FBs), was around 25 trillion yen, higher than that at the same date in the previous year, which was around 16 trillion yen. The outstanding balance of eligible collateral accepted by the Bank reached around 70 trillion yen as of the end of December 2002, representing an increase of around 3 trillion yen from the end of November. This was partly due to the decision at the previous meeting that the Bank would accept a broader range of loans on deeds as eligible collateral.

4Reports were made based on information available at the time of the meeting.
5The 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, interest rates on term instruments, including those maturing beyond the fiscal year-end, were generally at low levels. There had been so far no movement suggesting precautionary action by banks to raise funds by using instruments that would mature beyond the fiscal year-end. This was because the Bank was providing ample funds and the need for major banks to raise funds through the money market was decreasing substantially due to the decline in banks' lending and to the large inflow of funds into liquid deposits in the previous year.

In the bond market, yields on ten-year Japanese government bonds (JGBs) had fallen to as low as 0.80-0.85 percent. This was due to growing uncertainty about the economic outlook and market participants' perception that there was excess liquidity, as well as to institutional investors' and banks' strong demand for JGBs reflecting the recent appreciation of the yen against the U.S. dollar. There had also been a conspicuous decline in yields on longer-than-ten-year JGBs recently, as seen in a fall in those on 20-year JGBs to 1.28 percent.

In the stock market, the Nikkei 225 Stock Average remained sluggish, moving at around 8,500 yen, due to the uncertainty about the economic outlook.

The yen had appreciated against the U.S. dollar to the 117-118 yen level. This reflected developments in the U.S. dollar, which had tended to depreciate against major currencies since December due to increasing concerns about geopolitical risks, particularly the situation in the Middle East. The yen was, on the other hand, depreciating against the euro, reflecting markets' anxiety about the situation regarding North Korea.

C. Overseas Economic and Financial Developments

Regarding the U.S. economy, the firmness in housing investment and spending on durable goods, both of which were sensitive to interest rates, was supporting the modest recovery trend. On the other hand, the momentum for a cyclical improvement in production and employment continued to weaken.

With respect to developments in final demand, private consumption remained on a moderate upward trend, supported mainly by the growth in automobile sales. Holiday sales made a good start, and leveled off afterward. Overall, they marked a slight increase reflecting aggressive discounting by retailers. The decline in business fixed investment had almost come to a halt, but this did not constitute a recovery yet.

President George W. Bush announced a new economic stimulus plan on January 7, 2003, focused on measures to stimulate private consumption and investment.

In U.S. financial markets, a cautious view regarding the prospects for economic recovery remained prevalent, and concerns about geopolitical risks persisted. In this situation, both long-term interest rates and stock prices declined toward the end of December. They both rose temporarily in early January, but weakened again thereafter.

In the euro area, the possibility that the economy might decelerate again was increasing, as domestic demand was sluggish and exports were slowing. In European financial markets, stock prices followed a downward trend, and long-term interest rates were also declining. The recent developments in EURIBOR futures implied that market participants' expectations were growing that the European Central Bank (ECB) would cut interest rates further by the middle of 2003.

In Asian economies, there was no significant change from the previous month. In China, domestic and external demand remained strong. The South Korean and ASEAN economies were firm, particularly in domestic demand. However, in Taiwan, Hong Kong, and Singapore, which were largely dependent on exports, production was leveling off.

Financial markets in emerging economies were generally stable, supported by the inflow of funds from industrialized countries. In Venezuela, however, the bolivar depreciated sharply and yield differentials between sovereign bonds and U.S. Treasuries were expanding significantly, amid a prolonged general strike. In Turkey, the heightening of geopolitical risks had led to a simultaneous depreciation of the currency and fall in prices of stocks and bonds.

D. Economic and Financial Developments in Japan

1. Economic developments

With regard to developments in external demand, exports, especially to the United States, increased significantly in November. This seemed, however, to be due to temporary factors such as the resolution of the lockout at U.S. West Coast ports and shipping ahead of schedule in view of the strengthening of customs examination in the United States from December. Judging from these factors and anecdotal information, the basic trend of exports was virtually level.

There was no major change in domestic demand from the previous month.

Housing investment remained sluggish and public investment was declining.

The decline in business fixed investment had almost come to a halt, reflecting the improvement in corporate profits. However, the investment stance of firms was unlikely to become positive in the near future given the substantial uncertainty about the economic outlook.

With regard to private consumption, indicators related to retail sales had generally been weak in December amid the persisting severe employment and income situation. The decline seemed to be partly a reaction after the fairly high sales in autumn 2002 relative to household income. Private consumption as a whole remained weak.

Production for the October-December quarter of 2002 was projected to decrease moderately, by 0.8 percent, from the previous quarter, assuming that the December figure was in line with the production forecast index. A decrease in production in November seemed to have been caused partly by the completion of large-scale assembly projects, such as in shipbuilding and rolling stock.

Regarding firms' production behavior in the present situation, they remained cautious about increasing production and continued to reduce inventories even when shipments were increasing moderately, since they felt strong uncertainty about the economic outlook. This cautious stance was worth mentioning, because in the past firms would usually increase production to a level higher than shipments in order to raise inventory levels when they were low.

A similar situation could also be seen in firms' attitude toward investment: they remained cautious about increasing fixed investment, despite the rise in corporate profits. This cautious behavior of firms had reduced downside risks to the economy stemming from excessive accumulation of capital and inventory stocks, but at the same time it hindered growth of the momentum for economic recovery.

With regard to prices, crude oil prices weakened temporarily in November, but were on a rising trend since December reflecting the situation in Iraq and the general strike in Venezuela. In this situation, import prices continued to rise.

Domestic commodity prices had generally been on an upward trend since 2002, reflecting firm demand in Asian economies and progress in inventory adjustments. Against this background, although domestic corporate goods prices, especially machinery prices, continued to fall, the pace of the decline had become slower. Consumer prices remained on a gradual downtrend.

2. Financial environment

Banks' lending declined by 2.3 percent on a year-on-year basis in December, as in the previous month. The pace of year-on-year decline in the total amount of funds raised by the private sector was accelerating gradually, reflecting slower growth in firms' raising of funds in capital markets.

With regard to monetary aggregates, the year-on-year growth rate of the monetary base was 19.5 percent in December. The pace of increase had slowed slightly compared with November. The slowdown reflected the continued decline in the growth rate of banknotes, which constituted most of the monetary base, and the effects of the Bank's decision to raise the target for the outstanding balance of current accounts at the Bank in December 2001.

The year-on-year growth rate of the money stock dropped to 2.0-2.5 percent in December. This was mainly because the money stock in December 2001 was boosted by a substantial inflow from investment trusts to bank deposits following the bankruptcy of Enron. The year-on-year growth rate of broadly-defined liquidity was 1.0-1.5 percent, as in November.

In corporate financing, credit demand in the private sector continued to follow a downtrend due to the following: firms continued to restructure their balance sheets by using their increased profits to pay back their debts; and they were restraining business fixed investment. Banks remained selective about borrowers: they were cautious in extending loans to firms with high credit risks and were increasing interest rate margins for such firms, while they continued to be active in extending loans to blue-chip firms.

There had been no significant change in developments in corporate financing conditions since the previous meeting. Financial institutions' behavior and the corporate financing situation, and how both were influenced by the effects of an acceleration of nonperforming-loan (NPL) disposal, required close monitoring.

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 was appropriate to maintain the previous month's assessment as follows: Japan's economy had stabilized as a whole, but there was still substantial uncertainty about the prospects for a recovery. The uncertainty was due mainly to developments in overseas economies and the effects of the resolution of the NPL problem.

Some members said that the sluggishness of the economy was becoming increasingly apparent, as the growth in exports and production was slowing. One of these members noted that the current economic situation lacked a clear direction: although domestic demand components, such as private consumption and business fixed investment, had not shown any tendency to weaken noticeably, a self-sustained recovery was unlikely in the immediate future.

With respect to the economic outlook, many members said that, assuming that overseas economies would recover gradually, the basic scenario of a modest recovery of the economy remained valid.

These members said that the uncertainty and risks concerning the scenario remained substantial, pointing out the following factors: the U.S. and European economies lacked strong momentum and there were geopolitical risks centering on Iraq; and in Japan, in addition to weak stock prices, the progress in NPL disposal could have negative effects on corporate financing in the short term.

Some members added that the following required close attention: whether the firmness in private consumption relative to the weakness in household income could hold up in the present situation where the environment for exports was becoming more severe; and whether there was a risk that the U.S. dollar would depreciate further due to geopolitical risks.

Many members agreed that all these risk factors should continue to be examined closely.

Members then discussed developments in overseas economies, particularly the U.S. economy.

Some members said that the U.S. economy seemed to remain on a modest recovery trend, centering on private consumption. They also pointed out that holiday sales in the United States marked a slight increase, although some had anticipated a substantial decline.

One member, however, said that although the forecast for U.S. economic growth had not been revised downward in general, two factors gave cause for concern. First, some indicators of production, employment, and consumer confidence were somewhat weak recently. And second, the recent increase in the federal budget deficit and the current account deficit gave cause for concern about a resurgence of the "twin deficits."

A different member expressed the view that the main factor responsible for the U.S. current account deficit until around 2001 had been high levels of private investment underpinned by a high expected rate of return. Recently, however, it seemed to be shifting back to over-consumption and a fiscal deficit. This member continued that the risk that the "twin deficits" would lead to depreciation of the U.S. dollar required monitoring.

Another member said that, in the United States, high growth in labor productivity often tended to be regarded as demonstrating the strength of the economy. However, the growth rate of household and corporate income was not as high as that of labor productivity, and this might be partly due to the bursting of the bubble in stock prices. This member added that future developments in the U.S. economy required close monitoring, given the possibility that an increase in supply capacity might not be accompanied by a sufficient increase on the demand side and the output gap might widen as a result.

One member commented on European and Asian economies that the pace of increase in exports was decelerating, and private institutes' forecasts for these economies had been revised downward.

Many members then commented on geopolitical risks.

One member pointed out that the situation in major industrialized countries displayed common features as follows: economic activity as a whole had stayed at the same level or on a modest recovery path; firms' willingness to invest, however, was not strengthening due to uncertainty about the economic outlook; and, therefore, the prospects for economic recovery remained unclear. Many members including this member said that geopolitical risks were the major factor behind this significant uncertainty.

Some members commented that it was very difficult to project the outcome of such geopolitical situations and, depending on future developments, not only Japan's economy but the world economy as a whole might be exposed to significant upside or downside risks.

A few members said that geopolitical risks were likely to exert downward pressure on the economy if they materialized, and this seemed to be the majority view in the United States. A different member remarked that hawkish comments made by high U.S. government officials about Iraq seemed to be causing U.S. firms to postpone fixed investment temporarily.

Members then exchanged views on Japan's economy, for example, on demand components and price developments.

Many members commented on exports that the substantial increase in November was due to temporary factors and their basic trend was virtually level.

As for the outlook for exports, one member said that the environment would become more severe, given the depreciation of the U.S. dollar, the risk of a slowdown in overseas economies, and geopolitical risks. This member added that exports would not accelerate again this spring as had been projected.

One member noted that firms' stance on production was extremely cautious, pointing out the following phenomena: production for October-November decreased, although shipments increased slightly; and inventory levels of those industries whose shipments were sluggish, such as electrical machinery, were declining further.

A different member said that application of IT to inventory management, for example supply chain management, made such inventory control possible. This member added that low inventory levels were a reflection of firms' cautious and flexible management of inventories, and with these levels an increase in shipments would more easily lead to a rise in production.

Another member expressed the view that the decrease in production of steel and chemicals was in line with the decline in exports to Asia, noting that this was a case where the deterioration in the environment for exports had affected production to some extent.

Many members said that business fixed investment was still in the phase of leveling off, judging from some leading indicators and other related indicators such as electric power contracted for business use, and that firms were maintaining a cautious stance on fixed investment.

A different member expressed the view that firms' cautious stance on fixed investment was not solely due to their pessimistic view of the economic outlook but also to the following factors. First, restructuring of firms and streamlining of excess capacity in industries such as smelting, nonferrous metals, and pulp and paper were underpinning domestic commodity prices by improving the supply-demand balance. And second, firms had developed business strategies to establish a supply-side structure with a low break-even point to deal with the global deflationary trend, since the prevailing view among corporate managers was that the current price falls were largely a reflection of global structural adjustment pressure.

One member noted that close examination revealed that some manufacturers of digital cameras and liquid crystal displays were increasing fixed investment to expand production capacity.

As for the outlook for business fixed investment, some members expressed the view that investment was unlikely to decrease further, judging from the increase in corporate profits and capital inflows, as well as the relatively low level of capital stock, and the capacity utilization ratio was approaching a level to encourage fixed investment. However, it was difficult to project when fixed investment would start to increase, given the significant uncertainty about the economic outlook.

Many members said that private consumption was holding up fairly well relative to the weakness in household income, despite the fact that the employment and income situation remained severe.

These members added that one of the risks to the economy was whether this situation in private consumption could continue when the income situation was unlikely to improve for the time being. One of these members said that careful monitoring was required of a risk that consumer sentiment might become cautious, given the severity of the employment situation and a projected increase in the burden on households of essential expenditure in fiscal 2003 resulting from changes in the social security system.

As for prices, one member said that the pace of decline in the consumer price index (CPI) was expected to slow slightly for the following reasons. First, the CPI had been relatively stable at around zero percent, despite the widening output gap. And second, an increase in crude oil prices, reform of the system of medical care provision, and a rise in indirect taxes were expected to exert upward pressure on prices.

B. Financial Developments

Many members commented on money market developments that ample liquidity provision by the Bank had been restraining market concern over liquidity, despite the approach of the fiscal year-end.

Some members commented on long-term interest rates, which were declining conspicuously recently.

One member raised the following as the background to the decline: the unclear outlook for the world economy; increased awareness of the global downward pressure on prices; and the possibility that the Bank's commitment to continue the current monetary easing was reducing the risk premium arising from price fluctuations of JGBs.

This member continued that the 0.5-0.7 percentage point decline in long-term interest rates in the past twelve months might have stimulated the economy considerably if household spending in Japan were as sensitive to interest rates as in the United States. However, since it was not, the impact of the decline seemed to have been limited.

Regarding the stock market, one member commented that major banks' measures to improve their capital had been viewed favorably by the market, and this contributed to the recent recovery in bank stock prices.

A different member noted that developments in bank stock prices continued to require careful monitoring, given the scheduled special inspections by the Financial Services Agency. This member added that the effects of the following on stock prices also required monitoring: the improvement in corporate profits; valuation indexes suggesting that stocks were undervalued; the revision of the taxation on securities transactions; and the market's assessment of the supplementary budget for fiscal 2002 as well as the initial budget for fiscal 2003.

As for corporate finance, one member said that against the background of the improved liquidity position of banks, the risk that deterioration in corporate finance would exert downward pressure on the economy toward the end of fiscal 2002 due to developments in financial markets and in the financial system had been decreasing somewhat recently.

A different member expressed the view that the Bank was communicating appropriately with money market participants, since its preemptive monetary measures combined with earlier-than-usual liquidity provision had been restraining liquidity concerns in the market and contributing to market stability. This member added that major banks' measures to improve their capital, in addition to a rebound in bank stock prices, were contributing to removal of market anxiety. A few other members said that recent measures for the disposal of NPLs seemed to be intended to avoid a hard landing, and this was reducing the risk of a credit crunch in the short term.

Some members noted, however, that liquidity demand was likely to remain liable to fluctuation, as the financial system was still encumbered with problems, and there remained a risk that financial institutions' efforts to deal with the NPL problem might cause a further tightening of corporate financing conditions in the short term. A few members said that attention should be paid to how corporate finance would be affected by the following factors: banks' efforts to increase their capital and reduce assets; restructuring of firms; and developments in stock prices.

A few members said that one key to revitalization of the financial system was what business models major banks would establish to improve profitability while increasing their capital.

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

On the monetary policy stance for the immediate future, 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 since the previous meeting, and that there was stability in financial markets as a whole.

Some members added that, if liquidity demand surged, the Bank should take necessary action to secure market stability in accordance with the contingency clause of the guideline for money market operations.

Members discussed issues related to the future conduct of monetary policy.

First, members exchanged views on possible policy options.

One member noted that against the background of increasing attention paid to a worldwide deflationary trend, major overseas central banks' officials had made comments recently regarding easing measures that could be taken after short-term interest rates had been lowered to zero percent. This member continued that, excluding those that came under fiscal and foreign exchange policy, which were under the jurisdiction of the Government, the Bank had already implemented most of the policy options suggested. For example, the Bank had lowered interest rates with relatively long maturity by announcing that it would continue the current unprecedented monetary easing framework. The Bank had also substantially increased its outright purchases of JGBs. Moreover, the Bank had accepted a broader range of private debt as eligible collateral, and had provided loans directly to banks at very low interest rates. This member said that it was not easy to find further measures that could both be effective and be taken by the Bank alone.

A different member said that most of the possible measures for further easing when short-term interest rates had reached the zero lower bound would inevitably be accompanied by the following problems. First, the effects of such measures would be highly uncertain. And second, the substance of such measures would virtually fall into the category of fiscal policy, and accordingly the side effects and risks would likely be substantial.

The member also made comments regarding calls for the Bank to purchase exchange traded funds (ETFs). This member said that the aim of these calls was unclear and it would be reckless for the Bank to take such action, for the following reasons. First, if such purchases were intended as a measure to provide funds, they were unnecessary, since there were already sufficient measures for this purpose. And second, if the aim of ETF purchases was to influence stock prices, it would be a "price-keeping operation," intervention by an authority in the stock market.

One member said that it might be necessary to examine the current "ceiling" of the amount outstanding of banknotes issued on the Bank's holding of JGBs, to prepare for the possibility that the Bank would need to increase its outright purchases of JGBs in the future.

In relation to the above, a different member made the following remarks. First, since possible losses incurred by such purchases might impair a central bank's balance sheet and could eventually impose a burden on the public, the Bank should make careful projections of the state of its balance sheet in the next five or ten years, particularly the effects of its holding of JGBs and of the risk posed by their price fluctuations. Second, it was important to secure smooth functioning of the market mechanism, by maintaining discipline in both monetary and fiscal policy for the medium to long term. And third, as part of prudential policy, the Bank should carefully monitor financial institutions' management of risk, including the risk posed by JGB price fluctuations.

Members also discussed issues regarding inflation targeting.

One member pointed out that inflation targeting had never been adopted for the purpose of overcoming deflation by any central bank overseas, including those in New Zealand and Sweden. Another member pointed out that central banks in industrialized countries adopting inflation targeting had not set any specific time limit but aimed at a target range in the medium to long term, and the range was usually set between 0-3 percent on an average basis.

Based on this, one member said that setting an inflation target with a specific time limit when no conventional monetary easing measures were available differed significantly from the type of inflation targeting currently employed by other central banks. Based on this, another member said that it was somewhat misleading to describe the current debate as one about whether inflation targeting should be adopted or not.

Some members noted that the Bank's commitment to continue the current monetary easing framework until the inflation rate became stably zero or more had virtually already factored in most of the effects that inflation targeting purported to achieve. This was because the commitment using the actual figure of the CPI, not a forecast figure, reflected in fact the Bank's intention to achieve a small positive inflation rate, taking into account the time-lag.

Many members stressed that, in considering whether inflation targeting would have a positive impact on the economy or not, it was crucial to examine what effective measures could be taken to realize the target, especially in the current situation. First, there was a large output gap and a financial system problem. Second, short-term interest rates were at the zero lower bound. Third, fiscal consolidation and structural reform were in progress. And fourth, global downward pressure on prices of goods was substantial.

Some members remarked that, to make the inflation rate positive within a relatively short period, substantially expanding fiscal spending or conducting an active foreign exchange rate policy would have to be considered as policy options. These members said that, if an inflation target were set by the Bank alone, it would not be credible, since fiscal and foreign exchange policy was under the control not of the Bank but the Ministry of Finance. These members continued that, if Japan were to prioritize realizing a positive inflation rate with a certain time limit, it would be essential for the Government to give a concrete outline of how it would conduct fiscal and foreign exchange policy to achieve it.

One member raised, as a thought experiment, the question how the Bank should approach the issue of adopting inflation targeting, if the Government were to concede total control over both fiscal and foreign exchange policy to the Bank and if the Government were to cover all losses arising from the Bank's purchases of risk assets. This member said that this exercise would be useful in considering how the Bank should respond to calls to adopt inflation targeting, particularly from academics overseas.

A few members including this member remarked that the view that inflationary expectations would be shifted upward merely by a central bank's announcement of inflation targeting was becoming a minority opinion overseas. Moreover, the view that the remaining measures that could be employed by the Bank alone were ones whose effects were uncertain seemed to have become the majority view overseas. These members pointed out that the risks and side effects of individual policy tools had not been sufficiently understood, and this lack of understanding was behind the persisting view that the Bank should try adopting any policy tool, if the possible side effects could be considered small, even though its effectiveness might be uncertain.

In relation to this, one member said that there was an extreme view that the Bank should purchase not only JGBs and foreign bonds but also risk assets that were securitized such as stocks and real estate without limit until prices rose. However, if the Bank actually implemented such a policy, it would be likely to cause many side effects, such as a loss of fiscal discipline, a deterioration of the central bank's assets, and a rise in long-term interest rates, and would therefore negatively impact the economy before the inflation rate rose.

On this basis, a few members said that it was vital to explain the risks and the possible side effects of individual policy tools as concretely as possible, in order to gain greater public understanding of the Bank's conduct of monetary policy.

Members next exchanged views on the effects of inflation targeting on the formation of people's expectations.

One member said that, if both the Government and the Bank committed to share the same policy target, it could have some positive psychological effects on the public.

Some members remarked that there was a risk that adoption of inflation targeting could destabilize the economy in the present situation, where the traditional monetary policy tools had all been employed already and both structural adjustments and fiscal consolidation were in progress.

One member noted that inflation targeting was basically aimed at stabilizing people's expectations. However, the mechanism of an upward shift in inflationary expectations currently envisioned by advocates of inflation targeting was highly likely to destabilize people's expectations, and this could in turn destabilize long-term interest rates and the economy. This was because, as most people still expected that it would take time to overcome deflation, some would start to anticipate that to achieve the target the authorities would employ extreme means that could damage the public's confidence in them.

A different member noted the following. First, the current low level of long-term interest rates was partly attributable to the decline in the risk premium on such rates due to the Bank's commitment in terms of policy duration to maintain the monetary easing. Second, the bond market seemed to be somewhat overheated recently, as market participants were not factoring more than 1 percentage point of inflation risk into yields on bonds with 20 years' maturity. And third, long-term interest rates had recently surged in reaction to various events. The member expressed the view that given the current market situation, the risk that long-term interest rates would increase considerably once people's expectations shifted upward should be borne in mind, although there was a view that the rise in long-term interest rates would be relatively small compared to the possible rise in inflationary expectations.

Members then discussed the process of revitalizing the economy and overcoming deflation.

One member emphasized that the measures to overcome deflation were not ones designed to create inflation, but ones that would realize sound economic growth.

This member said that the yen should have depreciated if market participants had been pessimistic about the potential of Japan's economy against the background of a large difference in input prices such as labor costs and land prices between Japan and emerging countries such as China. The member also remarked that, given that prices reflected the state of the economy, the decline in prices in Japan should be taken as a sign that some kind of adjustment of the economy was necessary. In addition, market participants still seemed to have confidence in the yen and JGBs. The member continued that it was important to carefully consider what kind of adjustment process was essential in revitalizing the economy.

A different member said that overcoming deflation could only come into prospect when the economy realized sustainable growth. The member continued that the authorities should present credible policies to deal with the fundamental cause of the price falls, namely the lack of demand and the stagnation of the economy.

This member pointed out that two factors were causing the decline in economic growth in Japan, namely, the weakness in aggregate demand and the delay in overcoming structural problems of the economy. The latter was linked to the rigidity of the economic structure: production resources were not being reallocated to efficient sectors from inefficient sectors. The member expressed the view that, while fiscal spending to promote NPL disposal and to provide a safety net for the unemployed was expected to resolve the rigidity problem, conventional public investment could delay efficient allocation of resources. This member added that, nevertheless, fiscal policy could still have a great impact in revitalizing the Japanese economy, and the efficiency of fiscal spending would significantly affect the direction of the economy.

A different member said that, in conducting economic policy, emphasis should be placed on enhancing the private sector's expectations for growth, and it was important for the Government to promote deregulation and a review of fiscal spending to achieve this. Meanwhile, another member said that, if effective fiscal spending or tax reduction aimed at narrowing the output gap was implemented in an appropriate manner, one policy option would be to support such fiscal policy measures from the monetary side.

One member commented on the view outside the Bank that it was necessary to further increase the money stock to overcome deflation.

This member remarked that, when the economy was undergoing structural reform, the money stock would decline due to the following factors: progress in NPL disposal; reduction of interest-bearing liabilities by firms; firms' purchases of their own stocks; and reform of the legal framework and the tax system to encourage households to purchase stocks and JGBs. The member continued that, although the money stock would increase due to heightening of liquidity demand stemming from concern about the stability of the financial system and a shift of funds to deposits, such an increase would not stimulate economic activity.

This member further commented that the money stock would increase in line with economic activity in a situation where spending behavior of firms and households turned positive and firms became active in financing. In order to realize growth in the money stock in this way, it was necessary to implement policy measures that would increase expectations of economic growth rather than expectations of inflation.

IV. Remarks by Government Representatives

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

(1) The Government would aim to realize sustainable growth led by private demand by implementing the budget for fiscal 2003 and the supplementary budget for fiscal 2002 in an integrated and seamless manner and by further accelerating structural reform. To this end, the Government had submitted the supplementary budget for fiscal 2002 to the Diet prior to the budget for fiscal 2003.

Overcoming deflation continued to be the most important task for Japan's economic policy. Given this, the revised version of "Structural Reform and Medium-Term Economic and Fiscal Perspectives," which was discussed at the recent meeting of the Council on Economic and Fiscal Policy, stated as follows: the Government and the Bank should work together to overcome deflation and strive to make the inflation rate positive as soon as possible.

(2) The Bank was currently providing ample liquidity to financial institutions, but this had not led to economic recovery. Prices continued to fall, and financial institutions' lending continued to decrease. 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 overcome deflation.

(3) As in the previous meeting, the representative stated his personal view as follows: the Bank's outright purchases of JGBs should be increased to 2 trillion yen per month; and to this end, the current ceiling on the Bank's outright purchases of JGBs of the outstanding amount of banknotes should be removed, and the ceiling should be reviewed at the end of fiscal 2003. The representative explained that the reason for setting the time limit of the fiscal year-end was to prevent the Bank's purchases of JGBs without cap from continuing too long.

(4) The representative further stated his personal view that he would like the Bank to implement measures to facilitate smooth financing for small firms including those mentioned in the previous meeting. Moreover, there were arguments calling for the Bank to provide funds to the Institution for Industrial Revival.

The representative from the Cabinet Office made the following remarks.

(1) In its Monthly Economic Report released on January 17, 2003, the Government revised the assessment of the economy slightly downward from the previous month as follows: "While movements of an incipient recovery can be seen in some areas of the economy, the state of the economy has weakened somewhat." Regarding the outlook, the Government stated that "there are concerns that the uncertainty surrounding the future of the world economy and sluggishness of domestic stock prices may still exert a downward pressure on final demand." Therefore, economic and financial developments would require closer monitoring than in the past.

(2) The Government would aim to realize sustainable growth led by private demand by implementing the budget for fiscal 2003 and the supplementary budget for fiscal 2002, which was formulated in accordance with the "Program to Accelerate Reforms," in an integrated and seamless manner and by further accelerating structural reform. Regarding the Government's view of the economic outlook for fiscal 2003, it was expected that the Japanese economy would gradually move toward a moderate recovery centering on private demand, led by the positive policy impact of the above measures and a recovery of the world economy. As a result, the growth rate of real GDP was projected to be about 0.6 percent and the CPI was expected to fall by approximately 0.4 percent.

(3) The revised version of "Structural Reform and Medium-Term Economic and Fiscal Perspectives," a report submitted by the Council on Economic and Fiscal Policy on January 20, 2003, stated as follows. Overcoming deflation was the most important task in the intensive adjustment period from now through fiscal 2004, and comprehensive measures, including ones to deal with the financial situation, were essential, and thus the roles of the Government and the Bank were vital. The Government would like the Bank to implement further effective monetary policy measures to make the inflation rate positive as soon as possible, taking into consideration this thinking.

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 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.

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 January 23, 2003 in the Monthly Report of Recent Economic and Financial Developments (consisting of "The Bank's View" and "The Background")⁶.

6The original full text, in Japanese, of the Monthly Report of Recent Economic and Financial Developments was published on January 23, 2003 together with the English version of "The Bank's View." The English version of "The Background" was published on January 24, 2003.

VII. Approval of the Minutes of the Monetary Policy Meeting

The Policy Board approved unanimously the minutes of the Monetary Policy Meeting of December 16 and 17, 2002 for release on January 27, 2003.

Attachment

For immediate release

January 22, 2003
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: