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October 30, 2002
Bank of Japan
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Prices will probably continue to decline gradually in fiscal 2002 and 2003 as the output gap is not likely to narrow.
With respect to domestic private demand, assuming the above described export developments, production and corporate profits are likely to remain on a recovery trend, albeit with a temporary slowdown. Accordingly, uncertainty regarding prospects for demand will gradually diminish and capital spending is expected to recover in fiscal 2003. As a reduction in labor cost is expected to proceed notably in fiscal 2002, real income adjusted for price changes will stop declining by degrees and private consumption will gradually gain more resilience in fiscal 2003. Due to the persistence of excess debt and labor, however, growth momentum arising from the recovery of production and corporate profits is not likely to smoothly spread to domestic private demand. Consequently, the expected recovery in capital spending will be limited (Chart 4) and private consumption will recover only modestly. Private consumption will also be affected by a decline in disposable income resulting from the increasing burden associated with social security reform.
The growth of money stock is expected to stay at the current level and remain relatively high compared to economic growth (Chart 6). This reflects a substantial increase in demand deposits under the low interest rate environment as well as more investment in Japanese government debt by financial institutions, which are motivated to realize profits in the face of declining loan demand.
Reflecting the above factors, various price indexes are expected to continue to gradually decline. The year-on-year rate of change in both the domestic Wholesale Price Index and the Consumer Price Index (excluding fresh food) will probably continue to be negative in fiscal 2002 and 2003.
With such developments in the economy and prices, nominal income growth will probably continue to register a negative rate.
The above standard scenario expects that growth momentum arising from the recovery of production and corporate profits will gradually spread to domestic private demand assuming that the US-led gradual recovery in overseas economies will continue.
However, the two pillars of the US recovery scenario, the expected recovery of capital spending and continuous resilience of private consumption, are not immune to an asset price decline or deterioration in the confidence of the business and household sectors. If these US-related risks materialize, the associated decline in exports to the US is likely to drag down economic activity in Europe as domestic demand is already weak. East Asian economies as a whole are also likely to decelerate as a result of the decline in exports to the US although a self-sustained demand increase could somewhat mitigate the damage in some economies. Furthermore, geopolitical developments could exert downward pressures on the global economy through volatility in oil prices and financial markets.
The standard scenario expects capital spending will at last recover in fiscal 2003 following the increase in production and corporate profits. Even in this case, the recovery is likely to be modest as the recovery of cash flow will only give a limited boost to capital spending. At the same time, it should be noted that the strength of the recovery could vary as investment decisions by firms are made considering the extent of improvement in capacity utilization and corporate profits, prospects for the recovery of demand, and comparative benefits of domestic investment vis-à-vis overseas investment.
Faster progress in dealing with the NPL problem has both positive and negative effects on economic activity and its net impact depends on how and when those effects will emerge. In general, the impact of dealing with the NPL problem on the economy depends on various factors such as the scope of borrowers to be dealt with, financial institutions' lending policy including pricing, and the outcome of corporate rehabilitation plans. There is certainly a risk, however, that dealing with the NPLs will result in an increase in corporate bankruptcies and unemployment in the short run. Such a negative impact on the economy could be mitigated to some extent depending on what kind of safety nets will become available in the area of corporate finance and employment and how they will be implemented.
On the other hand, markets, both at home and abroad, may gradually start to react positively to such progress, perceiving it as a positive move to stabilize and strengthen the functions of the financial system. Once markets start to react in that way, it could have a positive impact on the economy through various channels. In particular, if the financial intermediation function is restored, it would help make the aggressive liquidity provision by the Bank of Japan already in place become more effective. If structural reform of the economy proceeds in tandem with the resolution of the NPL problem, it will induce the consolidation and revival of firms and stimulate corporate activity in promising areas through the reallocation of human resources and capital, thereby contributing to productivity growth.
The level of government debt outstanding in Japan is among the highest in industrial countries and financial institutions hold the bulk. Therefore, although long-term interest rates have been broadly stable, it should be noted that financial institutions are vulnerable to the risk of interest rate volatility.
Given considerable uncertainties regarding the global economy, careful monitoring is warranted with respect to international capital flows and their effects including those on foreign exchange rates. In this context, attention is also needed with respect to instability in emerging markets, especially in Latin America, and the impact on the economy and financial markets in developed countries.
|Real GDP||Domestic WPI||CPI (excluding fresh food)|
|Fiscal 2002||+0.2 to +0.5
(-0.5 to +0.1)
|-0.8 to -0.7
(-1.0 to -0.5)
|-0.9 to -0.7
(-1.0 to -0.8)
|Fiscal 2003||+0.4 to +1.0||-0.7 to -0.4||-0.6 to -0.4|
Note: The forecasts of Policy Board members are based on the assumption that there will be no change in monetary policy. Figures in parentheses are forecasts made in April 2002.
Forecasts of the majority of Policy Board members are shown as a range, with the highest and lowest figures excluded. The forecasts of all Policy Board members are as follows.
|Real GDP||Domestic WPI||CPI (excluding fresh food)|
|Fiscal 2002||+0.1 to +0.7
(-0.5 to +0.2)
| -0.9 to -0.6
(-1.0 to -0.3)
| -0.9 to -0.5
(-1.1 to -0.5)
|Fiscal 2003||+0.4 to +1.5||-0.8 to 0.0||-0.7 to -0.3|
Note: Figures in parentheses are forecasts made in April 2002. The new methodology of GDP estimation was introduced in August 2002 and the time series data since fiscal 2001 were revised accordingly.