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Opening Remarks by Mr. Masayuki Matsushima, Executive Director, Bank of Japan

--The Bank of Japan EMEAP High-Level Workshop on Development of Information Technology and Central Banking on October 2-3, 2000

March 2001
Masayuki Matsushima

I am very delighted that EMEAP members are willing to participate in this Workshop actively, and am also pleased to have two distinguished guest speakers with us: Mr. Bruce Summers, Director of Federal Reserve Information Technology, and Dr. Peter Dittus, Deputy Secretary General of the BIS. Both gentlemen will deliver keynote speeches today and take part in the discussion session.

Before getting into the subject of my own speech, I would like to give you some general description of our thoughts which embrace the idea of this EMEAP IT Workshop. As you may know well, in Japan, Prime Minister Mori has put top priority on IT on his policy agenda, and set up the IT Strategy Council to foster the IT-related industry as well as to promote wider use of IT in the traditional industries. Similarly, in the EMEAP region, many governments started to take new initiatives to transform their economies to more knowledge-based ones, although the degree of enthusiasm for IT may differ among nations. And many countries in the region have been seeing IT stocks moving closely co-related with the US NASDAQ's developments, which is a clear evidence that the financial markets' global integration is accelerating.

On the other side of the Pacific Ocean, IT issue does not dominate the presidential campaign, because, I guess, IT has become a way of life for everybody and in effect, IT has deeply taken root in the society and has already contributed to productivity gains.

From these episodes, we can draw following conclusions in the context of EMEAP's concerns.

  • 1) Much remains to be done, before IT bear fruit. We have to speed up the pace of the IT-related investments and promote capital deepening. We have already recognized the importance of implementing structural reforms to provide IT-friendly environment.
  • 2) We need to closely monitor the further development of IT in the US and its global impact. I think it particularly useful for EMEAP members to prepare to address potential impacts of IT on both real and financial economy, if necessary. To assure monetary and financial stability, a central bank should be fully aware of the IT implications.
  • 3) Not to mention, central banking business itself is not an exception to the impact of IT development.
  • 4) Therefore, we think it effective to hold workshop dealing with IT in this conjunction, in the light of central bank interests, from the broader spectrum of diversified background.

I feel most grateful if all attendants will actively get involved in the discussion. I most welcome all participants to make any kind of intervention, comments, questions, endorsement, refutation, etc, to contribute to the success of this workshop. We are at a workshop. We are not in the foreign exchange market. So please feel free to make interventions.

I strongly wish EMEAP's opinion about IT be reflected to moves in the discussion at international forum. I firmly believe EMEAP is really capable to add valuable inputs to the ongoing debates in the international financial circle. This workshop, I hope, helps enhance EMEAP cohesion.

In my speech today, I will first talk about the planning and management of IT in the central bank, which is not included in the annotated agenda. But because of it, I would like to begin my speech with this issue. Then, based on the background paper which was distributed to you beforehand, I will walk through several interesting and important issues regarding the relationship or implication of IT development on the real economy, payment and settlement system and monetary and financial stability.

Now, let's start with IT investment management policy in the central bank. I am not in a responsible position to talk about this area right now. Therefore, my remarks are based on my own experiences when I was an Associate Director of Information System Services Department during the period of launching BOJ-NET.

On this subject, I would like to touch upon two aspects. One is generic philosophy behind IT promotion, and the other is principle of system development. As for the underlying policy stance towards IT promotion, it is worthwhile to first consider what a central bank should do to maximize the benefits stemming from IT investment. Here, I think it would be useful to analyze the prerequisites of an IT revolution that would boost productivity. Needless to say, the accumulation of capital stock and capital deepening through high-tech investments are necessary conditions for further productivity gains. However, the more fundamental condition for the improvement in productivity is an IT-consistent economic environment. For example, a flexible labor market, improved human resources through higher quality of education, the enhancement of an open and competitive business environment, fostering entrepreneurship through deregulation, the lifting of bureaucratic red tape, and the reorganization of business institutions, without those conditions, you cannot expect high rate of returns from IT investments. As a result of interaction among these fundamental factors, capital deepening will materialize. In managing IT promotion, we should fully understand this point. Establishing an IT-friendly corporate culture should rather come prior to IT investment itself. Then, how can we groom a corporate culture that will benefit from IT investment? Let me cite three points which I think are particularly important.

The first is to enhance computer literacy through practice. Of course it would be best if one could completely master use of computers, but I do not think that is necessary. What we must not do is turn away from computers. As long as most staff use computers, be it e-mail or a word-processor, and can appreciate the convenience and take an interest in it, that is enough. While the security and integrity of computer systems is important, they should not lead to the loss of potential users.

The second point is to overhaul business practices. This can be realized through shortening the reporting line and giving flexibility in terms of decision-making process, given the size and content of each job. We must keep in mind that the effects of IT will not be seen without a bold overhauling of our entire business. Preventing organization from becoming rigid is significantly important in promoting IT.

The third point is the necessity of incentives to beef up human resources. In this respect, we should establish a compensation system that rewards staff according to challenges and achievements. In the case of a central bank, it is unrealistic to set a quantitative target for each job. It is possible, however, for a manager and staff to agree on a qualitative target. In essence, a consensus must be shared among staff members that their organization rewards them according to their efforts and achievements.

Now, the latter aspect, the principle in system development. First of all, how fast a central bank should respond to the fast-moving technological innovation. While introducing the latest technology may be the ideal, computer equipment and software quickly become out of date. New generation computers featuring upgraded functions are constantly appearing, and at an ever lower cost, in some cases, by two-digits a year. Hence, because of the speed of technological advancement, a central bank faces considerable risk in incorporating the latest technology, principally risk of being unable to control costs. Another risk is system failure due to bugs and system errors. To achieve steady system operation, a system must first undergo tests but which cannot be planned and effected overnight. Moreover, given that the soundness of a central bank's assets must be maintained at all times since such soundness supports the credibility of the currency, a central bank is not really the place to carry out system tests. We cannot be too careful about a project that has a potential to deteriorate the quality of central banks assets.

In this context, I remember the following phrase, if my memory is correct. More than ten years ago, Deputy Governor Blunden of the Bank of England said, "The IT system of a central bank does not need to be a forerunner of technological developments, although it should not miss the bus, either. It should aim always to stick with the second group, right behind the forefront." His words greatly impressed me, and I believe they hold true even today.

We must bear in mind that a central bank should be democratically accountable in exchange for its independence. Therefore, the cost and benefit analyses must be carefully conducted in making resources allocation.

Then, the next question I would like to raise is the modality of system development. In my view, systems should be open as much as possible, and development should be outsourced as much as possible. However, open systems may be criticized from the viewpoint of security and contagion risk via computer virus, and outsourcing from the viewpoint of security and confidentiality. But let me elaborate a little on my view. A closed system would run a risk of isolating the ongoing system from technological progress and tend to put a cap on the benefits of network externality. And, the development of central bank systems solely by the staff would involve a considerable redundancy. An attempt to make personnel costs for system development a variable one, would be more sensible.

My personal views on how a central bank should deal with IT may be somewhat provocative, but I do hope they will stimulate the discussions.

Now, based on the paper "Information Technology and Central Banks" which has been distributed, I would like to walk through several interesting and important points which deserve special attention. I should say here that my remarks represent my personal views and may not necessarily be those of the author of the paper.

First, I will talk about the relation between IT and the potential growth rate and productivity. As is well recognized, the US has been experiencing a technological revolution in information and telecommunications since the 1990s. However, until a few years ago there had been almost no empirical analyses which showed that the progress of IT development contributed to increased productivity and subsequent long-term economic expansion. Rather, it was questioned why productivity indicators were not improving. Dr. Robert Solow, a Nobel laureate, once said that the influence of computers was seen everywhere except in productivity indicators. On the other hand, Dr. Lawrence, Vice Chairman of CEA, recently told me that Improvement in productivity exceeded the long-term trend from 1995. An unprecedented phenomenon was that despite continuous economic growth over a long period of time, productivity still continued to accelerate. He also told me even though it could not be said that such continuous productivity improvement meant an end of the business cycle or ushered in a New Economy, there were many economists who insisted that this improvement in productivity was very fundamental and secular and would continue for at least a few more years.

Why has it taken so long to realize that productivity has improved? On this question, it is often said that to achieve a certain accumulation of capital as well as technological innovation, or to establish an appropriate supporting infrastructure, a certain amount of time is needed. In other words, strong preposition is gestation period does exist. Productivity will not improve until capital accumulation and technological innovation reach a certain threshold. Indeed, this has been well evidenced in the case of Canada. Governor Theissen of Bank of Canada told me that, in Canada, IT investment has accelerated since around 1995, while signs of an improvement in productivity have only been visible since last year. The current situation in Canada lags behind US by four to five years. And once, when Chairman Greenspan was questioned about the reason for the difference in productivity gains between the US and Europe, he replied that it did not result from merely the timing of IT investment but rather the rigid labor market in Europe. The rigidity in Europe prevented productivity gains from being realized. In the US, the cost to discharge an employee is very low, and so labor is easily substituted by capital. Chairman Greenspan suggested that the social framework and cultural background were key elements for the improvement of productivity.

Thus, in the US, the prevailing view is that the improvement in productivity is a trend rather cyclical. But still there remains the question of whether it is strong GDP growth or bubble-like demand that is feeding the improvement. It seems best to refrain from making a final evaluation about productivity until the current phase of the business cycle in the US comes to an end.

Although IT is a good thing to raise growth potential , it also exerts downward pressure on the general price index. To the extent of existence of inflationary bias and distortion in the price index, measurement and assessment of price movements have become further difficult. This difficulty has posed serious challenges for a central bank to conduct monetary policy.

Second is the transformation of the payment and settlement system. E-money and Internet banking mean the emergence of a new type of financial instruments, compared with traditional types of deposit, which will probably translate into diminishing demand for monetary base consisting of banknotes and current deposits with central bank. Looked at from a different perspective, it means IT development will result in a smaller monetary base. In response, we will be able to say that efficiency and effectiveness in society has been increased. However, central bankers instinctively tend to be cautious about any decrease in demand for their services. In fact, some will insist on imposing compulsory reserve requirements on new payment services or offer interest on central bank current deposits so as to increase demand for monetary base. I don't think there is any theoretical justification for this, rather it is instinctive cautiousness. Personally, I do not think recent electronic payment technology will pose completely brand new problems compared with those we experienced when credit cards, prepaid cards, and MMFs were first introduced.

Regarding the impact of IT development on financial stability, I emphasize the importance of recognition on central banks about who should take final responsibility in regulating and supervising payment and settlement systems provided by non-banks, for example retail chain-stores, and how to contain systemic risk.

Coming toward the end of my speech, I would like to make comments about monetary policy posture in the IT era. First, the appropriateness of a monetary policy framework should be reviewed. In order to minimize volatility in the real economy, in a situation where the demand for currency is unstable, it is said that a policy which is aimed at stabilizing interest rates is more desirable. This line of logic justifies current BOJ policy framework. Considering the possibility of a diminishing demand for central bank's money, it might be constructive for monetary policy to be directed to exert more influence on market expectation, not relying on traditional transmission mechanism or intermediary channels. Thus the price level of financial assets - foreign exchange, government bonds, and stocks -- moves in the anticipation of monetary policy directions. In this sense, communication with the market will become extremely important than before.

Second, IT will bring a sea change to Japan's economy and financial system. Then, how should central bank respond to increased uncertainty in the environment surrounding monetary policy operations? Should it be a gradual approach, or an aggressive approach? A wait-and-see approach, or a flexible approach? There can be many ways to be explored. I don't have any conclusions. But the lessons from our experiences in the late 80s are as follows. In the process of robust economic expansion, it is very difficult to make ex-ante judgment whether a bubble is being created or not. There is a possibility of overkilling economic growth in a situation where a fundamental structural change occurs, such as an improvement in productivity. To the contrary, there is also the possibility of allowing bubble to expand by misunderstanding it as part of the transmission process to the long-lasting prosperity. In this context I would appreciate learning from you which mistake you consider the more serious for central banks, given increased uncertainty.

I would like to conclude my remarks by saying that IT is filled with interesting challenges for central banks. In spite of increased uncertainties resulting from the fast-moving IT, we should acknowledge IT as an opportunity, and not as a threat.

Thank you very much for your attention.