[No. 202] Looking back on 10 years of monetary policy (Haruhiko Kuroda x Heizo Takenaka)

Thank you for the introduction. I'd like to explain using some materials. What I'd like you to look at is Japan's growth rate, consumer price inflation, and wage growth over the past 25 years. In other words, from 1998 to 2012, deflation continued for 15 years. If you look at this graph, the red line is the consumer price inflation rate. For 10 of those 15 years, it was negative, meaning prices fell every year. Wages were similar, falling in 10 or 11 of those 15 years. The rate of price decline was quite mild, averaging about -0.2% to -0.3% over the 15 years, but it was a persistent deflation. Wages fell by an average of about 0.99% per year. Because of this, the employment situation was very severe. The unemployment rate was around 5%, but the actual employment situation was more serious than that figure suggests. Japanese companies, even when facing a recession, would not lay off regular employees, but they would reduce non-regular workers. Many of those laid off as non-regular workers did not return to the labor market, so they didn't show up in the unemployment rate, but there was a significant number of potential unemployed. Furthermore, the most serious issue was for new graduates, who couldn't find regular employment. This period was called the 'employment ice age.' So, for these 15 years, not only were wages falling due to deflation, but the employment situation was also very bad, which was a terrible situation.

So, in January 2013, the Bank of Japan, in a situation where monetary easing had been insufficient, decided on a 2% price stability target. To achieve this 2% target as early as possible, it was decided to conduct monetary easing. This was included in the joint statement with the government in January 2013. Since then, the Japanese economy has changed. As I was introduced, I became Governor of the Bank of Japan in March 2013. I had extensive discussions with the Bank of Japan staff. Specifically, with the two Deputy Governors and six members of the Policy Board, we discussed for many days how much monetary easing was needed to achieve the 2% price stability target. We analyzed this in depth, and at the first Monetary Policy Meeting in April, we decided on a major monetary easing. At that time, it was generally understood that monetary policy effects have a time lag of about two years. So, at the first Monetary Policy Meeting after I took office in April 2013, we decided to conduct major monetary easing to achieve the 2% price stability target as early as possible, with a time horizon of about two years. This included doubling the monetary base within two years. This 'quantitative and qualitative monetary easing' was decided unanimously by the Policy Board members.

If you look at what happened next, after deciding on this major monetary easing in April 2013, the economy reacted very positively. In the spring of 2014, the consumer price inflation rate temporarily reached about 1.4%. However, at that time, as you can see from the gray line for wage growth, wages did not increase sufficiently. Furthermore, in April 2014, the consumption tax was raised, and there was a backlash from pre-tax-hike consumption, so the inflation rate that had risen to about 1.4% in the spring of 2014 started to fall. So, at the Monetary Policy Meeting, we decided to further expand the quantitative and qualitative monetary easing. As you can see from the blue line for economic growth, the economy recovered. However, at that time, oil prices fell significantly. In the international situation, oil prices, which were around $100 per barrel in 2014, fell to about $50 in 2015, and even below $30 at the beginning of 2016. So, in January 2016, we introduced negative interest rates. Then, in September, we introduced 'yield curve control,' which meant not just setting short-term policy rates to negative, but also targeting the 10-year government bond yield at around 0%. This stabilized the entire yield curve at a very low level, ensuring that the monetary easing's stimulative effect would continue and be sustained. In this environment, the unemployment rate, which had been halved since the start of quantitative easing, remained in the 2% range. Employment increased by over 4 million, and corporate profits nearly doubled. So, not only did the economy recover, but corporate profits doubled and employment increased by over 4 million. We were making steady progress toward the 2% price stability target, but then the COVID-19 pandemic hit the Japanese economy hard from early 2020. The drop in the blue line for real growth was fundamentally due to the decline in consumption during the pandemic. The red line for consumer price inflation and wage growth turned negative, but the decline was not that large. Growth recovered by 2021, and wage growth also picked up. During this time, the government provided employment adjustment subsidies, and the Bank of Japan, through its yield curve control and 'COVID-19 special financing,' provided about 90 trillion yen in loans to small and medium-sized enterprises. Thanks to these measures, the recovery from the pandemic began relatively quickly. As a result of continuously improving the major monetary easing to suit the conditions of the time, Japan's economic virtuous cycle became firmly established. Even during the pandemic, the unemployment rate remained in the 2% range, and corporate profits stayed at relatively high levels. So, even after the pandemic, the economic virtuous cycle continued. This meant not just increased profits or employment, but also that the labor market became tight, leading to wage increases and price increases. We were hoping this virtuous cycle would continue, but it didn't happen immediately. Then, in 2022, the war in Ukraine began. This significantly raised the prices of fossil fuels like natural gas and oil, as well as food prices. For Japan, which imports these in large quantities, the terms of trade deteriorated significantly. Combined with the weak yen, import prices rose sharply. This was reflected in the consumer price inflation rate, which rose to about 4%. Although it has since fallen to below 3% due to a decline in import prices, the spring wage negotiations this year resulted in a 2.6% increase, the highest in 30 years. So, over the past nine years, through monetary easing and various government policies, we moved out of deflation, corporate profits increased significantly, employment increased, and the labor market became tight. The conditions were in place, but we hadn't quite reached 2% inflation or 3% wage growth. Now, ironically, reflecting the rise in import prices, consumer prices have risen, corporate profits are very strong, and the labor market is tight, so we've seen wage increases not seen in 30 years. Looking back over the 10 years, many things happened, but by thoroughly discussing with the Bank of Japan staff and utilizing their wisdom, we consistently responded to the situation of the time by continuing monetary easing. This has led to the economic virtuous cycle. If next year's spring wage negotiations result in increases equal to or greater than this year's, we can expect to have completely escaped deflation.

There are several factors behind the deflation that lasted from 1998 to 2012. One was the prolonged problem of non-performing loans at financial institutions after the asset bubble burst in 1990. Fortunately, it took about 10 years, but it was resolved. By the 2000s, Japanese financial institutions had become extremely sound with sufficient capital. However, these institutions became quite risk-averse. The managers, having experienced the bubble and the painful process of dealing with non-performing loans, became reluctant to take risks. This had a negative impact on corporate investment. As you said, the Bank of Japan's monetary easing was insufficient. If it had been more bold and sustained, investment would have progressed and the economy would have recovered. Unfortunately, while financial institutions became sound, they became very risk-averse. On the other hand, the Bank of Japan's monetary easing was insufficient, so deflation continued. However, as I mentioned earlier, after the Abe administration was formed at the end of 2012, in January 2013, the Bank of Japan decided on the 2% price stability target and committed to achieving it as early as possible through monetary easing. Before that, the Bank of Japan didn't clearly state its target, and even when it mentioned 1%, it used the word 'guideline,' so the commitment was insufficient. As someone who worked at the Bank of Japan, I think that's something we should reflect on.

I thought it was a very groundbreaking joint statement. However, as is natural, under the new Bank of Japan Act of 1998, the Bank of Japan is completely independent from the government, and monetary policy is decided by the Monetary Policy Meeting, with the Governor, two Deputy Governors, and six members. This system was established. So, the Bank of Japan, on its own initiative, had the determination to escape from the 15-year deflation and return the Japanese economy to stable growth or ensure a virtuous economic cycle. The joint statement with the government was created, and if you look at it, the Bank of Japan clearly states that it will conduct monetary easing to achieve the 2% price stability target as early as possible. On the other hand, the government will conduct flexible fiscal policy, while of course considering the medium-term sustainability of fiscal policy. As a third pillar, it will promote a growth strategy through various structural reforms. So, the roles of the Bank of Japan and the government were clearly shown. In this joint statement, we emphasized escaping from deflation and putting the Japanese economy on a growth path. I think it was a very well-made joint statement. To say that it was due to government pressure or that the Bank of Japan promised the government to do this is a bit of an overstatement. The Bank of Japan decided this on its own initiative, and it was a division of labor with the government's policy. In that sense, it was a very meaningful joint statement.

Yes, this is about 'quantitative.' In the previous deflationary period, we also did quantitative easing, but much of it involved buying short-term government bonds. The interest rate on short-term government bonds was already almost zero. Buying them and increasing the Bank of Japan's reserves, which is the monetary base, also had a zero interest rate. So, the effect was limited. Therefore, we decided to buy longer-term government bonds as well. In the process of expanding the quantitative and qualitative monetary easing, we started buying longer-term bonds. So, it's not just about buying short-term bonds.

It wasn't just about buying government bonds from the market to expand the monetary base. At the same time, we bought long-term government bonds to directly influence long-term interest rates. Furthermore, we included ETFs, corporate bonds, and J-REITs. So it wasn't just about expanding the balance sheet by buying government bonds to expand the monetary base, but also long-term government bonds, risky assets like corporate bonds and CP, and even ETFs. That is precisely what is meant by Quantitative and Qualitative Monetary Easing. In that sense, we decided to influence the market comprehensively.

Yes. Actually, in January 2013, when the Bank of Japan decided on the 2% price stability target and aimed to achieve it as early as possible, the monetary policy decision meeting was not unanimous. However, in April 2013, at the monetary policy meeting, the decision on Quantitative and Qualitative Monetary Easing was unanimous. So, in that process, of course, the Governor and Deputy Governor changed, and some of the board members also changed. But as I mentioned earlier, the decision in January was a very weighty one. Having made that decision, we had to achieve the 2% target as early as possible to fulfill our responsibility as the central bank. All nine members of the policy board fully recognized this. We had extensive discussions. I can't go into too much detail as a staff member, but we even ran simulations using macro models to determine how much easing was needed to achieve the price stability target. It wasn't decided solely based on that, but including those discussions, all nine board members had various discussions with the staff, leading to the unanimous decision on the Quantitative and Qualitative Monetary Easing in April.

Yes. As I mentioned earlier, there were two factors. Core CPI rose to 1.4%, and the inflation outlook based on break-even rates also increased. However, wages were not keeping up. This was due to the mindset cultivated during 15 years of deflation, where wages and prices were reluctant to rise. Prices went up, but wages didn't. In addition, as you mentioned, the consumption tax was raised from 5% to 8% in April 2014. There was a surge in consumption beforehand, followed by a slump. While there are various debates about the long-term economic impact of the consumption tax increase, in the short term, it certainly suppressed consumption quite a bit. So, we took further easing measures.

Yes. The biggest factor was that oil prices, which were around $100 in 2014, halved to about $50 in 2015, and by early 2016, had fallen to around $30. As you can see from the red line representing core CPI, we fell back into deflation. Another factor, which isn't discussed much, is that the Chinese yuan depreciated sharply at this time. To become an SDR currency, it needed to be a freely usable currency, so China relaxed regulations on financial transactions, especially capital transactions. This led to capital outflows, and the yuan kept falling. A falling yuan meant exporting deflation to Asia and the world, as China was already the world's largest trading nation. Actually, at the Davos meeting in January 2016, I was asked by moderator Martin Wolf and said that China should re-tighten capital controls. My reasoning was that a falling yuan would export deflation to Asian countries, including Japan. So, these two factors were present. The biggest was the plunge in oil prices. Just as we had escaped deflation, we fell back into it. That's why we introduced negative interest rates. Then, in September, after a comprehensive assessment analyzing the effects of our past monetary policy, we introduced yield curve control.

Yes, of course, those discussions were part of it. The underlying problems of the Japanese economy were always being discussed. However, the biggest debate when we introduced negative rates in January was the plunge in oil prices pushing us back into deflation, and the sharp depreciation of the yuan exacerbating that. As you know, there were various debates about negative rates. Europe had introduced them earlier, but there was criticism that it could harm financial intermediation. The Fed decided not to introduce them. It was a delicate situation. However, we decided it was necessary. It wasn't unanimous; there were opponents. But the policy board members felt it was necessary here. To avoid harming financial intermediation, we implemented a three-tier system for the Bank of Japan's current account balances. The existing balances would continue to earn 0%. As the Bank of Japan's reserves increased through quantitative easing, only the marginal portion, around 20 trillion yen, would be subject to the -0.1% rate. This made short-term money market rates clearly negative, achieving the intended effect, while the design prevented a major negative impact on financial intermediation. Later, the ECB also adopted a similar tiered system. So, after thorough discussion, we introduced negative rates, and then yield curve control in September. There was considerable opposition, especially to negative rates.

To be honest, the amount of government bond purchases, like 8 trillion yen, is well understood by financial market participants, but it's confusing for the general public and businesses. It's clearer to say we will lower long- and short-term interest rates to a certain level and maintain them, and we will buy whatever amount of government bonds is necessary to do that. This makes it clear that monetary easing will continue. It's easier for the general public and businesses, including those with housing loans, to understand. Moreover, even if you buy the same amount of bonds, the easing effect can vary due to international capital flows. By directly setting long- and short-term interest rates and stabilizing the yield curve, we can continue monetary easing in a stable manner. This makes it clearer not just to financial market participants but also to the general public and households. It wasn't about reducing the amount of bond purchases.

That wasn't really a factor. In the West, inflation rose significantly, so they tightened monetary policy aggressively, pushing long-term rates up to 4% or 5%. However, the Fed and ECB did not reduce the balance sheets they had expanded through QE all at once. They did it gradually. While they tightened policy and raised rates significantly, they reduced the balance sheet, or QT, very gradually. Doing it abruptly would have a major impact on the market. So, while expanding the balance sheet through QE, it's natural that when financial normalization occurs and the 2% target is stably achieved, interest rates will rise. But there's no need to reduce the balance sheet abruptly. It will need to be reduced gradually in the future, but that's a long way off. And it will be done gradually to avoid a major market impact. So, there was no intention at that time to prevent the balance sheet from expanding.

Yes. At that time, the spread of COVID-19 caused consumption to plummet. This was more a drop in service consumption, like going out or traveling, rather than goods consumption. This had a huge impact on small and medium-sized enterprises. The government responded with measures like employment adjustment subsidies. As the Bank of Japan, preventing SMEs from going bankrupt is crucial because it would negatively impact the economy. When financial institutions support them, the BOJ providing backstop financing is a monetary policy action to prevent a major negative impact on the macroeconomy, rather than a debate about macro vs. micro. On this point, there was no opposition from the policy board members.

Yes. I think it's very good for the BOJ Governor to be a member of the Council on Economic and Fiscal Policy and participate in discussions on the overall economy. I also spoke and explained monetary policy during the council's various discussions, which I found very meaningful. Separately, I had frequent opportunities to exchange opinions with the Minister of Finance and the Minister of State for Financial Services. I also met with the Prime Minister about twice a year to explain monetary policy, financial markets, and the economy. This was done under Prime Minister Abe, Prime Minister Suga, and Prime Minister Kishida. I think there's absolutely no problem with that, and it was very meaningful. Regarding the council's composition, the law stipulates that private sector members must be at least five. While it's said there are four private members, the BOJ Governor is one of them as a private sector expert, not as a designated member. I think that's a very clever legal provision.

Second, the 2% price stability target was not only decided at the monetary policy meeting in January 2013 but was also clearly included in the joint statement with the government. This made the BOJ's commitment clear and strong. This was decided under the previous regime before I arrived, and it continues today. It was a very important decision, showing the BOJ's determination to escape deflation. The efforts from 2013 to 2022 involved expanding Quantitative and Qualitative Monetary Easing, introducing negative interest rates, and yield curve control, adapting to the situation at the time. As a result, we achieved a virtuous cycle. Corporate profits increased significantly, and employment grew by over 4 million. This led to an economic recovery and a virtuous cycle. However, it was difficult to extend this to a virtuous cycle of wages and prices. This was due to the deflationary mindset cultivated over 15 years, where wages and prices were reluctant to rise. This mindset existed not only among companies but also among labor unions, making it hard to break out of. However, wages and prices had been rising at around 1% for some time, so we were no longer in deflation. But we hadn't fully escaped it. Now, I believe we are on the verge of doing so.

Thank you very much.