Minutes of the Monetary Policy Meeting

on May 17, 2000
(English translation prepared by the Bank staff based on the Japanese original)

July 3, 2000
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 Wednesday, May 17, 2000, from 9:00 a.m. to 12:13 p.m., and from 1:01 p.m. to 3:28 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. S. Taketomi
Mr. T. Miki
Mr. N. Nakahara
Ms. E. Shinotsuka
Mr. K. Ueda
Mr. T. Taya

Government Representative Present
Mr. T. Haraguchi, Deputy Vice Minister for Policy Coordination, Ministry of Finance
Ms. Y. Koike, Senior State Secretary for Economic Planning, Economic Planning Agency

Reporting Staff
Mr. M. Matsushima, Executive Director
Mr. M. Masubuchi, Executive Director
Mr. S. Nagata, Executive Director
Mr. I. Yamashita, Director, Financial Markets Department
Mr. S. Murayama, Director, Research and Statistics Department
Mr. E. Hirano, Director, International Department
Mr. N. Inaba, Advisor to the Governor, Policy Planning Office
Mr. M. Amamiya, Chief Manager, Planning Division 1, Policy Planning Office
Mr. T. Yoshida, Senior Manager, Research and Statistics Department

Secretariat of the Monetary Policy Meeting
Mr. I. Yokota, Director, Secretariat of the Policy Board
Mr. T. Murayama, Advisor to the Governor, Secretariat of the Policy Board
Mr. S. Hida, Manager, Secretariat of the Policy Board
Mr. H. Yamaoka, Senior Economist, Policy Planning Office
Mr. S. Shimizu, Senior Economist, Policy Planning Office

The minutes of this meeting were approved by the Policy Board at the Monetary Policy Meeting held on June 28, 2000 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.

I. Approval of the Minutes of the Monetary Policy Meeting Held on April 10, 2000

The Policy Board approved unanimously the minutes of the Monetary Policy Meeting of April 10, 2000 for release on May 22, 2000.

II. Summary of Staff Reports on Economic and Financial Developments²

A. Money Market Operations in the Intermeeting Period

Market operations in the intermeeting period were conducted in accordance with the guideline determined at the previous meeting on April 27, 2000. As a result, the overnight call rate remained generally steady at around 0.02 percent.³ The Bank provided ample funds after Golden Week (the period from late April to early May that includes several national holidays), and consequently the balance of current accounts at the Bank amounted to just less than 6 trillion yen. The Bank conducted operations giving due consideration to the following. First, daily-average remaining required reserves (reserve balances that need to be maintained per day in the remaining days of the reserve maintenance period) increased. And second, demand for funds for payment and settlement was expected to increase after Golden Week. On May 8, the "morning projection for reserves" was 900 billion yen, below 1 trillion yen for the first time since February 25, 1999.⁴ However, the decrease did not cause major changes to market conditions, suggesting that the new formula for money market operations data adopted in March had become widely understood by market participants.

Interest rates on term instruments remained weak reflecting the reduced anticipation of an early termination of the zero interest rate policy.

The supply and demand balance in the market for treasury bills (TBs) and financing bills (FBs) was tightening due to an increase in buying by bond investment trusts, regional financial institutions, and other investors. The bid-to-cover ratio had been rising in auctions for newly issued FBs. Meanwhile, the Bank's offers to purchase TBs/FBs under repurchase agreements were not attracting bids, and both the bid-to-cover ratio and the average accepted bid rate declined. The Bank would therefore continue to provide an appropriate amount of funds by reducing slightly the proportion of purchases of TBs/FBs under repurchase agreements, and increasing that of purchases of CP under repurchase agreements as well as borrowing of Japanese government bonds (JGBs) against cash collateral (JGB repos).

2Reports were made based on information available at the time of the meeting.
3The guideline was as follows:
"The Bank of Japan will flexibly provide ample funds and encourage the uncollateralized overnight call rate to move as low as possible."
4The "morning projection for reserves," which the Bank stopped announcing on March 16, is defined as a projection of the "daily excess/shortfall of reserves." The "daily excess/shortfall of reserves"--which is affected by the Bank's market operations of the day--is the amount by which reserves exceed/fall short of daily-average remaining required reserves at the end of the day.

B. Recent Developments in Foreign Exchange Markets and Overseas Economic and Financial Conditions

1. Developments in foreign exchange markets

In the foreign exchange market, the yen and the euro were weakening on the whole against the U.S. dollar. The strength in the U.S. dollar could be attributed to the following factors. First, U.S. stock prices remained firm. Second, interest rate differentials between Japan and the United States and between Europe and the United States were widening. And third, capital continued to flow from Europe to the United States. The euro had been on a downward trend until the beginning of May, but had recently recovered somewhat due to heightened anticipation of possible market intervention following the release of a statement by the European Central Bank on the weak euro on May 5, and an announcement by the Euro 11 Group on May 8 that members shared a common concern about the weakness of the euro.

Volatility spreads showed that market concern about the possibility of a further decline in the U.S. dollar was fading, and implied volatility indicated that market participants expected unstable movements in the euro-U.S. dollar exchange rate.

2. Overseas economic and financial developments

On May 16, the U.S. Federal Open Market Committee (FOMC) decided to raise its target for the federal funds rate by 50 basis points. The FOMC believed that the risks were weighted mainly toward conditions that might generate heightened inflation pressures in the foreseeable future. Overall, U.S. financial markets reacted positively to the move, as seen in the slight decline in long-term and swap interest rates, the increase in stock prices, and the firmness in the U.S. dollar. Also, stock prices and currencies rose in Latin America. Federal funds rate futures rose marginally across the board, indicating that the market already anticipated another increase in the federal funds rate target.

A close look at the capital flow between the euro area and the United States from a longer-term perspective showed that (1) investment in medium- to long-term U.S. securities occurred almost in parallel with the decline of the euro against the U.S. dollar, and (2) recently, investment from the Euro area in U.S. securities was centered in stocks.

With regard to the United States, the economy continued to display robust growth as shown by the 5.4 percent annualized increase in real GDP for the January-March quarter of 2000 from the previous quarter. Production and capacity utilization in the manufacturing industry rose further, and there were no signs of a slowdown in the expansion of the economy. The unemployment rate declined below four percent for the first time in 30 years, and the employment cost index and average hourly earnings increased further. These data suggested that potential inflationary pressure was increasing. The consumer price index (CPI) for April was stable, roughly in line with market expectations.

Meanwhile, there were no major changes in the real economies of the euro area and East Asian countries.

C. Economic and Financial Developments in Japan

1. Economic developments

With regard to exogenous demand, net exports continued to follow an upward trend due to steady developments in overseas economies, and public investment had started to pick up reflecting the progress in the implementation of the supplementary budget for fiscal 1999. As regards domestic private demand, housing investment was on a moderate declining trend, and the recovery in private consumption continued to be weak. However, business fixed investment continued to increase gradually.

Although, as described above, the improvement in Japan's economy was becoming more distinct, the corporate and household sectors showed somewhat different developments.

In the corporate sector, exports and production were somewhat stronger than had been expected. Business fixed investment remained on a recovery track judging from developments in machinery orders, for example. According to anecdotal information, manufacturers of electronic parts and related sectors seemed to be bringing forward or revising upward their investment. In private consumption, the index of living expenditure level for March was weak partly due to the cut in the bonus payments of local civil workers. The income environment for households was somewhat severe; in negotiations on summer bonus payments, agreements reached by some major firms showed that industries undergoing deregulation, such as telecommunications, aimed to improve profitability by substantially lowering the level of bonuses.

With regard to prices, domestic wholesale prices were slightly firmer, consumer prices remained somewhat weak, and corporate service prices continued to edge lower.

The outlook for exogenous demand was unchanged; net exports were expected to remain on an upward trend, and public investment was likely to rise moderately until the summer reflecting progress in construction projects funded by the supplementary budget for fiscal 1999. As for domestic private demand, business fixed investment was expected to continue to increase gradually for a while. Anecdotal evidence showed that most firms expected production to increase in the April-June and July-September quarters. Meanwhile, positive developments in wages and salaries would be the key to a recovery in private consumption. Given the high probability that production and corporate profits would continue to increase, it was likely that scheduled cash earnings and overtime payments would increase moderately, and that summer bonus payments of firms with good performances, such as electrical machinery manufacturers would increase somewhat, and that some small and medium-sized firms that had suspended bonus payments would resume them. However, given that there were cases such as the telecommunications industry mentioned earlier, the overall picture of bonus payments was not clear from the information available at this point.

On balance, prices were likely to remain unchanged for a while. Domestic wholesale prices were likely to remain flat; electric machinery prices would continue to fall reflecting technological innovation, but this decline was likely to be offset by a gradual improvement in the domestic supply-demand balance and the feeding-through of the past rise in crude oil prices. As for consumer prices, they were likely to gradually stop declining and remain flat thereafter, as it was highly probable that the domestic supply-demand balance would improve moderately, and that the effect of the strong yen would weaken eventually.

2. Financial developments

The overnight call rate remained stable at around zero percent. Interest rates on term instruments and yields of Euro-yen interest rate futures weakened somewhat, indicating that market expectations of an early termination of the zero interest rate policy had receded. However, the market still expected the zero interest rate policy to be terminated by the end of this year or at the beginning of 2001. The market's view on the specific timing of termination seemed to be affected by movements in Japanese and overseas stock prices.

Yields on JGBs were confined to a narrow range and were recently moving around 1.7 percent.

With the exception of the Nikkei 225 Stock Average, which was affected greatly by a change in its composition, stock prices were relatively firm compared to those overseas, after recovering from a plunge triggered by a drop in U.S. stocks.

The spread between yields on corporate and government bonds continued to narrow. A recent increase in corporate bankruptcies had not undermined issuance of corporate bonds.

With regard to corporate financing, lending by private banks remained basically weak, but some of them, mainly major banks, were becoming more willing to increase lending. However, the improvement in economic activity had not stimulated corporate demand for external funds, since firms' cash flow was increasing in parallel with a recovery in profits.

III. Summary of Discussions by the Policy Board on Economic and Financial Developments

A. The Current Economic Situation

Members shared the following view of the current economic situation: "The improvement in Japan's economy is becoming distinct. Recovery has been observed in some areas of private demand, with business fixed investment continuing to increase gradually." Many members pointed out that (1) exports were stronger than had been expected, (2) business fixed investment continued to follow a moderate upward trend, (3) production was increasing sharply, and (4) the deterioration of the employment and income situation was coming to a halt, helped by an improvement in corporate profits.

With regard to the components of aggregate demand, the following views were exchanged.

Some members noted that exports were increasing at a faster-than-expected pace, driven by demand from Asian countries for goods related to information technology (IT).

Many members pointed out that business fixed investment was continuing to increase moderately for the following reasons. First, machinery orders, a leading indicator, had increased for three consecutive quarters from July-September 1999 on a quarter-on-quarter basis, and recently construction starts of non-residential buildings, another leading indicator, had steadily exceeded the level of a year earlier. Second, shipments of capital goods, regarded as a coincident indicator, continued to increase. Third, anecdotal information suggested that manufacturers of electronic parts and related sectors were revising their investment upward. However, one member was of the opinion that business fixed investment had yet to spread to a wide range of industries given that (1) machinery orders had not increased in non-IT-related sectors, and (2) the volume of leased personal computers indicated that IT-related fixed investment by small and medium-sized firms was not strong.

One member said that the following developments indicated that domestic demand had increased, especially business fixed investment. Domestic orders for iron and steel had been increasing year on year since autumn 1999. Further, since the turn of the year, orders had been growing in an increasing number of industries and the number of orders received was exceeding the levels of two years ago.

Some members pointed out that the expected improvement in corporate profits would support the current favorable trend of business fixed investment. One of these members, who had been concerned that the basis for corporate profits was still fragile, stated that there was now less cause for such concern given the improvement in domestic demand due to the increase in business fixed investment, the recent recovery in international commodity prices, and the recent weakness in the yen.

Many members noted that private consumption had been showing mixed developments. One of these members pointed out that indicators related to private consumption, such as real living expenditure and the index of living expenditure level, had recently been on the weak side. Another member added that (1) it seemed that consumption in the second half of Golden Week had not been particularly strong, and (2) analysis by industry showed that the propensity to consume was relatively low in households whose main wage earner was employed by firms where activity was brisk, and thus favorable developments in the economy, such as increased production, were unlikely to boost consumption immediately. In response to these views, another member stressed that monthly and quarterly developments in private consumption by main wage earner's industry should be analyzed carefully as statistics related to consumption tended to fluctuate due to changes in the samples used to compile them.

Members next exchanged views about the employment and income situation, the basis for private consumption. With regard to employment, one member pointed out the following concerns: the unemployment rate had remained at a record high and the number of workers continued to decrease. Another member expressed the view that the unemployment rate might reach 5 percent and stay high given the expected fall in public demand. In addition, the contrast between the unemployment rate of older age groups, which had been rising, and that of the younger age groups, which had been decreasing, would become more pronounced than before. In response to this, a few members said that one should not be overly concerned about the high unemployment rate as it was a lagging indicator and was probably being affected by structural changes, such as increased mobility of labor. These members said that by combining information from data such as the ratio of job offers to applicants, the number of new job offers, and the number of employees, one could judge that the employment situation had stopped deteriorating, although it was still severe.

As for wages and salaries, some members said that, although special cash earnings had decreased due partly to the decline in bonus payments for civil servants, scheduled cash earnings had started to slightly surpass the previous year's level and the upward trend of overtime payments had become more pronounced than before. One of these members pointed out that the level of wages, negotiated in the spring, had not declined, although the increase was a historical low. Many members, including this member, agreed that wages and salaries were about to stop declining. One member summarized the discussion as follows: the improvement in the corporate sector was starting to affect the household sector to some extent.

Another member commented that an analysis of the indexes of business conditions showed that since around January 2000, the momentum of the current economic recovery had exceeded those of past recovery phases.

With regard to prices, views were exchanged on how to interpret the year-on-year increase of 0.5 percent in domestic wholesale prices for April. One member noted that prices of machinery, particularly electric machinery, were decreasing due to technological innovation, but those of other types of product were increasing. Another member said that domestic wholesale prices might have been underpinned not only by exogenous factors, such as the strength of crude oil prices, but also by the improvement in the domestic supply-demand balance. As for consumer prices, a few members expressed the view that the CPI was weak due to the continuous decline in the prices of imported goods and domestic products competing with imports, stemming from the yen's appreciation.

One member summarized the situation as follows. The upward pressures on prices as a result of, for example, the rise in prices of international commodities such as crude oil, were offsetting the downward pressures stemming from, for example, technological innovation and rationalization of the distribution system. This member also commented that price indicators had been showing different developments because various factors that caused price changes influenced the indicators differently in terms of time lag and the degree of price change. Another member said that, despite the slight decrease in global oil consumption in the January-March quarter 2000, prices of crude oil rebounded, and natural gas prices in the United States surged. This member continued that developments in energy prices should be watched carefully.

One member remarked that according to a survey conducted by a major real estate agent, residential land prices in the Tokyo metropolitan area had been showing signs of increasing since the turn of the year, and that developments of these prices would require attentive monitoring.

B. Financial Developments

On the financial front, members expressed views on Japanese and U.S. stock prices.

Some members pointed out that Japanese stock prices fell sharply in the second half of April, reflecting the drop in U.S. stock prices, but they had generally been firm since then. Accordingly, these members expressed the view that at present it was unlikely that developments in stock prices would have an adverse impact on Japan's economy. One of these members remarked that, although foreign investors were recently reported to be selling a large volume of Japanese stocks, it was unlikely that they would hold back from investment in Japanese stocks for a long time because expectations of an improvement in Japan's economy remained intact, and corporate profits were expected to increase. Another member expressed a similar view that confidence in the Japanese economy among stock market participants had not been seriously undermined.

By contrast, a different member commented that the Nikkei 225 Stock Average had declined to the mid-point between the high so far this year marked in April and the post-bubble low of October 1998, and from a technical analysis perspective, this might suggest that the long-term upward trend in the stock market that had lasted for 18 months was reaching its end.

One member remarked that, when analyzing the trend of stock prices, it was more appropriate to use TOPIX (Tokyo Stock Price Index) than the Nikkei 225 given the recent change in the latter's components. This member, however, added that it should be kept in mind that TOPIX was a weighted average of stock prices while the Nikkei 225 was a simple average.

With regard to the recent fall in U.S. stock prices, a few members stated that it could be viewed as a healthy correction. One of these members, however, remarked that, although a gradual correction was desirable, U.S. stock prices could plunge, should the effects of higher interest rates start to permeate rapidly at some point, and thus it was difficult to predict future developments. On the same point, another member remarked that U.S. market participants' views on interest rates and stock prices were divided according to the market. Although bond market participants expected a substantial tightening of monetary policy, the majority of stock market participants expected a slight tightening and consequently were relatively bullish on the outlook for stock prices.

One member noted that the U.S. markets would continue to require close monitoring as (1) a divergence was emerging between institutional investors' sentiment and their actual investment behavior, and (2) the value of transactions in stock markets had increased to a historically high level, as seen in the recent surge of the total value of stock transactions on the New York Stock Exchange and Nasdaq to 300-400 percent of GDP from around 100 percent in 1996.

A different member commented on the effects of developments in U.S. stock markets on Japan's economy. This member noted the following two ways in which Japan's economy might be affected by a plunge in U.S. stock prices: (1) adjustments might occur in foreign exchange markets and the Japanese stock market; and (2) the environment for Japan's exports might deteriorate as a result of a slowdown in the U.S. economy. This member expressed the view that the economy had not been affected in either way to date.

A few members expressed views on long-term interest rates. One member commented that the zero interest rate policy was one of the factors leading to the recent relative stability in long-term interest rates, which usually reacted more sensitively to developments in economic indicators. Another member objected to these views, saying that the zero interest rate policy's contribution to the current stability of long-term interest rates was marginal at most, and they were basically reflecting expectations of future developments in the economy and prices.

Another member commented on corporate finance in relation to bankruptcies. This member said that, in view of the progress in structural adjustment, the increase in the number of bankruptcies, amid increases in production and overall corporate profits, should be perceived as a positive development and was not making financial institutions even more cautious about extending loans.

C. The Economic Outlook

On the economic outlook, members mainly discussed the outlook for the second half of 2000 and thereafter.

One member considered that it could be said that deflationary concern had been dispelled as (1) machinery orders, a leading indicator of business fixed investment, were firm, (2) the employment and income situation had been improving steadily, and (3) there was a strong possibility that production would continue to follow an upward trend.

In response to this, many members remarked that the following points should be considered before making such a judgment. First, whether the increase in business fixed investment was sustainable and whether it was spreading to a wide range of industries. Second, whether the employment and income situation would stop deteriorating and start to pick up. Third, how Japan's exports would be affected if the U.S. economy slowed. Fourth, whether private demand, such as business fixed investment and private consumption, would be able to support the economy when fiscal spending decreased in the foreseeable future.

The majority of members, however, agreed that downside risks stemming from endogenous factors had subsided to a great extent, and the economy was making steady progress toward a moderate growth path and continued to move toward a situation where it could be said that deflationary concern had been dispelled.

One member remarked that the risk that the economy would deteriorate had subsided considerably compared with an earlier period starting from the second half of 1997, noting the following differences. First, a framework for stabilizing the financial system had been formed. Second, business fixed investment was on an uptrend, especially in IT-related areas, and this uptrend was expected to continue for a while. Third, Asian economies remained strong. And fourth, as for fiscal policy, measures such as an increase in taxation, which would cause a strong deflationary shock, were unlikely.

With regard to components of aggregate demand, some members pointed out that, although the forecast for machinery orders for April-June had decreased from the previous quarter, business fixed investment was expected to increase moderately, as suggested by the firmness of leading indicators, which reflected the following: (1) corporate profits, especially those of large firms, were improving; and (2) the actual number of orders currently seemed to be exceeding forecasts.

A few other members pointed out that at present business fixed investment was concentrated in areas related to IT, and it had yet to spread to traditional businesses or small and medium-sized firms. In response to this, another member said that it was becoming increasingly certain that capital spending would follow an upward trend given the improvement in corporate profits and sentiment. A different member said that orders for machinery unrelated to IT were about to start increasing and the improvement in business fixed investment seemed to have started to spread to a wider variety of industries.

With regard to private consumption, members exchanged views on the employment and income situation. Some members remarked that anecdotal information to date suggested that one should not pin too much hope on an increase in summer bonus payments. In response to this, some other members expressed the view that one should not expect a large increase in bonus payments since they would be largely affected by firms' structural adjustments such as cuts in overall personnel expenses. These members added that scheduled cash earnings and overtime payments, which accounted for 80 percent of overall wages and salaries, should be taken into consideration when analyzing private consumption since these affected the underlying trend of consumer sentiment. One of these members said that, given the steady increase in scheduled cash earnings and overtime payments, the income situation could be judged firm unless summer bonus payments for 2000 dropped sharply below the previous year's level. Another member stated that, although it would require some time for the employment and income situation to improve, the risk that it might deteriorate had almost disappeared.

On these grounds, one member expressed the following view. First, the current level of consumption was reasonable as the propensity to consume had generally been stable at 70-72 percent. Therefore, when it became more evident that the employment and income situation had stopped deteriorating, private consumption, which had been showing mixed developments, was likely to start improving gradually. Second, when this happened at that stage, one could conclude that consumption had recovered to a normal level, given that employment and income were not expected to increase significantly.

A different member pointed out the following and expressed a more cautious outlook than the other members. First, there was a possibility that inventory adjustment pressures might materialize, chiefly in raw material industries. Second, the recent increase in construction starts and housing starts was merely due to temporary factors, such as large-scale redevelopment projects in the metropolitan area, a rush to construct buildings before the implementation of the Law concerning the Measures by Large Scale Retail Stores for Preservation of Living Environment, and a tax reduction on housing loans. And third, there was a possibility that orders received by Japanese machinery manufacturers might decrease since, reflecting the weakening of the euro, European firms were trying to increase machinery exports to Japan. The member continued that based on an analysis of leading indicators and long-term leading indicators of composite indexes, there was a risk of the economy entering a recession in or after this autumn.

With regard to the outlook on prices, the majority of members agreed that downward pressures on prices stemming from weak demand were steadily receding, reflecting the improvement in the domestic supply-demand balance. At the same time, potential downward pressures on prices would continue to require close monitoring since a self-sustained recovery in private demand had not been confirmed yet.

As for price indexes, one member remarked that although wholesale prices were currently rising somewhat, they were expected to shift to a gentler rate of increase unless the rise in crude oil prices affected them further. Another member commented that the recent weakness in consumer prices amid a continuing increase in corporate profits at firms of all sizes seemed to indicate that the contribution of weakness in demand to the fall in consumer prices was shrinking.

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

Based on the above assessment of the economic and financial situation, members discussed the monetary policy stance for the immediate future.

Many members' view of the economic and financial situation was as follows. First, the improvement in Japan's economy was becoming distinct. Second, recovery had been observed in some areas of private demand, with business fixed investment continuing to increase gradually. Third, stock prices were generally firm, although they had been temporarily unstable. Fourth, the momentum for a self-sustained recovery in private demand had to be examined further. And fifth, attention should still be paid to downward pressure on prices stemming from weak demand, although the pressure had weakened.

Based on the above assessment, many members judged that the economy was steadily approaching but had not yet reached a situation where it could be said that deflationary concern had been dispelled.

Therefore, with regard to monetary policy for the immediate future, the majority of members considered it was appropriate to continue the zero interest rate policy.

One member considered that deflationary concern had already been dispelled, and stated that the overnight call rate target should therefore be raised to 0.25 percent--the level before the zero interest rate policy was adopted. The reasons for this were as follows. The economy had entered a self-sustained recovery phase led by private demand, and thus there was very little risk that it would return to the brink of falling into a deflationary spiral. And second, if the zero interest rate policy was continued for a long period of time when the economy was recovering, its impact would be too strong and as a result, risks, such as economic activity becoming overheated, were likely to intensify.

In response to this, many members remarked that (1) the employment and income situation, which provided the basis for private consumption, should be examined further, and (2) U.S. rate hikes and their effects on U.S. financial markets required continued monitoring. The members were also still concerned that the recovery in private demand might not be sufficiently strong to support the overall economy if fiscal expenditure decreased, and therefore judged that the economy had not yet reached a situation where it could be said that deflationary concern had been dispelled. Some of them added that there remained a discrepancy between the Bank's view of the economic situation and the market's, and the Bank should therefore continue to make efforts to reduce this discrepancy.

One of these members, however, remarked that the positive mechanism operating in the corporate sector had started to spread to the household sector, and the risk that this process would be reversed had substantially decreased. Thus, the member would like to continue assessing the economic and financial situation with a stance leaning toward terminating the zero interest rate policy. Another member felt more strongly than before that the time was approaching to terminate the policy.

Members discussed issues related to criteria for terminating the zero interest rate policy and the impact of termination on the economy.

On criteria for terminating the zero interest rate policy, one member proposed clarifying the economic situation where it could be said that deflationary concern had been dispelled. The member commented that, even before the recovery in the corporate sector had clearly spread to the household sector, one could expect positive developments in the former to gradually have a positive effect on the latter provided that production was projected to maintain high growth due to strong exports and a recovery in business fixed investment. The member considered that, in this situation, the criteria for terminating the zero interest rate policy could be satisfied.

In response to this view, another member commented as follows. A probable recovery path of the economy would start from a recovery in the corporate sector followed by an improvement in employees' income, which would in turn lead to a recovery in consumption. Nevertheless, it would be risky to focus solely on developments in the household sector, and thus it was appropriate to watch developments in aggregate demand as a whole. The member continued that business fixed investment might not increase as much as had been expected even though employees' income had stopped deteriorating. On the other hand, it might be possible to terminate the zero interest rate policy even if a recovery in employees' income was not yet clearly evident, as long as it was certain that a sustainable recovery in business fixed investment would provide the driving force for economic growth. The member, however, also added that, as other members had pointed out earlier, attention should be paid to developments in employees' income toward the summer and how it would influence consumption.

Members then exchanged views on the risks that could arise from continuing the zero interest rate policy. The member who advocated terminating the zero interest rate policy called attention to the following issues. First, recent movements in the Marshallian k (money stock divided by nominal GDP) could indicate an excess provision of liquidity by the Bank, and thus the possibility of inflationary risks intensifying in the future could not be ruled out although such risks were not observed at present. And second, if the policy was terminated after the economy had achieved a full-scale recovery, there was a risk that market participants would anticipate a significant rise in interest rates, and this could cause confusion in the markets.

In response to these points, one member stated that, at present, the focus of the discussion should be on whether deflationary risks had decreased to a sufficiently low level, and thus it was too early to shift the focus of the discussion to inflationary risks. This member continued that, in conducting monetary policy, it was important to weigh the upward risks to prices against the downward risks both of which stemmed from the strength of demand. In view of this, if the economy was expected to continue expanding, this would be a reason to raise the overnight call rate target from zero percent. Another member added that, the Bank should decide whether to terminate the zero interest rate policy when the risk of deflation had become substantially small and should not wait until inflation had occurred.

A few members including this member commented that the monetary aggregates would have to be watched closely, but since the correlation between these and prices and real output had weakened in the past few years, one might have to be more careful than before in drawing conclusions from the Marshallian k.

A different member summarized the above discussion as follows. A decision to terminate the zero interest rate policy should be made based on the present criterion of "until deflationary concern has been dispelled," and a new criterion of, for example, a clear emergence of inflationary risks, should not be adopted. The criterion of "until deflationary concern had been dispelled" adopted in April 1999 did not refer to inflationary risks because it was assumed that a decision would be based on deflationary risks. If the current extremely easy policy was continued when the economy was improving, risks such as interest rates moving sharply or economic activity becoming overheated could intensify. It was therefore important to gradually change monetary policy giving due consideration to economic developments. Termination of the zero interest rate policy could thus be interpreted as an adjustment of the extremely easy policy in line with the improvement of the economy.

There were a few comments on the effects of terminating the zero interest rate policy. One member said that, as a result of the policy, (1) term premiums on short- and medium-term interest rates had become negligible reflecting the Bank's commitment to maintain the present policy until deflationary concern had been dispelled, and (2) liquidity premiums had also disappeared due to the Bank's ample provision of funds in a flexible manner. The member was therefore concerned that, when the policy was terminated, these premiums could rise and as a result, interest rates would be pushed up by more than the increase in the overnight call rate. The member also referred to the experience of the United States and pointed out that Japan could learn from it. The U.S. economy bottomed out in 1991, and bank lending started to increase after a time lag of two years. Comments by Mr. Alan Greenspan, Chairman of the Board of Governors of the Federal Reserve System, in October 1993 suggested that U.S. banks had completed their balance-sheet adjustment. And finally in February 1994, the Federal Reserve raised the target for the federal funds rate, thereby terminating its effectively zero-percent real interest rate policy.

Another member expressed the following views on the effects of terminating the zero interest rate policy. First, rises in long-term interest rates would be limited if market participants perceived termination of the policy as a slight adjustment within the Bank's easy monetary policy stance. Second, in this case, the impact on financial institutions holding JGBs would not be significant. Third, firms would have to make higher interest payments, but this would not be too much of a burden for most industries. Fourth, the impact on the dollar-yen exchange rate would be limited as the interest rate differential between Japan and the United States was widening. Fifth, private consumption could increase as a result of higher interest income. And sixth, the effect on business fixed investment was likely to be limited.

Members also discussed how the Bank should communicate with the market. One member remarked that there seemed to be a discrepancy between the views of the Bank and the public about the conditions for terminating the zero interest rate policy, that is, the latter held a persistent belief that the zero interest rate policy would be maintained until firms' structural reform and balance-sheet adjustment were completed. Against this view, a different member argued that developments in interest rate futures showed that market participants anticipated an increase in the overnight call rate target by the end of this year, and thus they did not expect the zero interest rate policy to continue until structural reform had been completed. On this point, the first member commented that, even though market participants' views seemed to be relatively close to the Bank's, there was a possibility that the Bank's view was not fully understood in business circles, and thus the Bank should also make efforts to increase communication with business people. The majority of members including the two above members stressed that monetary policy should not be employed to deal with structural problems but should be conducted based on an overall assessment of the economy.

Many members commented that the Bank should continue to make efforts to communicate with the market. One member remarked that it was important not only to guide the market's view to converge with the Bank's but also to understand the basis for the market's view. Another member remarked that, since the market seemed to attach greater importance to factors other than economic developments, such as the outcome of international meetings and political developments, it was sufficient if the market acknowledged to a certain extent the possibility that the zero interest rate policy would be terminated and the background to this possibility.

Meanwhile, one member advocated adopting monetary base targeting accompanied by setting a target for the rate of increase in the CPI, and increasing current account balances at the Bank to achieve these targets.

The reasons for the proposal were as follows. First, from the perspective of economic cycles, the momentum of the economy seemed to be currently at its peak. However, since structural adjustment pressure was strong, demand had not yet increased significantly. Second, the effects of fiscal measures that were underpinning the improvement of the economy were expected to subside in the second half of fiscal 2000. The Bank should therefore ease monetary policy further while the effects of fiscal measures remained. Third, the U.S. financial market was showing signs of instability. Fourth, the zero interest rate policy was an inflexible policy that allowed only two courses of action --to continue it or discontinue it. Fifth, the Bank should explicitly set a target for the CPI to fulfill its responsibility for price stability. And sixth, the Bank should release projections for the factors underlying prices, such as GDP growth and economic developments, as this would help make monetary policy more forward-looking and preemptive.

V. Remarks by Government Representatives

The representative from the Economic Planning Agency made the following remarks.

(1) Japan's economy continued to improve moderately due to the effects of various policy measures and of the economic recovery in Asia. Signs of a self-sustained recovery of the economy were gradually appearing, particularly in the corporate sector. The employment and income situation, however, continued to be severe. For example, the unemployment rate remained at a historical high, and firms were continuing full-scale restructuring. Against this background, a steady recovery in private consumption had not materialized yet, and the effect of the recovery in the corporate sector had not yet spread to the household sector. In addition, there was some uncertainty in the outlook for the U.S. economy.

(2) The Government would do its utmost to steer the economy toward a full-scale recovery by realizing a smooth shift in the driving force for an economic recovery from public to private demand.

(3) The Government would like to ask the Bank to continue implementing monetary policy appropriately and in a timely manner to ensure a recovery of the economy--for example, by flexibly providing ample funds in the market giving due consideration to developments in financial markets, including the foreign exchange market.

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

(1) Japan's economy was improving moderately but remained in a severe situation with the recovery in aggregate demand remaining weak. Also, Japanese stocks had recently been unstable reflecting movements in U.S. stocks.

The Government had been implementing fiscal measures in order to realize a full-scale recovery of the economy. It would smoothly and steadily implement the budget for fiscal 2000, to realize a smooth shift in the driving force for an economic recovery from public to private demand and to achieve a full-scale economic recovery led by private demand.

(2) Given Japan's critical fiscal condition, as seen in the fact that the fiscal 2000 budget relied on debt for 38.4 percent of revenues, to achieve an ideal economy and society in the 21st century, the Government considered it essential to implement necessary measures for fiscal reform when the economy was back on a full-fledged recovery path. However, as the economy remained in a severe situation, the Government would continue to place top priority on steering it toward a recovery.

(3) The Government would like to ask the Bank to continue implementing monetary policy appropriately and in a timely manner, harmonizing its actions with the Government's measures to ensure a recovery of the economy--for example, by flexibly providing ample funds in the market giving due consideration to developments in financial markets, including the foreign exchange markets.

VI. Votes

The views of many members of the economic and financial situation were summarized as follows. First, the improvement in Japan's economy was becoming distinct. Second, recovery had been observed in some areas of private demand, with business fixed investment continuing to increase gradually. Third, stock prices were generally firm, although they had been unstable temporarily. Fourth, the momentum for a self-sustained recovery in private demand had to be examined further. And fifth, attention should still be paid to downward pressure on prices stemming from weak demand, although the pressure had weakened somewhat.

Based on this understanding, the majority of members considered it appropriate to continue the zero interest rate policy.

However, one member proposed changing the guideline for money market operations back to that employed before the adoption of the zero interest rate policy on February 12, 1999. Another member proposed adopting quantitative easing accompanied by a target for the rate of increase in the CPI and the growth rate of the monetary base.

As a result, three policy proposals were put to the vote.

Ms. Shinotsuka proposed the following as the guideline for money market operations for the intermeeting period ahead:

The Bank of Japan will encourage the uncollateralized overnight call rate to move on average around 0.25 percent.

Regardless of the above target for the call rate, the Bank of Japan will provide more ample funds, if judged necessary, to maintain the stability of the financial markets.

The proposal was defeated with one vote in favor, eight against.

Mr. Nakahara proposed the following as the guideline for money market operations for the intermeeting period ahead:

The Bank of Japan will aim at realizing a 0.5 to 2.0 percent annual increase in the CPI (excluding perishables) in the October-December quarter of 2002 as a medium-term target of price stability. In achieving this target, the Bank will raise the average balance of current accounts at the Bank in the intermeeting period ahead to about 7 trillion yen, and by continuing to increase the amount thereafter, induce approximately 15 percent annual growth of the monetary base (change from the average for the January-March quarter of 2000 to the average for the same quarter of 2001) to realize quantitative easing (expansion of the monetary base).⁵

Regardless of the above target for the monetary base, the Bank will provide ample funds should there be a risk that financial markets might destabilize, for example, should demand for liquidity surge.

5Refers to the newly defined monetary base announced on May 15, 2000. The newly defined monetary base is the total of banknotes and coins in circulation and current account balances at the Bank of Japan. Previously, the monetary base was defined as the total of banknotes and coins in circulation and reserves at the Bank.

Mr. Nakahara explained that the target dates for the CPI and the monetary base had been extended and that the targeted growth rate of the monetary base had been raised to 15 percent from 10 percent to reflect changes in its definition.

The proposal was defeated with one vote in favor, eight against.

To reflect the majority view, the chairman formulated the following proposal.

Chairman's Policy Proposal:

The guideline for money market operations in the intermeeting period ahead would be as follows, and publicized by the attached statement (see Attachment).

The Bank of Japan will flexibly provide ample funds and encourage the uncollateralized overnight call rate to move as low as possible.

Votes for the proposal: Mr. M. Hayami, Mr. S. Fujiwara, Mr. Y. Yamaguchi, Mr. S. Taketomi, Mr. T. Miki, Mr. K. Ueda, and Mr. T. Taya.

Votes against the proposal: Mr. N. Nakahara and Ms. E. Shinotsuka.

Ms. Shinotsuka dissented for the following reasons. First, the economy had entered a self-sustained recovery phase led by private demand, and thus there was very little risk that the economy would fall into a deflationary spiral. And second, if the zero interest rate policy was continued for a long period of time when the economy was recovering, its impact would be too strong and as a result, its negative side effects would be likely to intensify.

Mr. Nakahara voted against the chairman's proposal on the following grounds. First, the zero interest rate policy would not provide adequate support for the economy, as the economy was expected to recede in the second half of fiscal 2000 and public expenditure to decrease substantially from fiscal 2001. Second, under the zero interest rate policy, the only options were to continue or discontinue it. And since the basis for deciding when to end it was ambiguous, termination of the policy could trigger a substantial increase in interest rate term premiums and liquidity premiums, which might result in tighter-than-intended monetary conditions. And third, in that case, shocks to traditional industries could be much greater than expected. In view of the above, it would be appropriate to change the policy regime to quantitative easing.

VII. 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. The Board unanimously determined "The Bank's View," for publication on May 19, 2000 in the Monthly Report of Recent Economic and Financial Developments (consisting of "The Bank's View" and "The Background").⁶

6The original full text, written in Japanese, of the Monthly Report of Recent Economic and Financial Developments was published on May 19, 2000 together with the English version of "The Bank's View." The English version of "The Background" was published on May 31, 2000.

Attachment

For immediate release

May 17, 2000
Bank of Japan

At the Monetary Policy Meeting held today, the Bank of Japan decided, by majority vote, to maintain its "zero interest rate policy" to assure permeation of the effects of monetary easing.

The guideline for money market operations in the inter-meeting period ahead is as follows: