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Minutes of the Monetary Policy Meeting

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

September 20, 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 Monday, July 17, 2000, from 9:00 a.m. to 12:31 p.m., and from 1:13 p.m. to 4:01 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 Representatives Present
Mr. Y. Murata, Senior State Secretary for Finance, Ministry of Finance
Mr. E. Kawade, Director-General of the Coordination Bureau, Economic Planning Agency

Reporting Staff
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. M. Shirakawa, 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. T. Kurihara, Senior Economist, Policy Planning Office
Mr. S. Uchida, Senior Economist, Policy Planning Office

  1. The minutes of this meeting were approved by the Policy Board at the Monetary Policy Meeting held on September 14, 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 June 12, 2000

The Policy Board approved unanimously the minutes of the Monetary Policy Meeting of June 12, 2000 for release on July 21, 2000.

II. Summary of Staff Reports on Economic and Financial Developments 2

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 June 28, 2000. As a result, the overnight call rate remained steady at 0.02-0.03 percent.3

In the market, there had been upward pressure on the overnight call rate at the end of the previous week as financial institutions increased procurement of funds to accumulate reserves, anticipating termination of the zero interest rate policy at the July 17 meeting. However, as a result of massive funds provision by the Bank, the weighted average of the overnight call rate stood at 0.03 percent.

  1. 2Reports were made based on information available at the time of the meeting.
  2. 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."

1. Developments in domestic financial markets

The money market had factored in a possible increase of 0.25 percentage point in the overnight call rate target at this meeting, but expectations of a rate increase faded significantly after department store operator Sogo Co. announced on the evening of July 12 that it had filed for reconstruction proceedings under the Civil Rehabilitation Law. The decline in interest rates, however, was smaller in longer-term rates, reflecting the market's expectations that the zero interest rate policy would be terminated in August or September if it was not terminated at this meeting.

Long-term interest rates (yields on ten-year Japanese government bonds) moved in a similar manner reflecting such speculation over monetary policy. However, the market's consensus seemed to be that long-term interest rates would stay for the time being within a range of 1.6-1.9 percent regardless of whether or not the zero interest rate policy was terminated.

Despite the rise in short- and long-term interest rates, stock prices were strong reflecting firm U.S. stocks. However, they subsequently declined to almost 17,000 yen following Sogo's filing for reconstruction proceedings. Meanwhile, selling of Japanese stocks by foreign investors, which had continued since the plunge in Nasdaq stocks, lost momentum.

2. Developments in foreign exchange markets

The yen had fallen against the U.S. dollar despite growing expectations that the zero interest rate policy would be terminated. The depreciation could be attributed to the following: (1) U.S. stock prices had been firm; and (2) there had been a string of negative factors for the Japanese economy, such as the downgrading of Japanese government bonds (JGBs) by a credit-rating agency and the failure of Sogo. Some market participants considered that termination of the zero interest rate policy at this point would lead to a depreciation of the yen, as they expected termination to have an adverse effect on the Japanese economy.

C. Overseas Economic and Financial Developments

In the United States, while the economy continued to show robust expansion led by domestic demand, recent economic indicators suggested that the economy was about to slow down. Consequently, short- and long-term interest rates declined due to reduced expectations of an increase in the federal funds rate target at the next Federal Open Market Committee (FOMC) meeting on August 22. The Federal Reserve indicated that it intended to examine whether signs that economic growth was moderating would continue.

In the euro area, production trended upward led by an expansion in domestic demand and strong exports, and business confidence in the manufacturing sector reached a record high. The unemployment rate remained at a low level. Given this situation, the European Central Bank (ECB) decided to keep policy interest rates unchanged at its meeting of the Governing Council on July 6. Following the meeting, President Duisenberg told a press conference that over the coming months the rate of increase in consumer prices could continue to be affected by lagged effects of the increase in import prices, indicating that the ECB would be vigilant against inflationary risks.

In NIEs and ASEAN countries, business fixed investment as well as private consumption continued to improve. This could be attributed to the following factors: (1) exports of information technology (IT)-related goods to the United States, Japan, and other countries had been buoyant; and (2) the effects of economic stimulus measures in NIEs and ASEAN countries had permeated throughout these countries. Meanwhile, reflecting a delay in their structural reforms, the currencies of Indonesia, the Philippines, and Thailand had depreciated and the yield spreads between their government securities and U.S. Treasury securities had expanded.

D. Economic and Financial Developments in Japan

1. Economic developments

With regard to exogenous demand, net exports continued to follow a moderate upward trend, and public investment seemed to be picking up. As regards domestic private demand, business fixed investment was increasing. The recovery in private consumption continued to be weak as a whole, although there were somewhat positive signs in some indicators. Housing investment was mostly unchanged.

Reflecting these developments in final demand, production was increasing, and corporate profits and sentiment continued to improve. In the manufacturing sector in particular, the momentum of the virtuous circle was strong with growing demand at home and abroad, mainly for IT-related products, beginning to induce increases in the business fixed investment of small firms in addition to large firms. The income situation of households remained severe. However, the decrease in the number of employees and in wages was slowing, as the recovery in corporate activity was starting to have a favorable effect on the household sector as seen in the increase in overtime payments and new job offers.

As described above, Japan's economy was recovering gradually, with corporate profits and business fixed investment continuing to increase. The Bank's staff upgraded their view of the current economic situation as the June Tankan (Short-Term Economic Survey of Enterprises in Japan) confirmed that (1) a virtuous circle was operating between exports, production, profits, and business fixed investment, mainly in the manufacturing sector, and (2) small firms had successively revised their business fixed investment plans upward.

With regard to prices, domestic wholesale prices were unchanged. Consumer prices remained somewhat weak on the whole owing to a decline in prices of imported products and of domestic products competing against imported goods. The decline in corporate service prices expanded temporarily partly due to a reduction in communications charges.

The key to a sustainable economic recovery would be whether demand other than public investment would be able to make up for the expected decrease in public investment. However, it was likely that the gradual recovery of the economy would continue given the following factors. First, exports were likely to continue increasing driven by strong demand for IT-related products and a robust world economy. Second, business fixed investment in IT-related areas was likely to continue increasing, and small firms were likely to revise their business fixed investment plans for fiscal 2000 upward judging from the past relationship between profits and business fixed investment. Third, as the risk of a deterioration in consumer confidence resulting from concerns over unemployment had decreased, private consumption was expected to start improving gradually provided that there was a clear increase in employees' income. Employees' income, mainly regular and overtime earnings, was likely to increase very moderately in line with production activity, although significant increases in bonus payments could not be expected for the time being. And fourth, a decrease in public investment was unlikely to trigger a large-scale inventory adjustment. This was because manufacturers of public investment-related goods were maintaining a cautious stance toward production, while the electrical machinery industry, which was enjoying buoyant demand, had been increasing inventories in line with an increase in shipments.

Attention should be paid to the fact that, in IT-related areas--which were promoting the positive interaction between exports, production, profits, and business fixed investment--firms were expanding production capacity not only in Japan but also overseas. Therefore, if the expansion in production capacity exceeded growth in demand and prompted a plunge in prices of IT products, the economy could be seriously damaged through a negative interaction. Nevertheless, the risk of this happening was small in the foreseeable future as demand was strong at present. In addition, the failure of Sogo was unlikely to increase unemployment significantly or trigger a chain of bankruptcies. One point of concern was whether the Sogo's failure would dent consumer confidence and corporate sentiment more seriously than expected. This issue should continue to be monitored carefully.

With regard to factors determining the outlook for prices, the domestic supply-demand balance was expected to continue improving. Against this background, downward pressure on prices stemming from weak demand was declining significantly. However, the streamlining of distribution channels and deregulation as well as technological innovation would exert downward pressure on prices. Given the above situation, price indexes overall were expected to move sideways or trend slightly downwards.

2. The financial environment

Private banks basically maintained a cautious lending stance. Major banks, however, were becoming more willing to increase lending according to anecdotal information and various diffusion indexes. The environment for corporate financing via such instruments as corporate bonds and commercial paper (CP) remained favorable, but some signs of change were being observed such as the emergence of expectations of a possible rise in interest rates and increased awareness of credit risk. For example, there had been a rush to issue CP by firms anticipating an increase in interest rates, and the credit spread, which had previously been narrowing, had expanded slightly. These developments, though still not significant, were considered important points to look out for in future monitoring of capital markets.

Meanwhile, credit demand in the private sector remained stagnant. As a result, private bank lending had been basically weak and issuance of corporate bonds and CP remained stable.

As a result, the year-on-year growth rate of money stock remained at around 2 percent. Growth in the July-September quarter was expected to be somewhat weaker than that in the April-June quarter.

Against this background, firms recently saw the lending attitude of financial institutions as having become less severe, which was evidence that corporate financing conditions were easing. A survey by National Life Finance Corporation revealed that the financing conditions of small firms, and their perception of the lending attitude of financial institutions both of which had been lagging behind compared to larger firms, were starting to improve.

Recently, the number of bankruptcies had been around 1,500-1,600 per month, and one notable feature was that construction firms were accounting for an increasing proportion.

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

A. The Current Economic Situation and the Economic Outlook

Members discussed the current economic situation and the economic outlook based on the results of economic indicators released since the previous meeting on June 28, including the June Tankan.

One member expressed the view that public investment would decrease moderately in the future, although it was increasing somewhat at present due to the implementation of projects funded by the supplementary budget for fiscal 1999. This member continued that housing investment had been decreasing slightly on a year-on-year basis but this was not acting as a restraint on economic growth. As for exports, this member was of the view that judging from year-on-year changes in exports and imports, net exports were continuing to follow an upward trend.

Regarding the corporate sector, most members shared the view that the recovery had become clear and was spreading to a wider range of industries and to smaller firms, as shown in the June Tankan.

One member stated that production was clearly on a recovery path, judging from positive signs such as the increase in business fixed investment, in addition to a rise in exports. A few members further commented that the uptrend in both corporate profits and sales was becoming firmer.

Many members exchanged views on the uptrend in business fixed investment and the extent to which it was spreading. Some members noted that in the June Tankan, firms belonging to a wider range of industries than in the previous one had revised their investment plans upward. In their opinion, capital spending plans were likely to be revised upward further considering the current situation of production and profits. One of these members commented that this view was consistent with developments in leading indicators, such as machinery orders. Another member was of the opinion that machinery orders for the July-September quarter were likely to be firm, judging from a forecast of machinery orders compiled by the Japan Machinery Federation. Furthermore, one member commented that IT-related fixed investment had spread to raw materials producers and small firms.

Following the above discussion, members generally shared the view that the momentum for recovery in the corporate sector had further strengthened.

However, one member expressed a more cautious view than the other members for the following reasons: (1) growth in business fixed investment would be restrained when firms paid greater attention to return on assets; and (2) IT-related investment would provide support to the economy to a lesser degree than in the United States, since the output of IT-related industries accounted for only about 15 percent of industrial production in Japan.

Many members agreed that the recovery in the corporate sector was gradually affecting the household sector recently and that an improvement in the employment and income situation was starting to appear. Some members, however, remarked that they would like to examine various indicators for June, which would incorporate the effects of summer bonus payments, before making a final assessment of the trend in the employment and income situation.

A few members said that the outlook for the employment situation was encouraging, although pressure arising from corporate restructuring still existed. One of these members remarked that various indicators released recently, such as the unemployment rate, the ratio of job offers to applicants, the ratio of new job offers to new applicants, and the number of new job offers, showed an improvement in the employment situation. An exception was the number of regularly employed, which was declining slightly year on year. Another member commented that the number of employed was expected to stop declining, as the number of new job offers was increasing even in industries where the number of regularly employed was falling, such as manufacturing, wholesaling and retailing, and services. Regarding the unemployment rate, a different member remarked that the fall in the employment rate and the rate of job vacancies being filled suggested that a significant fraction of unemployment was attributable to a mismatch between supply and demand in the labor market rather than a lack of demand. In response to this, another member pointed out that the labor-force participation ratio was falling (i.e., the number of people aged fifteen and above who were not looking for a job was rising). This member said that although the unemployment rate was falling, the real situation could be far worse than the figure suggested. Another member held a cautious view that the downside risks regarding the employment situation would remain since the corporate sector was still under pressure to restructure.

As for the income situation, some members were of the view that nominal wages per capita had started to increase moderately. Members generally agreed that regular and overtime earnings were increasing slowly but steadily with (1) overtime earnings continuing to increase due to a rise in production, and (2) regular cash earnings increasing by about 1 percent year on year since the turn of the year. With regard to special cash earnings, some members were of the view that summer bonus payments were likely to be around the same level as a year earlier, judging from the results of various surveys. In response to this, some other members said that they would like to wait for economic indicators for June, which would be released in late July, before making a final judgment on the income situation.

One member remarked that the view that labor's share in income distribution would not decline unless personnel expenses were reduced was wrong. The member explained that various simulation analyses, based on the assumption that sales would grow in line with forecasts in the Tankan survey, showed that labor's share in income distribution would decline to the level before the bubble period in about two years if companies somewhat restrained growth in personnel expenses.

A member commented that spending by consumers remained in line with their disposable income as evident in the fact that the propensity to consume had generally stayed within a range of 70-72 percent. The member added that consumption was recovering to normal levels. A different member noted that the propensity to consume had been improving gradually since the turn of the year, pointing out the fact that the index of living expenditure level for May had risen for the second consecutive month. This member, however, added that some indicators of consumer sentiment had stopped improving reflecting recent developments in stock prices and the very slow improvement in the employment and income situation.

Taking into account the above circumstances, many members expressed the view that private consumption could be expected to improve modestly in the future, although it lacked momentum at present. One member pointed out that employees' income, which had decreased in previous years, had begun to increase, albeit slowly, since the turn of this year and this trend had become clearer in the past few months. Private consumption could therefore be expected to contribute to economic growth, even if the propensity to consume remained at the same level. Another member said that the risk that private consumption would deteriorate sharply had almost disappeared although (1) structural as well as cyclical factors were having a large effect on private consumption and (2) it was likely to take some time for the employment and income situation to improve given firms' efforts to make structural adjustments. This was because a number of factors supportive of private consumption such as a recovery in corporate profits, an uptrend in total cash earnings, a fall in the unemployment rate, and stable consumer prices had emerged.

In response to this, one member who had a cautious view of the economy made the following three points. First, consumer sentiment had not improved, as was evident in the Bank's opinion survey on lifestyle and financial behavior, which showed that the proportion of households answering that they were reducing expenditure had changed little since 1998. Second, the implementation of the Civil Rehabilitation Law and discussions by the Tax Commission showing an inclination toward an increase in taxes were having a negative effect on consumer sentiment. And third, there was a strong correlation between the trend in bankruptcies and the consumption of households whose main earners were employed by small firms or self-employed. The main reason for the recent increase in bankruptcies was weak sales, and this was related to sluggishness in nominal GDP growth.

On the basis of the above discussion, members generally shared the judgment on the economic situation that "Japan's economy is recovering gradually, with corporate profits and business fixed investment continuing to increase," which represented an upgrading of their view of the economic situation from that of the previous meeting.

One member commented that although the economy had not yet achieved solid, sustainable growth led by a self-sustained recovery in private demand, the prospects for such growth were increasing, and thus the economy was on a recovery track.

At the meeting, various views were exchanged on the sustainability of a recovery led mainly by business fixed investment.

One member made the following comments with regard to the sustainability of the current economic recovery from the perspective of the business cycle. First, the average length of economic expansion phases in the past was 34 months. Second, some economic expansions had ended after about two years, but all of these had either been affected by a major external shock, such as an oil crisis, or had been expansions with limited growth in business fixed investment. And third, although business fixed investment had started to increase clearly, growth in capital stock remained low. Judging from this and the rapid progress in technological innovation, it was unlikely that pressure to adjust capital stock would increase in the near future. This member and a different member added that the view that the economy would soon enter a phase of inventory adjustment was overly pessimistic given that the inventory cycle was still in an early stage.

A different member was of the view that unless there was a significant external shock, the virtuous circle led by business fixed investment was very likely to continue. This member compared the recent economic situation with the situation in 1997 and remarked that they differed. The economic slowdown in 1997 was due mainly to (1) problems in Japan's financial system, (2) the financial crisis in Asia, and (3) a shift in fiscal policy. In contrast, at present the financial system was in significantly better shape than around 1997-98, although there were still problems to be solved. The member also pointed out that the virtuous circle in the economy led by business fixed investment was likely to continue, even if there was no supplementary budget this year, because the recent increase in business fixed investment was mainly in IT-related areas and was not fueled by government expenditure. This member added that one need not expect a large negative impact on exports in the near future, although the extent of the slowdown in the U.S. economy was still uncertain, since the growth rate of overseas economies as a whole was continually being revised upward.

Members discussed the impact of Sogo's filing for reconstruction proceedings under the Civil Rehabilitation Law.

Members generally agreed that the negative impact from the failure of Sogo would be limited because (1) creditor banks had already set aside reserves for possible losses arising from loans to Sogo on the assumption that a debt-waiver scheme would be applied, and (2) a chain-reaction of bankruptcies among suppliers to Sogo was likely to be limited partly because small-lot claims on Sogo would be protected.

Members discussed from various angles the impact of the sudden change in the scheme for the reconstruction of Sogo. One member commented that the core of this issue was who would bear the losses already incurred. Therefore, the impact on the economy would be more or less the same irrespective of whether a debt-waiver scheme was applied or Sogo filed for reconstruction proceedings. A few other members were of the view that the risk was small that this issue would trigger concerns over the financial system or a credit crunch and have a negative impact on the economy as a whole. One of these members said that financial institutions were assumed to be deciding their lending and business policies based on an accurate assessment of the situation of financially troubled firms. Therefore, the lending attitude of financial institutions was unlikely to be affected seriously.

Many members commented on the psychological effects of the issue. One member pointed out that there was strong concern over balance-sheet problems of certain sectors. This member and some other members said that it would be better to monitor for a while how the sudden change in Sogo's reconstruction scheme would affect market developments and business sentiment.

In response to the above arguments, one member commented that (1) the failure of Sogo might trigger full-scale structural reform and lead to a third financial crisis following those of 1994-95 and 1997, and (2) the fact that firms with low stock prices held a large amount of debt was cause for concern.

With regard to the economic outlook, members generally shared the view that the economy was likely to recover gradually, led mainly by business fixed investment, unless there were major adverse external shocks.

Based on the above discussion, members generally shared the view that downward pressure on prices stemming from weak demand was declining significantly.

Many members expressed the view that it was almost certain that the supply-demand gap would shrink in the near future as it was becoming more likely that economic growth in fiscal 2000 would be relatively high. One of these members, however, said that the supply-demand gap calculated using a production function remained large, and one could not rule out the possibility that downward pressure on prices, even if it weakened, would remain. In response to this view, a different member remarked that (1) the economy normally overcame the large supply-demand gap that existed when it hit bottom and started to turn around, and (2) therefore, in assessing the outlook for prices, it was more important to focus on the momentum of the recovery centering around business fixed investment even though there was a large supply-demand gap.

On the background to developments in various price indexes, many members presented their analyses of the actual data to see whether downward pressure from weak demand still existed.

With regard to the recent rise in domestic wholesale prices on a year-on-year basis, one member said that, even if the effect of rising crude oil prices was discounted, there was increasing evidence that they had stopped falling. A different member pointed out the fact that domestic wholesale prices had been rising from a year earlier for the first time since the bursting of the economic bubble suggested that corporate activity had become buoyant. Another member expressed the view that judging from developments in wholesale prices, downward pressure stemming from weak demand had almost disappeared.

As regards the continued moderate fall in consumer prices on a year-on-year basis, one member said that given that prices in Japan were still too high compared with prices in other countries, the decline seemed to reflect falls in prices caused by the IT revolution and rationalization of the distribution system, and price falls caused by these factors should be distinguished from those caused by weak demand. Another member was of the view that the main causes of the recent downtrend in consumer prices were a fall in unit labor cost (wages per person divided by productivity) in the supply side and the distribution revolution. The member continued that although the moderate downtrend in consumer prices was expected to continue for a while, this should not be described as deflationary because at the same time corporate profits were increasing. A different member commented that the results of the Tankan showed that firms' perception of output prices was not improving, while their perception of supply and demand conditions for products was improving moderately. This member continued that these developments came against a background of (1) a narrowing of the price differential between Japan and abroad, (2) technological innovation, and (3) the distribution revolution. The member said that given that corporate profits were increasing and employees' income was not decreasing, there was no deflationary risk even if consumer prices weakened. Another member commented that falls in unit labor cost are caused by a rise in productivity and/or a fall in wages, and the latter may reflect a supply-demand gap. Thus, in order to be certain, it would be better to wait for the release of information on the level of summer bonus payments before judging whether wages overall had stopped falling. A different member was of the view that it was necessary to further examine the background to the fall in consumer prices.

One member pointed out that deflationary pressure on some corporate service prices, such as those for real estate and general services, persisted. The member continued that the excess of office buildings and facilities built during the investment boom that started in the second half of the 1980s could be having a large impact on office rents and commercial land prices. The member, however, added that it was important to examine overall prices rather than focusing on the issue of structural deflationary pressures observed in certain sectors.

One member commented that, positive developments were emerging in land prices reflecting the economic recovery. This member pointed out that the rate of vacancies in buildings was falling mainly in Tokyo, and according to some surveys the bottoming out of residential land prices in Tokyo and Nagoya was becoming clear.

Another member expressed a cautious view of the economy on the following grounds. First, although the economy was recovering and the coincident indicators of the composite index were approaching the level of the previous peak in March 1997, it seemed to lack strength. Second, judging from the ratio of the coincident indicators to the lagging indicators for business conditions and the deterioration in the terms of trade, the economy might start declining from around October to December 2000. The member added that (1) although crude oil prices were falling recently, they could start rising from the early autumn to winter unless oil-producing countries boosted production and increased inventories, and (2) in the United States, the rise in crude oil prices could create cost-push inflation, and it was likely that the Federal Reserve was paying attention to this risk.

B. Financial Developments

On the financial front, members discussed the impact of developments related to Sogo on the stock market and other financial markets and their assessment of the financial environment.

With regard to the impact of the failure of Sogo and the commencement of reconstruction proceedings, a few members pointed out that Japanese stocks fell on the day after the announcement of these developments but rose thereafter. Another member commented that, if financial markets were seriously destabilized by this shock, the member would have to take into consideration the impact that structural problems might have on the business cycle via financial markets. However, recent developments in various markets indicated that the present case at least might not make such a change in thinking necessary. The member, however, added that it was important to pay close attention to developments in the financial markets to see whether the current trend in the markets would continue. A different member commented that some investors considered the commencement of Sogo's reconstruction proceedings as a positive sign that the economy was undergoing structural reform, but at the same time, it was causing some concern in the markets in the short term. On these grounds, members generally agreed that it was appropriate to wait a little while longer for clearer signs that financial markets had overcome the shock and had become stable.

One member pointed out that the financial environment was improving steadily, as revealed in a survey on how firms perceived their financial position and banks' lending stance. The member pointed out that judging from firms' credit demand and banks' current lending stance, firms' financing conditions would remain favorable even if the zero interest rate policy was terminated. Another member commented that it would take some time for firms' demand for external funds to rise as the level of their fixed investment was lower than their cash flow. In other words, it could be said that a slight increase in fund-raising costs would not significantly damage the environment for corporate financing.

One member further mentioned the fact that a foreign credit-rating agency had downgraded JGBs. This member considered that the move reflected concern over the continued increase in fiscal expenditure; theoretically, government debt explodes if the nominal rate of economic growth continues to be lower than yields on government bonds.

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

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

Many members' view on the economic and financial situation was as follows. First, Japan's economy was recovering gradually, with corporate profits and business fixed investment continuing to increase. Second, the financial environment remained favorable. Third, the economy was likely to recover gradually led mainly by business fixed investment unless there were major adverse external shocks. And fourth, downward pressure on prices stemming from weak demand was declining significantly.

On the basis of the above assessment, many members generally agreed that the economy was coming to a stage where deflationary concern was dispelled.

For example, many members expressed such views as "it can be said that a self-sustained recovery path of private demand is in sight," "the condition for terminating the zero interest rate policy--the disappearance of deflationary concern--has been satisfied," and "the economy is coming to a stage where the zero interest rate policy can be terminated."

However, many members were of the opinion that the Bank should take some more time to assess the effect of the failure of Sogo on market sentiment before deciding to terminate the zero interest rate policy. Some of them pointed out that the failure of Sogo could also have a negative impact on the sentiment of firms and consumers. One member, cautioning against focusing on individual firms, expressed the view that the public was concerned about the structural problems of certain sectors, symbolized by Sogo's failure. This member continued that, in the circumstances, the possibility could not be ruled out that terminating the policy at this meeting would negatively affect corporate sentiment. Thus, termination of the policy should not be decided at this meeting. Another member also remarked that it would be difficult to reach a decision at this meeting given the current economic situation and the potential psychological impact of the failure of Sogo on business and financial circles.

The following view was also put forward. Termination of the zero interest rate policy was not the first step toward monetary tightening, but it was the first rise in the policy rate in about ten years. Therefore, it was desirable to ensure the judgment on the firmness of economic conditions. With regard to employment and household income, some members specifically pointed out that the current level of wages including summer bonus payments should be examined further. One member also added that, in addition to this, developments in the consumer price index (CPI) should be monitored a little while longer. Further, the member called for attention to the findings of studies mentioned at the last meeting on the optimal interest rate based on the Taylor Rule. The member remarked that the risk that the decline in prices stemming from weak demand would accelerate had become extremely small. However, the optimal interest rate derived from the Taylor Rule, which should be viewed with a certain amount of latitude, had only just risen to a level around zero. In the circumstances, the Bank could maintain the zero interest rate policy until the optimal interest rate had risen clearly above zero.

Based on the above discussion, the majority of members considered that at this meeting it was appropriate to decide to continue the zero interest rate policy.

In response to this, one member commented that a self-sustained recovery of the economy was in prospect, and therefore the Bank should terminate the zero interest rate policy at this meeting. The member commented that, in a situation where the economic outlook was uncertain, the following two risks could emerge if the zero interest rate policy was continued until it was absolutely or almost certain that the economy was no longer in danger of falling into deflation. First, if external shocks occurred, the Bank could be forced into adopting unorthodox policies, such as underwriting of JGBs. And second, the market could overreact when the policy was terminated. Therefore, monetary policy should be fine-tuned in line with the recovery of the economy using economic forecasts based on accurate analysis of data. Through such efforts the Bank could build a strong track record and enhance its credibility.

Meanwhile, a few members expressed the view that termination of the zero interest rate policy would not conflict with the stance of fiscal policy. One of them commented that monetary policy would continue to be accommodative even after termination of the zero interest rate policy, and therefore the Bank needed to explain thoroughly that it was conducting accommodative monetary policy that was compatible with the Government's economic policy. The member also pointed out that the contribution of public investment to economic growth had declined quarter on quarter for three consecutive quarters from July-September 1999. Another member added that the United States, which had been hoping for an expansion in Japan's domestic demand, was likely to understand that even if the zero interest rate policy was terminated, the Bank would continue its extremely easy monetary policy until the recovery of private demand became firm.

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 this were as follows. First, the current recovery of the economy was mostly underpinned by exogenous demand, such as fiscal expenditure and exports. However, the effects of fiscal expenditure would diminish from early autumn without significant support from a supplementary budget. Therefore, monetary policy should be eased further to accelerate economic growth to its potential rate. Second, economic recovery was not yet widespread in small enterprises. Third, it was feared that the failure of Sogo would have a negative impact on such sectors as construction, real estate, and distribution, and further damage consumer and corporate sentiment. And fourth, falls in land prices were accelerating, and growth of money stock was slowing. Furthermore, the member commented that termination of the zero interest rate policy implied that the time frame effect would disappear and the de facto quantitative easing would end.

V. Remarks by Government Representatives

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

(1) Japan's economy continued to improve moderately, but the employment situation remained severe. Private consumption had been more or less unchanged. Although the improvement in business fixed investment had recently become clearer, its sustainability and the extent to which it would spread would continue to require close monitoring. It was not yet clear whether the recent substantial improvement in corporate profits would lead to an improvement in the employment and income situation and an increase in private consumption. Under these circumstances, the impact on the labor market and the economy of the recent bankruptcy of a major corporation warranted attention. Regarding prices, the GDP deflator and the CPI continued to decrease year on year. The economy therefore required further monitoring to determine whether deflationary concern had been dispelled and a full-scale recovery of the economy led by private demand could be achieved.

(2) The Government would continue to place top priority on steering the economy toward recovery, and, to this end, had promptly made a decision to use the contingency fund for public works. 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. Since the outlook for the economy was not clear yet, the Government considered it appropriate to decide future fiscal policy after studying preliminary GDP data for the April-June quarter.

(3) The Government explained its economic policy stance as above at the meeting of G-7 finance ministers held in July and considered it had gained the understanding of other G-7 countries. The Government would continue to conduct appropriate economic management.

(4) The Government would like to ask the Bank to continue conducting 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 market.

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

(1) The Government's judgment of Japan's economy was that it continued to improve moderately due to the effects of various policy measures and of the economic recovery in Asia. Movements toward a self-sustained recovery of the economy were gradually strengthening, particularly in the corporate sector. However, the employment situation remained severe, and private consumption remained generally unchanged. The number of bankruptcies had increased recently, and thus attention needed to be paid to the effect, including the psychological impact, of developments in interest rates on the economy.

(2) There were various factors that made it hard to predict the course of the economy, such as developments in the world economy, including the U.S. economy, and their effect on the foreign exchange and stock markets, developments in long-term interest rates, a possible rise in the yen's exchange rate, the sustainability of business fixed investment and the extent to which it would spread to various industries, an acceleration in the pace of corporate restructuring, the effects of mergers and acquisitions in the financial sector and the disposal of nonperforming assets on corporate activity, and a reduction in social infrastructure investment by local governments.

(3) The Government would compile a new set of economic measures to achieve the objectives laid down in the Plan for the Rebirth of Japan, which aimed to put the economy on a self-sustained recovery track and create the economic and social foundation for development in the 21st century.

(4) The Government would like to ask the Bank to continue conducting monetary policy that would contribute to an economic recovery--for example, by flexibly providing ample funds in the market giving due consideration to developments in financial markets, including the foreign exchange market.

VI. Votes

The views of many members on the economic and financial situation were summarized as follows. First, Japan's economy was recovering gradually, with corporate profits and business fixed investment continuing to increase. Second, the financial environment remained favorable. Third, the economy was likely to recover gradually led mainly by business fixed investment, unless there were major adverse external shocks. Fourth, downward pressure on prices stemming from weak demand was declining significantly. And fifth, it could thus be considered that the economy was coming to a stage where "deflationary concern is dispelled," the condition for terminating the zero interest rate policy. However, there were views that, before reaching a final decision to lift the zero interest rate policy, it was desirable to ensure the judgment on the firmness of economic conditions, including employment and household income. In addition, it was pointed out that the Policy Board needed to see how the commencement of Sogo's reconstruction proceedings could affect market developments and business sentiment.

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.

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).

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.

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 1).

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 zero interest rate policy was an extreme monetary measure adopted when the economy was on the brink of falling into a deflationary spiral. Thus, if it was continued when the economy was recovering, the risk of large fluctuations in the economy would increase in the future. Second, in order to achieve a sustainable economic expansion, the degree of monetary easing should be adjusted in line with changes in the economic situation. And third, although uncertain factors in the future such as the effect of the failure of Sogo on economic developments required continued monitoring, the zero interest rate policy should be terminated if it was likely that the economy would recover.

Mr. Nakahara voted against the chairman's proposal on the following grounds. First, although the supply-demand gap was narrowing, it was still large. Second, the rate of decline from the previous year in the CPI and the GDP deflator was increasing. And third, the Bank could not conduct a forward-looking and preemptive policy without a clear target for the CPI or clear projections for GDP growth.

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. By majority vote, the Board determined "The Bank's View," for publication on July 19, 2000 in the Monthly Report of Recent Economic and Financial Developments (consisting of "The Bank's View" and "The Background").4

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

Vote against the proposal: Mr. N. Nakahara.

Mr. Nakahara dissented for the following reasons. First, the supply-demand gap remained large, and this showed that downward pressure on prices stemming from weak demand was not declining significantly as stated in the report. Second, considering the developments in the CPI and the GDP deflator, too much emphasis should not be placed on the decline in downward pressures on prices. And third, it was difficult to distinguish between benign and malignant price declines. Furthermore, it was not clear how one should measure either type.

  1. 4The original full text, written in Japanese, of the Monthly Report of Recent Economic and Financial Developments was published on July 19, 2000 together with the English version of "The Bank's View." The English version of "The Background" was published on July 31, 2000.

VIII. The Release of a Statement on the Current Monetary Policy

Many members held the view that it would be appropriate to release a statement on the Bank's decision reached at this meeting, considering the fact that this meeting was attracting a lot of attention and the market had once almost fully priced in termination of the zero interest rate policy. Publication of a statement was therefore put to the vote. By majority vote, the immediate release of the statement, "On the Current Monetary Policy" (see Attachment 2), was decided.

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

Vote against the proposal: Mr. N. Nakahara.

Mr. Nakahara dissented for the following reasons. First, no policy change was made at the meeting. Second, the statement contained many ambiguous expressions, and it did not include any specific conditions or figures that when satisfied or achieved would allow termination of the zero interest rate policy. And third, although the Bank, aiming at enhanced communication with the market, had fueled expectations within the market that the zero interest rate policy would be terminated, it was doubtful that the statement would help the market and the public understand the process by which the Bank had arrived at the decision to continue the current policy at this meeting.

Attachment 1

For immediate release

July 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:

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

Attachment 2

July 17, 2000
Bank of Japan

On the Current Monetary Policy

  1. (1) At the Monetary Policy Meeting held today, the Bank of Japan decided to maintain its "zero interest rate policy."
  2. (2) The Policy Board views that Japan's economy is recovering gradually, with corporate profits and business fixed investment continuing to increase. The Policy Board also judges that the economy is likely to recover gradually led mainly by business fixed investment, unless there are major adverse external shocks.
  3. (3) With regard to the prices, the Policy Board views that the downward pressure on prices stemming from weak demand is declining significantly while an economic recovery is expected to continue moderately.
  4. (4) Given the above considerations, the majority of the Policy Board views that Japan's economy is coming to a stage where deflationary concerns are dispelled, which the Board have clearly stated as the condition for lifting the zero interest rate policy.
  5. (5) At the Meeting, however, some views were expressed that before reaching a final decision to lift the zero interest rate policy, it was desirable to ensure the judgment on the firmness of economic conditions including employment and household income. Besides, it was pointed out that the Board needed to see how the commencement of reconstruction proceedings of Sogo Co. could affect market developments and business sentiments.
  6. (6) Taking account of these factors, the Policy Board decided, by majority vote, on the maintenance of the zero interest rate policy.