Minutes of the Monetary Policy Meeting

on March 19, 2001
(English translation prepared by the Bank's staff based on the Japanese original)

May 1, 2001
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, March 19, 2001, from 9:01 a.m. to 12:12 p.m., and from 1:01 p.m. to 5:27 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 Japan²
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. S. Murakami, Senior Vice Minister, Ministry of Finance
Mr. K. Iwata, Director General for Economic Assessment and Policy Analysis, Cabinet Office³
Mr. T. Sakai, Senior Vice Minister, Cabinet Office⁴

Reporting Staff
Mr. M. Matsushima, Executive Director
Mr. M. Masubuchi, Executive Director
Mr. S. Nagata, Executive Director
Mr. M. Shirakawa, Advisor to the Governor, Policy Planning Office
Mr. M. Amamiya, Chief Manager, Planning Division 1, Policy Planning Office
Mr. T. Umemori, Chief Manager, Planning Division 2, Policy Planning Office⁵
Mr. I. Yamashita, Director, Financial Markets Department
Mr. T. Kurihara, Manager, Financial Markets Department⁶
Mr. H. Hayakawa, Director, Research and Statistics Department
Mr. T. Yoshida, Senior Manager, Research and Statistics Department
Mr. E. Hirano, Director, International 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. S. Uchida, Senior Economist, Policy Planning Office
Mr. S. Nagai, Senior Economist, Policy Planning Office

1. The minutes of this meeting were approved by the Policy Board at the Monetary Policy Meeting held on April 25, 2001 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.
2. Mr. Fujiwara was absent from 9:27 a.m. to 10:55 a.m. due to his attendance at a Diet session.
3. Mr. Iwata was present from 9:01 a.m. to 12:12 p.m.
4. Mr. Sakai was present from 1:01 p.m. to 5:27 p.m.
5. Mr. Umemori was present from 9:01 a.m. to 9:18 a.m.
6. Mr. Kurihara was present from 9:01 a.m. to 9:39 a.m.

I. Approval of the Minutes of the Monetary Policy Meeting Held on February 9, 2001

The Policy Board approved unanimously the minutes of the Monetary Policy Meeting of February 9, 2001 for release on March 23, 2001.

II. Decisions on a Revision of the "Rules and Criteria for Selecting Counterparties for the Purchase of Bills"

A. Staff Proposal

The Bank's staff proposed revising the "Rules and Criteria for Selecting Counterparties for the Purchase of Bills" (decided on April 27, 2000), in order to select counterparties for bill purchasing operations conducted at all of the Bank's business offices and those conducted only at the head office in accordance with the "Principles Regarding Revision of Bill Purchasing/Selling Operations" (decided on April 27, 2000) and "Improvements in the Way of Liquidity Provision and Reduction in the Official Discount Rate" (decided on February 9, 2001).

B. Members' Discussion and Votes

Members unanimously approved the proposal and decided that the decision should be made public.

III. Summary of Staff Reports on Economic and Financial Developments⁷

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 February 28, 2001.⁸ As a result, the overnight call rate was generally steady at around 0.15 percent. Since the previous meeting, the market's concern about the availability of funds maturing beyond the fiscal year-end had been subsiding due to the Bank's implementation of measures to facilitate liquidity provision including the introduction of a complementary lending facility, in addition to the Bank's provision of ample funds.

1. 7Reports were made based on information available at the time of the meeting.
2. 8The guideline was as follows: The Bank of Japan will encourage the uncollateralized overnight call rate to move on average around 0.15 percent.

B. Recent Developments in Financial Markets

Stock prices had fallen significantly: the Nikkei 225 Stock Average and TOPIX (Tokyo Stock Price Index) fell below 12,000 yen and 1,200 points respectively, reflecting a sharp fall in U.S. Nasdaq stocks following a string of downward revisions in the earnings forecasts of information technology (IT)-related firms. Prices of bank stocks had fallen further in response to a growing view that unrealized losses on their stock holdings had increased. Looking ahead, although factors typical of the fiscal year-end that caused deterioration in the supply-demand balance--sales of stocks to realize capital gains before firms closed their books and unwinding of cross-shareholdings--had subsided, many market participants expected that downward pressure on stocks was likely to continue for a while as (1) instability in U.S. stock prices was growing, and (2) an increasing number of Japanese firms were announcing downward revisions to their earnings forecasts.

Regarding short- and long-term interest rates, the following developments were observed. Term rates in the money market had fallen sharply due, in addition to the rate cut by the Bank at the previous meeting, to the market's growing anticipation of a further monetary easing. As a result of this sharp fall and investors' strategy of increasing the duration of their portfolios in the face of limited investment opportunities, long-term interest rates had fallen markedly and the yield curve had flattened slightly.

As for indicators showing credit risk, credit spreads between corporate debts and government bonds had been generally unchanged and the Japan premium remained at around zero. However, spreads between U.S. Treasury securities and some preferred debentures issued by overseas affiliates of Japanese banks had widened.

In the foreign exchange market, the yen had slid against the U.S. dollar, reflecting the sharp fall in Japanese stock prices and the further decline in short- and long-term interest rates. As for the outlook, many market participants expected that the yen would depreciate further for a while as (1) firms had almost completed sales of foreign currency-denominated assets aimed at realizing capital gains before closing their books at the fiscal year-end, and (2) Japanese government officials had made comments suggesting they would tolerate a weaker yen.

C. Overseas Economic and Financial Developments

The U.S. economy had continued to decelerate. Specifically, firms were adjusting their inventories in response to a slowdown in final demand and production was on a declining trend. Orders for capital goods, a leading indicator of business fixed investment, were decreasing, and the increase in orders for IT-related goods was slowing. In the household sector, retail sales, although showing volatile movements, followed a downward trend reflecting sluggish consumer confidence.

Against this background, private research institutes had successively revised downward their forecasts for the U.S. economy. However, most of them still expected that the economy would recover to close to its potential growth rate in the second half of 2001. Many of these forecasts, however, were based on the following somewhat optimistic assumptions: (1) inventory adjustments would be completed in the first half of 2001; (2) the scale of capital stock adjustment would not be large; and (3) consumption would remain firm and the savings rate would stay below zero percent.

In U.S. financial markets, stock prices had continued to decline with significant fluctuations mainly led by high-tech stocks. It was worthy of note that stocks in the financial sector, which had been relatively firm, had also fallen sharply since the middle of February. Against this background of increased volatility in stock prices, concern about credit risk had increased as observed in the widening credit spreads between corporate obligations, such as CP and corporate bonds, and comparable Treasury securities.

In the euro area, although there were signs of a slowdown in production and exports, economic developments had continued to be firm, mainly supported by private consumption. Looking ahead, the view was widely held that a slowdown would be moderate because (1) the economies' dependence on external demand was relatively low, and (2) tax cuts and a decline in the unemployment rate were likely to support consumer confidence. However, attention should be paid to factors such as the sluggishness of the German economy and the possibility of weak stock prices overseas affecting stocks in the euro area.

Among East Asian economies, it was mainly NIEs, where IT-related goods accounted for a large proportion of exports, that were likely to decelerate significantly due to a sharper-than-expected slowdown in the U.S. economy. On the other hand, the Chinese economy continued to be buoyant supported by strong domestic demand fueled by fiscal spending and direct investment from abroad, although its exports were slowing down.

D. Economic and Financial Developments in Japan

1. Economic developments

The recovery in Japan's economy had recently come to a pause, reflecting a decrease in exports.

With regard to final demand, business fixed investment was increasing. The recovery in private consumption continued to be weak as a whole, but there were somewhat positive signs in some indicators. Housing investment was virtually unchanged. Public investment was bottoming out. Net exports were plummeting reflecting a sharp slowdown in the economies of the United States and East Asia.

Against this background, production was starting to decline mainly due to a slowdown in exports, and inventories of electronic parts and some materials were becoming excessive. Corporate profits had continued to improve but the pace was thought to be slowing significantly, particularly in manufacturing. The income situation of households had not deteriorated, but the effects of the decline in production were starting to be observed in some areas of the economy such as the number of new job offers and overtime hours.

As for the outlook, the economy was likely to remain stagnant for some time. There were factors that would give support to the economy such as projects to be implemented based on the supplementary budget for fiscal 2000 and a backlog of orders related to business fixed investment. However, production was likely to follow a declining trend toward the middle of 2001 given that (1) adjustments in overseas economies would continue for some time, and (2) inventory adjustments, although not large ones, were becoming necessary. Furthermore, machinery orders, a leading indicator for business fixed investment, had already peaked out. If business fixed investment remained sluggish, the growth of not only corporate profits but also household income would become sluggish and, consequently, domestic private demand, which had lacked momentum, was likely to gradually level off. As evident from the above, it was becoming unlikely that the mechanism of income generation starting from the corporate sector would continue. The economic outlook depended largely on the widely accepted scenario of a moderate recovery in overseas economies, particularly the U.S. economy, in the second half of 2001. However, it could not be denied that this scenario was in some respects somewhat optimistic. It could be considered that there was also a risk that the economic adjustment would become more severe should the economy be adversely affected by a deterioration in corporate and household sentiment in response to a further decline in stock prices.

Regarding the outlook for prices, various price indexes were likely to be somewhat weak overall for the time being. Although the recent depreciation of the yen would exert upward pressure on prices, the domestic supply-demand balance was likely to exert downward pressure for the time being because inventories were becoming excessive in some industries and the economy had come to a pause. In addition, prices would be affected to a certain extent by technological innovation and deregulation of communications charges, and the effects of the streamlining of distribution channels, for example by apparel manufacturers, were likely to persist although they might weaken gradually. Due attention should be paid to the possibility that downward pressure on prices stemming from weak demand would increase if downside risks to the economy materialized.

2. The financial environment

The financial environment remained easy as evident in the following recent developments. First, firms' borrowing costs had declined further in line with a fall in various interest rates. Second, issuance of corporate bonds and CP remained buoyant. And third, financial institutions remained keen to increase lending to firms displaying good performance.

The weakness in stock prices would require close monitoring as it had adversely affected equity financing as evidenced by the low number of initial public offerings. The following areas would also warrant attention: (1) some negative signs had started to appear in funds demand, for example inventory financing reflecting a decline in exports, and (2) small firms' perception of their financial position had deteriorated according to some surveys.

The monetary base in February was 3.4 percent higher than in the same month the previous year, marking a year-on-year increase for the first time in three months. This reflected developments in the previous year: the monetary base declined considerably in February 2000 after surging in December 1999 and January 2000 due to Year 2000 concerns. The growth rate of money stock (M2+CDs) had been increasing gradually since summer 2000 mainly due to an inflow of funds from postal savings that had matured.

The number of corporate bankruptcies remained around the previous year's level, but careful monitoring was required for small firms' financial position and the effects of termination of special guarantee systems for the financial stabilization of small and medium-sized firms at the end of March 2001.

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

Based on the results of economic and financial indicators and other information that had become available since the previous meeting, members discussed mainly (1) whether the standard scenario of a gradual economic recovery starting from the corporate sector was still valid, and (2) how strong the pressure was from structural adjustment, including the disposal of firms' and financial institutions' nonperforming assets.

Many members expressed the view that the economy was currently at a pause due mainly to a decrease in exports and production reflecting the sharper-than-expected slowdown in the U.S. economy. A different member expressed an even more pessimistic view of the state of the economy. This member, citing developments in the Indexes of Business Conditions and various indicators showing business sentiment, said that the standard scenario had already become invalid and the economy was currently entering a recession as the risks that had been noted as warranting attention had materialized against the background of a plunge in U.S. stock prices. Another member said that concerns about the economy deteriorating from the current lull were materializing and that it was already unlikely that the economy would continue to recover gradually.

Regarding each demand component, a few members noted that although private consumption continued to show mixed developments, there were also somewhat positive signs. One member, however, pointed out that the recent improvement in some sales statistics was largely accounted for by temporary factors such as a surge in demand for appliances before the coming into force of a new law requiring electrical appliance makers to recycle old appliances, and for passenger cars following the launch of new models. One member commented that considering that the volume of aggregate supply of consumer goods had continued to increase moderately and the level of household spending was consistent with household income, consumption should not be judged as sluggish but as having recovered to normal levels. Members shared the view that business fixed investment had remained on an increasing trend due to a backlog of orders.

Regarding exports and production, however, most members gave a pessimistic assessment. Many members agreed that the recent fall in exports had been larger than expected and that prospects for an improvement in the environment for exports were bleak at the moment. One member expressed strong concern about the fact that the trade surplus had peaked out at a time when, in this member's opinion, the economy was entering a recession.

Members generally agreed that production was likely to continue declining in the April-June quarter following an expected decline in the January-March quarter. A few members pointed out that inventory adjustments in some industries were affecting production. One member held the view that inventory adjustments in the steel, petrochemical, pulp and paper, and semiconductor industries were inevitable. This member continued that although the impact of inventory adjustments on economic growth was decreasing as their duration had been shortened due to improvements in inventory management with the use of IT, adjustments in production would continue for the time being.

Pessimistic views were also put forward regarding the economic outlook. Many members said that it had become unlikely that the mechanism of a moderate economic recovery starting from the corporate sector would continue to operate, and thus it had become difficult to maintain the standard scenario.

Members exchanged views on the outlook for the U.S. economy, which was one of the key factors for the standard scenario of Japan's economy. Many members were cautious about the scenario that the U.S. economy would recover in the second half of 2001, suggesting that it was based in part on somewhat optimistic assumptions and that the risk that the sluggishness would persist warranted attention. One member said that the ongoing change in the U.S. economic trend was not merely a downturn in a business cycle but was challenging the "new economy," a paradigm of economic growth. The member expressed concern about the impact of this shock on the sentiment of economic entities. Another member attributed the recent drastic change in the economy to a reversal of past developments, where the overoptimistic expectation of everlasting U.S. economic prosperity had led to overborrowing by firms and households. This member said that signs of a crisis of confidence had started to appear in the United States. Another member said that an analysis of long-term trends in stock prices, the University of Michigan consumer sentiment index, and the cost of advertising per job offer showed that a large-scale economic bubble had emerged and burst in the United States. This member said that the plunge in U.S. stock prices was the first downturn of the long-term trend in the seven decades since 1929. This member continued that in a shorter time frame, U.S. stock prices were expected to bottom out after a further fall, and depending on what policy measures were taken, they might rebound slightly toward the middle of 2001. By contrast, a different member said that the level of U.S. stock prices was still high judging from conventional analyses and thus they might undergo further adjustment. Another member said that if stagnation of the U.S. economy was prolonged, the U.S. dollar might weaken due partly to the nation's structural problems such as a huge current account deficit and a low savings rate. This member expressed concern that in this case Japan's exports might be adversely affected.

One member commented that the price of West Texas Intermediate (WTI) crude oil was unlikely to fall below the recent range of US$25-30 per barrel for a while and might rise slightly.

Many members expected a deterioration in corporate profits, which were the starting point of the economic recovery in the standard scenario. A few members expressed a cautious view on the earnings forecasts by some private research institutes because the expected increase in fiscal 2001 assumed that the U.S. economy would recover. Another member said that corporate profits had clearly started to deteriorate because the prices of goods were falling while sales volume remained flat. This member continued that although firms' profits for fiscal 2000, ending in March 2001, would improve reflecting the increase in profits in the first half of the fiscal year, the fragile profit base of firms, which was supported by temporary factors such as restructuring, mainly in personnel expenses, and a decrease in fixed costs per unit produced owing to an increase in exports, was likely to be further weakened by the fall in prices.

Many members expressed the view that various leading indicators suggested business fixed investment was peaking out and would decelerate reflecting a deterioration in the environment for corporate profits. One member mentioned that, in January, machinery orders were weak in the electrical appliance sector in particular. According to a different member, while manufacturers of IT-related goods were becoming reluctant to invest in capital equipment because of the slackening of the semiconductor market, corporate users of IT-related goods were also becoming less willing to do so due to heightening uncertainty about the economy.

Regarding the employment and income situation, some members said that a deceleration in the increase in new job offers and overtime payments reflecting a decrease in production warranted attention although it was still a marginal development. A few of these members expressed concern that developments in corporate profits were starting to adversely affect income. One member noted that a sustained increase in wages had become unlikely since wages had increased only marginally even at a time when firms' current profits for fiscal 2000 on a consolidated basis were likely to increase by more than 30 percent.

Turning to prices, views were divided slightly on the extent to which supply-side factors (streamlining of distribution channels, deregulation, technological innovation, and a narrowing of the price differential between Japan and other countries) and demand-side factors were causing the recent fall in prices, although the majority of members shared the view that it was due to a mixture of the two. However, as for the outlook, members shared concern that downward pressure stemming from the demand side was likely to increase. One member said that the pace of the price fall was not accelerating at the moment, and the extent to which depreciation of the yen offset the fall in prices deserved attention. Another member said that the export drive of other Asian countries, fueled by a chronic oversupply of IT-related goods in the region, was likely to lead to a fall in prices of these goods in Japan. A different member said that prices were falling because nonviable firms, in an attempt to survive, had raised their capacity utilization and had slashed prices ignoring production costs. The member was concerned that this excessive price competition had engulfed viable firms and was exhausting both viable and nonviable firms. One member said that in this situation, nominal GDP would decrease in fiscal 2001.

Based on these discussions, a few members summarized the economic and price developments since 2000 and the outlook as follows. A comparison between last year's real economic growth of 1.7 percent and an estimated potential growth of around one and a half percent suggested that the domestic output gap had either stopped expanding or had contracted slightly in 2000. However, in 2001 even a moderate narrowing of the output gap as seen in the previous year was unlikely, as it was becoming likely that the economic growth rate would fall short of the potential growth rate. In this case, downward pressure stemming from weak demand was likely to intensify and the risk of the economy falling into a deflationary spiral would increase.

Besides the factors above, many members pointed out the strong adverse effects stemming from structural adjustment pressure. One member noted that the economy was currently under two kinds of pressure, from the short-term business cycle on the one hand, which was being influenced by the slowdown in the U.S. economy, and on the other, deflationary pressure from structural adjustment. Thus it was important to examine policy measures that could be taken, giving due consideration to the worst-case scenario that could materialize when these two kinds of pressure strengthened simultaneously.

With regard to Japan's financial system problems, many members noted that increasing uncertainty regarding the economic outlook was arising from the possibility of a resurgence of concerns about stability of the financial system, which might occur through (1) a decrease in unrealized gains on stocks held by financial institutions as a result of a fall in stock prices, and (2) the economic slowdown. One member was concerned about "event risk," citing the fact that a credit-rating agency's decision to place the ratings of 19 Japanese banks under review for possible downgrading had affected stock prices not only in Japan but also in the United States. Another member expressed concern that the creditworthiness of Japan might decline further unless its bad loan problem improved, citing the increasing trend of the credit default swap rate on Japanese bonds. A different member remarked that concerns about stability of the financial system stemmed mainly from concerns over a potential insufficiency in the capital bases of financial institutions, and a liquidity crisis had not occurred due partly to support from the Bank's recent timely employment of policy measures. A few members welcomed the acceleration of major banks' disposal of nonperforming loans, against a background of mergers and tie-ups, and hoped that this trend would spread further.

Many members pointed out that the effectiveness of monetary policy was being undermined by the fact that the credit creating function of financial institutions was not operating sufficiently. They therefore concluded that in order to enhance the effectiveness of monetary policy and put the economy back on a sustainable growth path, it was crucial that firms and financial institutions disposed of their nonperforming assets drastically, but downward pressure on the economy arising from this process would warrant attention. On the other hand, one member said that an acceleration of the disposal of nonperforming assets might have a positive effect on the economy if it improved prospects for the financial system and drew a positive reaction from financial markets. Another member noted the increasingly unstable relationship between the monetary base and money stock and stressed that it was crucial that both lenders and borrowers made efforts. Specifically, lenders should remove nonperforming loans from their balance sheets to prevent concerns arising about possible losses on bad loans growing larger, and financially weak lenders should receive another injection of public funds. As for borrowers, the member said that firms should reduce excess capacity, employee numbers, and excessive debts and regain international competitiveness by increasing their productivity.

Some members pointed out that it was also important to solve other structural problems besides those in the financial system. One member said that fiscal management could be improved by changing the structure of fiscal expenditure without increasing the total outlay. This member suggested the following as examples of policies that could be adopted: (1) increase the proportion of fiscal expenditure in industries with high productivity; (2) expand the safety net by, for example, improving unemployment insurance to deal with progress in structural adjustment; (3) accelerate deregulation further; and (4) introduce a new tax concession to encourage private investors to invest in stocks. Another member said that a combination of firms' efforts, fiscal management, and monetary policy was necessary to solve structural problems. The member explained that emphasis should primarily be on the efforts of firms and banks, while the government should respect market principles and improve the environment for the private sector through tax measures, deregulation, and measures to increase mobility in the labor market and foster new industries. It was also important for the government to present a clear vision of how it would deal with the fiscal deficit and problems concerning the social security system to dispel the corporate and household sectors' concerns about the future. This member continued that, regarding monetary policy, the Bank should provide ample liquidity so that the credit creating function of banks would operate fully and firms would be able to procure necessary funds. One member, referring to the Financial Statements Statistics of Corporations by Industry, Quarterly, said that firms' employee numbers and personnel expenses had been increasing since hitting bottom in the April-June quarter of 2000 and this suggested that insufficient corporate restructuring had taken place.

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

Members then discussed the monetary policy stance for the immediate future.

A. Basic Thinking

Many members' view of the economic and financial situation was as follows: (1) Japan's economy had come to a pause, reflecting a decrease in exports and production; (2) it was becoming unlikely that Japan's economy would follow the standard scenario of a gradual recovery starting from the corporate sector; (3) attention should be paid to factors that could further depress the economy, such as a possible further slowdown in overseas economies and unfavorable developments in capital markets at home and abroad; and (4) downward pressure on prices stemming from demand-side factors was intensifying and it was becoming more likely that the economy would fall into a deflationary spiral.

Based on the above assessment of the economy and taking account of the deflationary pressure that might be caused by the structural reform that was expected to take place, the majority of members concurred that the Bank had come to a stage where it should adopt a drastic measure from among the options available. They also agreed that as monetary policy alone was not sufficient to ensure economic recovery, the Bank should make it clear that it was essential to advance structural reform with determination in the financial system as well as in the economy and industry.

A few members, on the basis of discussions at previous meetings, summarized their thinking on drastic measures unlikely to be taken under ordinary circumstances, such as quantitative easing, as follows. First, the effects of such measures were uncertain and they might have negative side effects. Second, whether the Bank should go further and adopt such measures depended on whether the economic situation warranted them. And third, although it had not been appropriate to adopt such measures in the past two years because the economy had been recovering gradually, the current situation required the Bank to adopt drastic measures.

Regarding the policy measures that could be adopted at this meeting, one of these members raised the following points for discussion: (1) whether the Bank should further reduce the interest rate target or adopt quantitative easing; (2) how the Bank could enhance the effects of policy measures through a commitment in terms of policy duration; and (3) whether outright purchases of government bonds should be increased. The discussions that followed centered on these points.

B. Discussions on the Bank's Operating Target for Money Market Operations

Regarding the operating target of money market operations, members discussed from various perspectives whether it should be changed from interest rates to quantitative indicators such as the outstanding balance of accounts at the Bank and whether the Bank should continue to pursue the maximum policy effect within the current framework of interest rate targeting (i.e., reinstate the zero interest rate policy).

A few members expressed the view that the following effects could be expected if the Bank set the outstanding balance of current accounts at the Bank--a quantitative indicator--as its operating target for market operations, and increased its amount sufficiently. First, the overnight call rate would decline to close to zero percent, and thus this policy move was expected to have similar effects to the zero interest rate policy. And second, the increase in the current account balance itself might ease monetary conditions further although uncertainty remained as to the extent. A few members were of the opinion that the economic effects of an increase in the outstanding balance of the current accounts at the Bank were uncertain in some respects, but, at the same time, it could not be denied that it might have some effects. Thus, the Bank, in view of the economic situation, should try out the measure as long as no significant harmful effect could be anticipated. A few members remarked that a quantitative operating target could prompt an autonomous decline in market rates through the market mechanism since interest rates would not be fixed and would be determined by the market. One of these members said that it was important to ensure "a fair game between market participants and the Bank" by allowing interest rates to move freely to some extent, instead of keeping them at zero percent.

One member argued that the Bank should change its operating target to the monetary base, citing a VAR (vector auto regression) model analysis that showed that expansion of the monetary base had positive effects on Japan's stock prices, business fixed investment, and production.

With regard to finding an "exit policy"--ways to terminate such an unprecedented policy--one member pointed out that the exit might be easier if the operating target was a quantitative indicator such as the outstanding balance of current accounts and interest rates were left to move freely, as interest rates were expected to rise when the economy started to recover.

On the other hand, a few members remarked that, as a drastic measure for monetary easing within the current framework of interest rate targeting, the combination of (1) reducing the overnight call rate to zero percent and (2) making a commitment in terms of policy duration was simple and easy to understand. One member compared the zero interest rate policy and a policy realizing a virtual zero interest rate as a result of targeting current account balances at the Bank. According to this member, the latter could have only two additional effects compared with the former: (1) increased liquidity might have an additional easing effect, although this was not certain; and (2) the Bank's outright purchases of government bonds, which would directly influence the supply-demand balance of these bonds, might have some kind of effect. Regarding the first effect, this member noted that the generally accepted view was that increased liquidity had theoretically no effects, and empirical analysis could lead to any conclusion depending on the specifications used. The member continued that, since quantitative targeting would not necessarily reduce the overnight call rate to close to zero percent, the targeting of zero interest rates had a stronger commitment effect than quantitative targeting.

A different member expressed the view that, although it could not be denied that the increased quantity itself would have an additional easing effect through its influence on the expectations of economic entities, it was not appropriate to give the impression that the Bank could further ease monetary conditions since there was uncertainty about its effect, and the Bank should make it clear that there was a limit to what monetary policy could do.

In the course of discussions on the advantages and disadvantages of setting a quantitative target or an interest rate target, members gradually came to share the view that the effects previously brought about by the zero interest rate policy could be achieved and at the same time the market mechanism could be maintained to some extent, if the operating target was changed to the outstanding balance of current accounts at the Bank and the amount was increased to a level that would reduce the interest rate to virtually zero percent (the level was estimated to be around 5 trillion yen given the experience of the zero interest rate policy). Members, at the same time, agreed to continue examining what would be the effects of increasing the outstanding balance of current accounts at the Bank as well as the possibility of a further easing through an increase in the outstanding balance.

One member noted that interest rate policy and quantitative easing could have opposite effects and the two might be incompatible, pointing out that long-term interest rates might rise if quantitative easing raised the expected inflation rate. In response, the view was expressed that such incompatibility might not occur if the quantitative easing was limited to the level necessary to achieve a fall in the overnight call rate to virtually zero percent.

Responding to the above discussion, a different member put forward the following argument. First, it was inappropriate to shift to a zero interest rate policy or a policy targeting the outstanding balance of current accounts at the Bank with the aim of reducing the overnight call rate to virtually zero percent, given that the Bank had not yet made a thorough assessment of the effects of the previous zero interest rate policy. Second, however, there was a risk that financial markets, which had already factored in a further easing, might be disrupted if the possibility of a reinstatement of a zero interest rate policy was totally ruled out. Third, with regard to the effects on the economy, the member believed that there was no substantial difference between an overnight call rate of 0.15 percent, the current level, and one of zero percent. Fourth, it was, therefore, appropriate to encourage the uncollateralized overnight call rate to move on average at or below 0.15 percent through market operations. And fifth, it was extremely important to make a commitment in terms of policy duration to enhance the effectiveness of monetary easing, a suggestion this member had made at the previous meeting.

Members also discussed the extent to which interest rates would be allowed to temporarily rise in response to market conditions under a framework where the Bank's operating target was the outstanding balance of current accounts at the Bank. One member expressed the view that the ability of the complementary lending facility to prevent interest rates from surging was limited because the facility required borrowers to put up collateral. A few members remarked that given that the Bank's current guideline for market operations was to encourage the overnight call rate to move around 0.15 percent, the Bank should avoid a situation where interest rates might rise above 0.15 percent as a result of adopting a further easing measure. They continued that the Bank should add a proviso that would allow the staff to provide funds in a flexible manner depending on market conditions. With regard to the directive on the Bank's money market operations, a few members said that it should set a benchmark for the interest rate, for example "at or below 0.15 percent," to make the Policy Board's intention clear to the public and to provide the Bank's staff with a clear directive. On the other hand, a few other members were of the view that it could be inconsistent to set both a quantitative target and an interest rate target. As a result of discussion, they came to the conclusion that the directive did not have to refer to a specific interest rate level or range, as the Bank's intention to restrain a rise in interest rates would be reflected in the public statement to be decided later in the meeting.

C. Discussions on the Effects of Policy Duration

Members generally agreed that whatever monetary easing measure the Bank decided to adopt, (1) it was necessary to make a strong commitment in terms of policy duration in order to ensure the "commitment effect," and (2) it was desirable to make the commitment clearer than "until deflationary concern was dispelled," the phrase the Bank had used under the zero interest rate policy.

Members discussed how the Bank could make a commitment to policy duration in terms of the year-on-year rate of increase in the consumer price index (CPI), excluding perishables, as such a proposal had been put forward by one member at the previous meeting.

Some opinions were expressed on the rate of increase in the CPI that the Bank could use as the basis for the policy commitment. A few members said that although there was no consensus among the members on the desirable medium- to long-term rate of inflation, they were in agreement that a situation that was neither inflationary nor deflationary was desirable, and thus, it was appropriate to make a commitment to continue the policy until the rate of increase in the CPI recovered to zero percent. In response, some members argued that pinpointing a specific figure, for example, zero percent, was inconsistent with the Bank's view that in the current situation it was difficult to express price stability in terms of a specific numerical value. One member added that, although the Policy Board should further discuss the desirable rate of increase in prices, it would be appropriate to use a phrase such as "stably a zero percent or an increase year on year" and imply that it would conduct policy aiming at a small but positive inflation rate. One member, however, said given that the upward bias of the CPI was about 0.9 percent according to one estimate, an increase of zero percent was inappropriate and a higher rate of increase was desirable.

One member said that, when considering the desired specific rate of increase in the CPI, it was important to make sure that the policy would be terminated neither too late nor too early. This member said that, according to this member's simulation applying the Taylor rule, when the economy recovered in the future, termination of the policy when the inflation rate was slightly above zero percent would not be premature. The member, however, continued that it was necessary to pay attention to the risk that the rate of change in the CPI would not recover to zero percent and the Bank might not be able to terminate the policy. A few members also expressed concern that it was likely to take quite a while for the CPI to rise by zero percent or more because of downward pressure on prices arising from ongoing structural change. In response to this, one member said that this was the very reason why the Bank should announce clearly that the continued fall in prices was undesirable, with the aim of raising prices by changing the public's expectations.

Many members agreed that such a commitment differed from inflation targeting in that under the latter a desirable inflation rate from a medium- to long-term perspective was set as a target and monetary policy was changed when the inflation rate was expected to deviate from the target.

As a result of the above discussions, members came to concur that, in order to show the Bank's determination to prevent the economy from falling into a deflationary spiral, it would be appropriate to express the Bank's policy duration commitment as "until the CPI (excluding perishables) registered stably a zero percent or an increase year on year." Members also agreed to continue to examine the specific level of inflation--a small but positive figure.

D. Discussions on the Bank's Outright Purchases of Government Bonds

One member proposed that in the current environment where reducing interest rates would have only a limited effect on the economy, the Bank should consider increasing the amount of government bonds it bought outright, in order to affect the public's expectations and underline the Bank's commitment to the targeted interest rate in terms of duration.

In response, a few members voiced concern that an increase in outright purchases of government bonds could have significant side effects depending on the way it was conducted. They also shared the view that it was important to avoid misunderstandings by making it clear that the measure was not aimed at supporting government bond prices or government financing. The opinion was put forward that the Bank should adopt the policy of increasing its outright purchases of government bonds as a measure to ensure the smooth provision of funds, which might be disrupted by a lack of bids in the market operations auctions if the operating target of market operations was changed to the outstanding balance of current accounts at the Bank. Many members agreed with this opinion.

A few members warned that there still remained a risk that demands for a further increase in the Bank's outright purchases of government bonds might intensify if the economy remained sluggish. Members generally agreed that in order to avoid such a situation, the Bank should maintain the policy principle that outright purchases of government bonds should be conducted in accordance with the long-term trend of increase in banknotes. They also agreed that the Bank should introduce a new guideline to limit the outstanding amount of government bonds the Bank could hold to the outstanding balance of banknotes issued, instead of, as under the current guideline, to the amount of banknotes additionally issued during a certain period.

VI. Remarks by Government Representatives

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

(1) The economic recovery appeared to be pausing: the employment situation remained severe and private consumption was generally unchanged, and in the corporate sector production was weakening reflecting a decline in exports. Factors such as the rapid deceleration in the U.S. economy gave cause for concern about Japan's economic outlook. Regarding prices, the CPI and the GDP deflator continued to decrease year on year despite the surge in crude oil prices, and concern was growing about the impact of the fall in prices on the economy through a rise in real interest rates and real debt burden.

(2) Real interest rates, which affect economic activity, had not declined due to the fall in prices, although nominal short-term interest rates were at a low level. In view of the situation above, further monetary easing was necessary. One of the following measures or a combination of them could be considered as policy options: (a) resume the zero interest rate policy and make clear the intention to maintain easy monetary conditions for a certain period of time, (b) set an explicit price stability target, and (c) increase the types of instrument eligible for market operations to ensure ample funds provision. The Government would like to ask the Bank to examine these measures, and take prompt action to further ease monetary policy.

(3) The Government did not consider that monetary policy alone would solve the problems of Japan's economy, and would therefore do its utmost to address issues that needed to be tackled to achieve economic and fiscal structural reform, including the disposal of nonperforming loans.

The representative from the Cabinet Office made the following remarks.

(1) In the Cabinet Office's Monthly Economic Report released on March 16, the Government's assessment of Japan's economy had been revised downward, to "economic recovery appears to be pausing." As for the outlook, the slowdown of the U.S. economy and signs of deceleration in business fixed investment were factors that gave cause for concern. If "deflation" was defined as a sustained fall in prices, Japan was currently experiencing moderate deflation, which was an extremely unusual situation for any country or historical period.

(2) Against this background, the Government would continue to steadily implement the supplementary budget for fiscal 2000 and considered it important to make efforts to obtain the Diet's approval of the fiscal 2001 budget as quickly as possible and to implement the budget appropriately in the new fiscal year. In addition, in order to promote structural reform of the economy, the Government would establish a council on regulatory reform in April, and at the fifth meeting of the Council on Economic and Fiscal Policy, in addition to the state of the economy, ways to address issues related to the disposal of nonperforming loans were discussed. Furthermore, in view of the severe economic situation, the Government and the three ruling parties had set up a committee to draw up an emergency economic package and its first meeting had taken place. Due consideration should be given to the emergency economic package proposed by the three ruling parties and it was important to come up with concrete measures as quickly as possible to revitalize the stock market and to promote disposal of nonperforming loans.

(3) The Government considered it important that monetary policy would be conducted in an appropriate, timely, and preemptive manner, and would like to ask the Bank to implement further monetary easing to achieve price stability in view of the current economic situation.

VII. Votes

Based on the above discussion, the majority of members considered it appropriate to (1) change the main operating target for money market operations to the outstanding balance of the current accounts at the Bank of Japan, (2) make a commitment to continue this new framework until the CPI registered stably a year-on-year increase of zero percent or more, (3) increase the amount of the Bank's outright purchases of government bonds when it was considered necessary in order to provide liquidity smoothly, (4) establish a clear ceiling for the Bank's government bond holdings, set at the outstanding amount of banknotes issued, and (5) increase the outstanding balance of current accounts at the Bank to around 5 trillion yen for the time being.

The following two opinions were also put forward. First, the Bank should reduce the target for the overnight call rate to 0.15 percent or less and buy a larger amount of government bonds until the CPI registered stably a year-on-year increase of zero percent or more. And second, the Bank should expand the monetary base, setting targets for the rate of increase in the CPI and for the monetary base. The member who expressed the second opinion explained that the interest rate reduction decided at the previous meeting was "too little and too late," and that it was now necessary to adopt a more powerful easing measure than the zero interest rate policy.

As a result, the following policy proposals were submitted.

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 at or below 0.15 percent.

The Bank will maintain this guideline until the CPI (excluding perishables) registered stably a year-on-year increase of zero percent or more.

The Bank will increase its outright purchases of government bonds to around 800 billion yen per month from the current 400 billion yen in view of enhancing the flexibility of the Bank's market operations.

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 July-September 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 two related proposals.

Chairman's Policy Proposal on New Procedures for Money Market Operations:

1. The Bank will change its main operating target for money market operations to the outstanding balance of the current accounts at the Bank of Japan.
2. The Bank will continue the new framework for money market operations prescribed in 1. until the CPI (excluding perishables, on a nationwide basis) registers stably a zero percent or an increase year on year.
3. In conducting market operations in accordance with the framework prescribed in 1., the Bank will increase the amount of its outright purchases of government bonds when it considers an increase necessary for the smooth provision of liquidity. The Bank will keep the outstanding amount of long-term government bonds effectively held by the Bank (i.e., the amount after taking account of the government bond sales under gensaki repurchase agreements) below the outstanding balance of banknotes issued.
4. A public statement will be decided separately.
   Votes for the proposal: Mr. M. Hayami, Mr. S. Fujiwara, Mr. Y. Yamaguchi, Mr. S. Taketomi, Mr. T. Miki, Mr. N. Nakahara, Mr. K. Ueda, and Mr. T. Taya.
   Vote against the proposal: Ms. E. Shinotsuka.

Chairman's Policy Proposal on the Guideline for Market Operations:

1. The guideline for money market operations in the intermeeting period ahead would be as follows.
   The Bank of Japan will conduct money market operations, aiming the outstanding balance of the current accounts at the Bank at around 5 trillion yen.
   Should there be a risk of financial market instability, e.g., a rapid surge in liquidity demand, the Bank will provide ampler liquidity irrespective of the guideline above.
2. A public statement will be decided separately.
   Votes for the proposal: Mr. M. Hayami, Mr. S. Fujiwara, Mr. Y. Yamaguchi, Mr. S. Taketomi, Mr. T. Miki, Mr. N. Nakahara, Mr. K. Ueda, and Mr. T. Taya.
   Vote against the proposal: Ms. E. Shinotsuka.

Ms. Shinotsuka voted against the above proposals for the following reason. Given that the Bank had consistently been against adopting a quantitative target on the grounds that the relationship between quantitative indicators and developments in the economy was not stable, the issue of changing the Bank's monetary policy had not been sufficiently discussed.

VIII. Discussion on the Public Statement

Following the above decision, members discussed the draft of a public statement prepared by the staff and put it to the vote. The Board approved, by majority vote, "New Procedures for Money Market Operations and Monetary Easing" and decided to release it after the meeting (see Attachment 1).

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

Abstention: Ms. E. Shinotsuka.

IX. 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 decided to publish "The Bank's View" on March 21, 2001 in the Monthly Report of Recent Economic and Financial Developments (consisting of "The Bank's View" and "The Background").⁹

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, he considered that the economy was entering a recession, and had not "come to a pause." Second, it was inappropriate to judge that "income conditions of households have not deteriorated," as various labor statistics were showing deterioration. Third, the view that "overseas economies will follow a gradual recovery trend from the latter half of 2001" was questionable. And fourth, downward pressure on prices was likely to increase further as the economy was entering a recession.

1. 9The original full text, written in Japanese, of the Monthly Report of Recent Economic and Financial Developments was published on March 21, 2001 together with the English version of "The Bank's View." The English version of "The Background" was published on March 22, 2001.

X. Approval of the Scheduled Dates of the Monetary Policy Meetings in April-September 2001

At the end of the meeting, members approved the dates of Monetary Policy Meetings to be held in the period April-September 2001, for immediate release (see Attachment 3).

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Attachment 1

For immediate release

March 19, 2001
Bank of Japan

New Procedures for Money Market Operations and Monetary Easing

1. Japan's economic recovery has recently come to a pause after it slowed in late 2000 under the influence of a sharp downturn of the global economy. Prices have been showing weak developments and there is concern about increase in downward pressures on prices stemming from weak demand.
2. In retrospect, both monetary and fiscal policies have taken considerably strong actions during the past decade in Japan. Whereas fiscal policy has repeatedly implemented expansionary measures, the Bank of Japan has adopted a policy of maintaining interest rates at levels unprecedentedly low during the history of central banking at home and abroad, thereby providing ample liquidity. All this notwithstanding, Japan's economy has failed to return to a sustainable growth path, and is now faced again with a threat of deterioration.
3. In light of this, the Bank has come to a conclusion that the economic conditions warrant monetary easing as drastic as is unlikely to be taken under ordinary circumstances. Accordingly, the Bank decided at its Monetary Policy Meeting of today to take the following policy actions.
   1. a) Change in the operating target for money market operations
      The main operating target for money market operations be changed from the current uncollateralized overnight call rate to the outstanding balance of the current accounts at the Bank of Japan. Under the new procedures, the Bank provides ample liquidity, and the uncollateralized overnight call rate will be determined in the market at a certain level below the ceiling set by the Lombard-type lending facility.
   2. b) CPI guideline for the duration of the new procedures
      The new procedures for money market operations continue to be in place until the consumer price index (excluding perishables, on a nationwide statistics) registers stably a zero percent or an increase year on year.
   3. c) Increase in the current-account balance at the Bank of Japan and declines in interest rates
      For the time being, the balance outstanding at the Bank's current accounts be increased to around 5 trillion yen, or 1 trillion yen increase from the average outstanding of 4 trillion yen in February 2001 (see Attachment 2). As a consequence, it is anticipated that the uncollateralized overnight call rate will significantly decline from the current target level of 0.15 percent and stay close to zero percent under normal circumstances.
   4. d) Increase in outright purchase of long-term government bonds
      The Bank will increase the amount of its outright purchase of long-term government bonds from the current 400 billion yen per month, in case it considers that increase to be necessary for providing liquidity smoothly. The outright purchase is, on the other hand, subject to the limitation that the outstanding amount of long-term government bonds effectively held by the Bank, i.e., after taking account of the government bond sales under gensaki repurchase agreements, be kept below the outstanding balance of banknotes issued.
4. The Bank of Japan has decided to implement these policy measures with firm determination with a view to preventing prices from declining continuously as well as preparing a basis for sustainable economic growth.
5. In order to make this monetary easing fully effective in restoring Japan's economy on a sustainable growth path, progress in structural reforms with respect to the financial system, e.g., resolution of the nonperforming asset problem, as well as in the area of economy and industry is essential. Structural reform may be accompanied by painful adjustments. Without such adjustments, however, neither improvement in productivity nor sustainable economic growth can be obtained. The Bank of Japan strongly hopes that decisive actions be taken to address fundamental problems both with a clear support of the nation for structural reform and under a strong leadership of the government of Japan.

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Attachment 2

For immediate release

March 19, 2001
Bank of Japan

At the Monetary Policy Meeting held today, the Bank of Japan decided, by majority vote, to change the guideline for money market operations for the inter-meeting period into the following:

The Bank of Japan will conduct money market operations, aiming the outstanding balance of the current accounts at the Bank at around 5 trillion yen.

Should there be a risk of financial market instability, e.g., a rapid surge in liquidity demand, the Bank will provide ampler liquidity irrespective of the guideline above.

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Attachment 3

March 19, 2001
Bank of Japan

Scheduled Dates of Monetary Policy Meetings in April-September 2001¹

1. The above schedule was revised on April 3 due to a decision to change the duration of Monetary Policy Meetings.