Minutes of the Monetary Policy Meeting

on February 13 and 14, 2003
(English translation prepared by the Bank's staff based on the Japanese original)

March 10, 2003
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 Thursday, February 13, 2003, from 2:00 p.m. to 4:17 p.m., and on Friday, February 14, from 9:00 a.m. to 1:14 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. K. Ueda
Mr. T. Taya
Ms. M. Suda
Mr. S. Nakahara
Mr. H. Haru
Mr. T. Fukuma

Government Representatives Present
Mr. T. Taniguchi, Senior Vice Minister of Finance, Ministry of Finance²
Mr. H. Tsuda, Deputy Vice Minister for Policy Planning and Coordination, Ministry of Finance³
Mr. Y. Kobayashi, Vice Minister for Economic and Fiscal Policy, Cabinet Office

Reporting Staff
Mr. E. Hirano, Executive Director
Mr. M. Shirakawa, Executive Director
Mr. A. Yamamoto, Executive Director
Mr. H. Yamaguchi, Adviser to the Governor, Policy Planning Office
Mr. T. Wada, Associate Director, Policy Planning Office⁴
Mr. S. Kushida, Chief Manager, Planning Division I, Policy Planning Office
Mr. K. Yamamoto, Director, Financial Markets Department
Mr. H. Hayakawa, Director, Research and Statistics Department
Mr. K. Monma, Senior Manager, Research and Statistics Department
Mr. A. Horii, Director, International Department

Secretariat of the Monetary Policy Meeting
Mr. Y. Hashimoto, Director, Secretariat of the Policy Board
Mr. Y. Nakayama, Adviser to the Governor, Secretariat of the Policy Board
Mr. N. Yoshioka, Chief Manager, Planning Division II, Policy Planning Office⁴
Mr. M. Ohsawa, Chief Manager, Money and Capital Markets Division, Financial Markets Department⁴
Mr. H. Onobuchi, Manager, Secretariat of the Policy Board
Mr. K. Etoh, Senior Economist, Policy Planning Office
Mr. T. Hiroshima, Senior Economist, Policy Planning Office

The minutes of this meeting were approved by the Policy Board at the Monetary Policy Meeting held on March 4 and 5, 2003 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.
Mr. Taniguchi was present on February 14.
Mr. Tsuda was present on February 13.
Messrs. Wada, Yoshioka, and Ohsawa were present on February 14 from 9:00 a.m. to 9:14 a.m.

I. Decision on the Maximum Limit for Interest Rates on Liquid Deposits

A. Staff Reports

Following the amendment of the Deposit Insurance Law in December 2002 extending the measures to fully protect liquid deposits by two years to the end of March 2005, the maximum limit for interest rates on liquid deposits, which was set to prevent moral hazard, would need to be applied for another two years. On February 3, 2003, in accordance with the Temporary Interest Rate Adjustment Law, the Commissioner of the Financial Services Agency (FSA) and the Minister of Finance requested the Bank's Policy Board to change the period during which the maximum limit would be applied.

In response to this request, the Bank's Policy Board consulted with the Financial System Council (FSC) in accordance with the above law, and on February 7, 2003 the council submitted to the Board a report regarding extension of the period during which the maximum limit would be applied.

B. Members' Vote

Members of the Policy Board voted unanimously to extend the period during which the maximum limit for interest rates on liquid deposits would be applied in accordance with the FSC's report and to report the decision to the Commissioner of the FSA and the Minister of Finance. Members agreed that the decision should be made public after the meeting.

II. Acceptance of Dematerialized Commercial Paper as Eligible Collateral

A. Staff Proposal

The staff proposed that the Guidelines on Eligible Collateral, the Temporary Rules of Eligibility Standards for Asset-Backed Commercial Paper (ABCP), and the rules for conducting the Bank's business be amended in preparation for the start of operation of the book-entry system for dematerialized CP, including ABCP, on March 31, 2003 by the Japan Securities Depository Center Inc., the designated central securities depository. The Bank should accept dematerialized CP as eligible collateral with a view to further facilitating money market operations, because it would basically fulfill the same economic function as the physical certificates of CP.

B. Members' Discussion and Vote

Members voted unanimously to approve the proposal and agreed that the decision should be made public.

III. Summary of Staff Reports on Economic and Financial Developments⁵

A. Money Market Operations in the Intermeeting Period

The Bank conducted market operations in accordance with the guideline decided at the previous meeting on January 21 and 22, 2003.⁶ It aimed at an outstanding balance of current accounts at the Bank of around 20 trillion yen. As a result, the weighted average of the uncollateralized overnight call rate remained at 0.001-0.002 percent.

Undersubscription had not occurred in the Bank's funds-supplying operations, except for CP purchasing operations under repurchase agreements. This was partly due to steady bidding in the Bank's operations by financial institutions, particularly city banks, to raise funds that would mature beyond the fiscal year-end. However, there had been so far no movement suggesting precautionary action by financial institutions to raise funds, and bid rates in the Bank's market operations were generally stable. Against this background, recently participants were feeling more strongly that there was excess liquidity, and interest rates in funds-absorbing operations with one- to two-week maturity were low at 0.001-0.002 percent.

5Reports were made based on information available at the time of the meeting.
6The guideline was as follows:
The Bank of Japan will conduct money market operations, aiming at the outstanding balance of current accounts held at the Bank at around 15 to 20 trillion yen.
Should there be a risk of financial market instability, such as a surge in liquidity demand, the Bank will provide more liquidity irrespective of the above target.

B. Recent Developments in Financial Markets

In the money market, interest rates on term instruments including yields on treasury bills declined further reflecting the Bank's provision of ample liquidity. Short-term interest rates for funds maturing beyond the fiscal year-end were stable so far, although the amount of transactions in the money market was small. There had been no movement suggesting precautionary action to raise funds by city banks, for example, partly for the following reasons. First, the need for such banks to raise funds through the money market was declining due to their improved net balance of deposits against loans. And second, the Bank had started much earlier than in the past to provide ample funds that would mature beyond the fiscal year-end through its market operations. Market participants, however, remained cautious about the credit risk of Japanese banks, and as a result, the cost for foreign banks of raising yen funds had become negative. Given this situation, some foreign banks were lending yen funds in the call market at negative interest rates.

In the stock market, the Nikkei 225 Stock Average remained sluggish, moving at around 8,500 yen, due to substantial uncertainty about the outlook for the Japanese economy against the background of greater geopolitical tension in the Middle East. Market participants were concerned about the deterioration in the supply-demand balance in the stock market due to selling by some employees' pension funds that had changed their schemes and by firms that were unwinding their cross-shareholdings. Recently, however, individual and foreign investors were buying stocks, taking advantage of the reasonable prices.

In the bond market, yields on ten-year Japanese government bonds (JGBs) temporarily fell below 0.8 percent to a record low. This was because pension funds and financial institutions decided to increase their holdings of JGBs with longer maturities given that the uncertainty about the economic outlook was growing and interest rates overseas were declining. However, the yields rose slightly thereafter owing to market participants' concern that JGB prices might fall, and recently they were moving at around 0.85 percent. The yield differentials between corporate bonds and JGBs remained generally unchanged. However, for corporate bonds issued by firms with Baa or lower ratings, they narrowed slightly because some market participants started to purchase corporate bonds with high yields as long-term interest rates declined further.

The U.S. dollar continued to depreciate reflecting increasing concerns about geopolitical risks, particularly the situation in the Middle East. The euro had appreciated to around 1.08 U.S. dollars recently. The yen, on the other hand, had fluctuated within the range of 117-120 yen against the U.S. dollar, and thereafter depreciated slightly to the 119-122 yen level, reflecting market participants' anticipation of possible intervention by the Japanese authority.

C. Overseas Economic and Financial Developments

The U.S. economy had stayed on a modest recovery trend, but the pace of improvement in production, employment, and income was slowing.

Regarding developments in U.S. final demand, private consumption remained on a moderate upward trend, supported mainly by aggressive discounting by retailers. However, a deterioration in the employment situation and consumer confidence gave cause for concern. Housing investment remained firm reflecting lower mortgage interest rates, but the pace of increase in housing prices was slowing. Business fixed investment was judged to have stopped declining. However, uncertainty about the outlook for corporate profits persisted, and there had been no sign that business fixed investment was on a recovery trend as was evident in weak data for new orders for nondefense capital goods, a leading indicator of business fixed investment. In this situation, the pace of recovery in production was sluggish, and firms were reducing labor costs.

The real GDP of the United States increased from the previous quarter at an annual rate of 0.7 percent in the October-December quarter of 2002. This was a significant deceleration from the 4.0 percent growth rate of the July-September quarter, due mainly to a decrease in automobile sales after a surge in the July-September quarter.

In U.S. financial markets, a cautious view regarding the prospects for economic recovery remained prevalent as geopolitical risks were increasing. In this situation, stock prices were weak due partly to the announcement of weak earnings forecasts by some firms. Long-term interest rates remained virtually level with two opposing factors, the uncertainty about the economic outlook and concerns about deterioration in the fiscal balance, almost offsetting each other.

In the euro area, the possibility that the economy might decelerate again was increasing, as domestic demand was sluggish and exports were slowing. In European financial markets, long-term interest rates declined in late January and remained virtually level thereafter and stock prices were weak, reflecting a more cautious view of market participants about the economic outlook. Judging from recent developments in EURIBOR futures, market participants' expectations had strengthened that the European Central Bank (ECB) would cut interest rates by the middle of 2003.

NIEs and ASEAN economies stayed on a recovery trend. Domestic demand components, such as private consumption and business fixed investment, remained firm, although the pace of increase in exports, especially of IT-related goods, slowed slightly. In China, economic growth remained high due to an uptrend in exports in addition to strong domestic demand supported by an increase in fiscal spending and large direct investment from abroad.

Financial markets in emerging economies remained stable overall. Financial market stability was restored in Turkey and Venezuela. In East Asian economies including South Korea, Hong Kong, and Singapore, stock prices fell on the whole, due to factors such as a rise in crude oil prices and concern about deterioration in profits mainly in firms in IT-related industries.

D. Economic and Financial Developments in Japan

1. Economic developments

Net exports remained virtually level, with both exports and imports increasing at a very modest pace. Recently, the growth in exports accelerated in the October-December quarter of 2002 after decelerating in the previous quarter, but on the whole, exports were judged to be increasing only very moderately. The situation seemed to reflect the worldwide expansion of demand for high-value-added audiovisual-related equipment, a field in which Japan was internationally competitive, and an increase in both exports to and imports from China due partly to an increase in production by Japanese firms in China. However, the increase in exports was expected to remain modest for the time being, given the weakness in overseas economic recovery. Firms were cautious about the outlook for exports, as significant uncertainty about geopolitical factors persisted.

With regard to domestic demand, housing investment remained sluggish and public investment was declining. Business fixed investment had almost stopped declining against the background of the improvement in corporate profits. However, there had been no sign that the investment stance of firms would become positive given the substantial uncertainty about the outlook for overseas economies.

As for private consumption, many sales indicators deteriorated in December, but in January, passenger-car sales increased slightly and sales at department stores seemed to have recovered. Overall, private consumption remained weak, but it was relatively firm considering the severe employment and income situation. Nevertheless, careful monitoring was required of developments in consumption, since consumer sentiment was somewhat weak.

The preliminary figure for the real GDP growth rate for the October-December quarter of 2002, released on February 14, 2003, was 0.5 percent on a quarter-on-quarter basis, exceeding the average market expectation of a decline of around 0.4 percent. Looking at the contribution of demand components to real GDP growth, that of net exports was 0.3 percent, which was a sharp rebound from a negative figure in the previous quarter, and that of business fixed investment was 0.2 percent. The contribution of private consumption decreased to 0.1 percent from 0.4 percent in the previous quarter. Past GDP data had been revised simultaneously with the release of the figures for the October-December quarter. Real GDP growth rates had been revised upward with the downward revision of most deflators, especially the fixed investment deflator, due to the switchover of the wholesale price index to the 2000 base-year corporate goods price index.

Production decreased by 0.9 percent on a quarter-on-quarter basis in the October-December quarter of 2002 after increasing by 2.2 percent in the previous quarter. The decline seemed to be mostly due to temporary factors such as the decrease in shipbuilding. Given this and the fact that high-value-added audiovisual-related equipment, whose production had been strong recently, was not included in the Indices of Industrial Production, it was judged that production remained virtually level.

As for the employment and income situation, the number of new job offers was on a gradual rising trend, and the number of employees in the Labour Force Survey, which covered various types of employees including non-regular employees such as temporary workers, appeared to be declining at a slower pace. However, the number of regular employees continued to fall, and winter bonuses declined significantly following summer bonuses in 2002, but the decline was not as large as that of summer bonuses. In sum, the employment and income situation overall remained severe.

On the price front, import prices were on a rising trend, reflecting developments in overseas commodity prices such as that of crude oil. Domestic corporate goods prices had been declining gradually. Consumer prices had also been declining gradually, but the pace of year-on-year decline was expected to become somewhat slower. This was because the year-on-year change in prices of petroleum products was expected to become positive, and the burden on households of medical costs was projected to rise due to public insurance reforms.

2. Financial environment

With regard to credit aggregates, private banks' lending declined by 2.3 percent on a year-on-year basis in January. The amount outstanding of funds raised through issuance of CP and corporate bonds generally continued to be at the previous year's level. Thus, on the whole, the total amount of funds raised by the private sector continued to decline by 2.5-3.0 percent year on year.

As for monetary aggregates, the year-on-year growth rate of the monetary base was lower in January. This reflected the significant increase in banknotes and the outstanding balance of current accounts at the Bank in the same month of the previous year. The year-on-year growth rate of the money stock remained almost unchanged in January, after declining substantially in December. The year-on-year growth rate of broadly-defined liquidity was about 1 percent, despite some monthly fluctuations.

In corporate financing, credit demand in the private sector continued to follow a downtrend as business fixed investment was sluggish and firms continued to reduce their debts.

Private banks remained cautious in extending loans to firms with high credit risks, while on the other hand they continued to be more active in extending loans to blue-chip companies. Recently, however, banks that had received an injection of public funds seemed to have gradually become willing to lend to small firms, in line with the "Business Improvement Administrative Order." The Bank's Senior Loan Officer Opinion Survey on Bank Lending Practices at Large Japanese Banks showed that banks' lending attitude toward small firms had started to become slightly positive. In addition, regarding terms and conditions of loans, banks started to ease collateralization requirements and their firm stance of increasing interest rate margins. The survey by the Japan Finance Corporation for Small Business (JFS) for January also showed that financial institutions' lending attitude as perceived by firms seemed to have become slightly less severe.

Credit spreads in the CP market were stable despite increasing issuance of CP maturing beyond the fiscal year-end. This was against the background of the increase in market participants' purchases of CP, which reflected a sense of excess liquidity in the money market.

There had been no significant change in the financial environment as a whole. However, market participants' concern about financial system stability had subsided somewhat compared with around October to December 2002 when concern about banks' business condition and firms' financing situation heightened reflecting the Government's guidelines for accelerating nonperforming-loan (NPL) disposal. This was partly because of efforts by major banks: for example, they announced plans to increase the amount of NPL disposal and their capital. This situation where concern about the financial environment had subsided seemed to be reflected in the stability of financial markets and in various diffusion indexes relating to corporate financing. However, the financial environment through the fiscal year-end continued to require careful monitoring because there remained substantial uncertainty, for example, in the effects of special inspections of financial institutions and of the implementation of the measures in the Government's "Program for Financial Revival."

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

A. Economic Developments

On the current state of Japan's economy, members concurred that it was appropriate to maintain the previous month's assessment as economic activity remained flat amid substantial uncertainty about the outlook for the economy. Many members said that future economic developments required careful monitoring because some indicators were weak, for example in production and private consumption.

With respect to the economic outlook, most members said that, assuming that overseas economies would recover gradually, the basic scenario of an increase in exports and production generating the momentum for a recovery remained valid. These members, however, added that the uncertainty regarding the outlook for overseas economies remained substantial due to the fact that an increasing number of indicators of the U.S. and European economies were somewhat weak, and geopolitical risks such as those centering on Iraq were substantial. Many members said that, although there was still a risk that developments on the financial side, such as an acceleration of NPL disposal, might exert downward pressure on the economy, the possibility had declined slightly compared with the period around October to December 2002.

Most members raised developments in overseas economies, particularly the U.S. and European economies, and their effects on Japan's exports as risk factors for the immediate future.

Members generally agreed that, although the U.S. economy was recently on a modest recovery trend and was likely to show an acceleration of recovery in the second half of 2003, uncertainty about the economic outlook was still considerable due to geopolitical risks. One member pointed out the fact that market participants had been revising downward their forecasts for the U.S. economy. A different member said that the markets had not reacted much to a new economic stimulus plan that included substantial tax cuts, and this gave cause for concern. A few members also noted the weakness of recovery in European economies, particularly the German economy partly reflecting difficulties in its financial sector.

Many members said that the self-sustained recovery in Asian economies continued to be firm, and the sustainability of this firm recovery was one of the key factors determining the outlook for Japan's exports. These members also expressed the view that, due to further progress in international division of the production process among Asian economies, trade--both exports and imports--between Japan and other Asian economies was increasing, and this was underpinning economic activity in Japan. Some members said that, in this situation, the following were cause for concern: anxiety about a possible deterioration in firms' business performance and a subsequent fall in stock prices in countries such as South Korea; the effects of the rise in crude oil prices; and the situation regarding North Korea.

With regard to domestic private demand, members generally agreed that there had not been any marked developments in economic indicators to greatly change the judgment made at the previous meeting. The decline in business fixed investment had almost come to a halt but there were no signs of a recovery, and private consumption remained weak on the whole, although it was relatively firm considering the severe employment and income situation.

Many members pointed out that careful monitoring was required of whether this firmness relative to the severe income situation would continue. In relation to this, a few members noted that some sales indicators had recently been somewhat weak. A few other members pointed out that the consumer confidence index was deteriorating recently. Therefore, they pointed out as cause for concern the increasing number of firms reviewing their entire traditional wage system, including wage base raises and annual raises, and the effects of such developments on consumer sentiment.

Many members commented on price developments that the pace of year-on-year decline in consumer prices was decelerating slightly recently, and it was expected to become somewhat slower, given the effects of the rise in crude oil prices and the projected increase in the burden on households of medical costs from April 2003.

A few members explained the background to the recent deceleration in the pace of decline in consumer prices. First, the expansion of the output gap was coming to a halt recently, judging from developments in the real GDP growth rates up to the October-December quarter of 2002 released on February 14, 2003. Second, prices of raw materials were rising, reflecting the firmness of other Asian economies. Third, firms were becoming less inclined to continue their low-price strategy. And fourth, consumers were showing a preference for high-value-added products. A few members, however, expressed the view that prices would basically stay on a gradual declining trend, given the following factors. First, the contraction in the pace of decline in consumer prices was largely due to temporary factors such as the rise in crude oil prices. Second, the output gap remained at a high level. And third, an increase in the supply capacity of overseas economies, especially other Asian economies, would continue to have a considerable effect on prices in Japan.

One member commented on the assessment of recent price developments in relation to the economic situation. The member said that the economy had not fallen into a deflationary spiral, judging from indicators relating to the economy and prices, including the retroactively revised GDP data, and this was evidenced by firms' price-setting strategy and consumers' preference for high-value-added products.

B. Financial Developments

With regard to the overall financial environment, most members said that risks stemming from the financial side had subsided somewhat compared with the situation in the period around October to December 2002 for the following reasons. First, the money market was very stable, and stock prices were weak but remained generally unchanged. And second, regarding corporate finance, banks' lending attitude seemed to have become somewhat less cautious. Members, however, generally agreed that there were still some unpredictable risk factors in the period through the fiscal year-end, such as geopolitical risks and their effects on financial markets.

With regard to developments in the money market, members said that participants continued to feel strongly that there was excess liquidity, despite the weakness in bank stock prices and the approach of the fiscal year-end. Members cited the following as the background to this. First, the Bank was providing funds through instruments maturing beyond the fiscal year-end earlier than in the past. Second, market participants were feeling more secure following the postponement of the removal of blanket deposit insurance for liquid deposits. And third, excessive concern about banks' soundness had subsided. Regarding the third factor, a few members pointed out that uncertainty related to financial institutions' capital adequacy ratios through the end of fiscal 2003 was subsiding, as major banks made efforts in line with the "Program for Financial Revival," for example announcing plans to increase the amount of NPL disposal more than they had initially planned and to increase their capital.

A few members referred to the fact that some banks were lending funds in the call market at negative interest rates. One member said that this reflected the market's concern about the soundness of the Bank, given the increases in its outright purchases of JGBs and purchases of stocks held by banks, and therefore the Bank should attentively examine its soundness. Another member said that future developments would require close monitoring, but for the time being such call market transactions could be regarded as probably a transitory irregularity.

As for corporate finance, many members said that small firms' financing situation remained difficult, but financial institutions' lending attitude was likely to have become somewhat less severe, as suggested by the results of the Bank's Senior Loan Officer Opinion Survey on Bank Lending Practices at Large Japanese Banks for the October-December quarter of 2002, and the diffusion indexes for firms' perception of financial institutions' lending attitude for January 2003 released by the JFS. A few members expressed the view that banks that had received an injection of public funds were trying to increase lending to small firms in line with the Government's "Business Improvement Administrative Order," although they needed to ease their firm stance of increasing interest rate margins.

Many members said that the overall financial environment, including developments in stock prices in the capital market, was currently in a lull, but there remained a high degree of uncertainty such as the effects of geopolitical risks on financial markets, the outcome of the implementation of measures to accelerate NPL disposal, and the results of special inspections of financial institutions. One member expressed the view that risks stemming from the financial side had not subsided: rather, risks were merely being held down due to the implementation of measures such as the postponement of the removal of blanket deposit insurance for liquid deposits. Some other members pointed out that the markets' view of banks' soundness remained basically severe, and the financial system problems remained significant.

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

On the monetary policy stance for the immediate future, members agreed that it was appropriate to maintain the current guideline for money market operations, given that there were no major changes in the Bank's assessment of economic and financial developments since the previous meeting, and that financial markets remained extremely easy.

Members stressed that the Bank should provide ample liquidity in a timely and flexible manner if there was any risk of financial markets becoming unstable. This was because unpredictable risk factors persisted, for example geopolitical developments, and also because there was the risk that the weakness in financial conditions would increase through the fiscal year-end depending on stock price fluctuations, the results of special inspections of financial institutions, and progress in increasing banks' capital. Given this, some members said that it would be desirable to publicly state that the Bank would provide more liquidity when necessary to secure financial market stability through the end of the fiscal year. Members agreed to indicate this in the contingency clause of the guideline for money market operations.

Many members then commented on proposals made to the Bank regarding the future conduct of monetary policy.

A few members commented regarding the fact that there were still calls for the Bank to increase the money stock. One member said that deposits, which constituted a large part of the money stock, were a liability of financial institutions, and therefore an increase in deposits would require a corresponding rise in asset items on the balance sheet, particularly loans. However, financial institutions' lending was unlikely to increase in the immediate future because firms were reducing their excess debts and this was a necessary adjustment process. This member said that the important task for policymakers was therefore to enhance financial institutions' intermediary function and to strengthen other channels of financial intermediation. In relation to this, a different member said that the monetary base had already been provided to a sufficient level relative to nominal GDP through the Bank's monetary easing, and this had provided the foundation on which the money stock could rise if economic activity increased.

Many members commented on increasing outright purchases of JGBs and purchasing nontraditional assets, both of which were often raised as additional monetary easing measures the Bank could take.

One member said that, before launching into a debate on this issue, it should be made clear whether the objective of these policy options was solely to increase the outstanding balance of current accounts at the Bank or to directly influence asset prices. A few members including this member said that, in considering the former point, the implications of the fact that the effects of an increase in the outstanding balance of current accounts were not evident at present should first be discussed. Regarding the latter point, they said that it should be borne in mind that policy action with such an aim might eventually result in measures to underpin asset prices. A few members said that it was not appropriate to employ such policy measures at present, pointing to the problem of the feasibility and side effects of influencing asset prices.

One member said that there was a possibility that drastic action by the Bank to increase the amount and range of assets eligible for purchase could influence people's expectations. Another member commented that if inflationary expectations increased, this would be due to people's loss of confidence in the Bank's control over prices. This member continued that the decline in prices was certainly undesirable, but the Bank should carefully weigh the negative effects arising from the current mild decline in prices and those stemming from drastic measures taken by monetary policy alone to end it.

Regarding an increase in the Bank's outright purchases of JGBs, a few members raised the question of the risk that they would increase the volatility of long-term interest rates that were historically low at present.

In relation to the Bank's policy options for additional monetary easing, some members commented on the effects of the financial system problem on the conduct of monetary policy. A few members expressed the view that quantitative easing was necessary and effective to maintain financial market stability, given the uncertainty about the financial system. One of these members said, however, that one factor that was reducing the positive effects of quantitative easing was the financial system problem. This was because, although NPL disposal was essential for a recovery of the credit creating function of financial institutions, it caused credit contraction in the short term through, for example, a reduction in unprofitable lending and a rise in banks' interest margins. On this basis, this member commented as follows. First, the Bank had been employing quantitative easing to date, but the main factor influencing the current financial situation was the financial system problem. Second, when examining various possible policy options, it was important to consider their effects and implications taking this problem into account. And third, amid the disinflationary trend worldwide, monetary authorities overseas and academics were discussing possible monetary easing measures to be employed once interest rates reached the zero bound, but policy measures that were effective for economies overseas might not be effective for Japan's economy, because it was burdened with a difficult financial system problem. In response to this, one member said that resolution of the NPL problem was essential for the Japanese economy, but if it took a long time, it was vital that the Bank continued quantitative easing measures to secure financial market stability.

VI. Remarks by Government Representatives

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

(1) The supplementary budget for fiscal 2002 had recently passed the Diet, and the Government would continue its efforts to obtain the Diet's approval for the fiscal 2003 budget as soon as possible. The Government would aim to realize sustainable growth led by private demand by implementing the two budgets in an integrated and seamless manner and by further accelerating structural reform.

Overcoming deflation continued to be the most important task for Japan's economic policy. Given this, it was necessary for the Government and the Bank to work together and implement powerful and comprehensive measures to make the inflation rate positive as soon as possible.

(2) The Bank had decided at the end of October 2002 to implement further monetary easing measures, but this had not led to economic recovery as deflation continued. This was evident in developments in prices, which showed no sign of a rebound, and in a decrease in financial institutions' lending and a slower pace of increase in the money stock.

(3) In addition to the Bank's current ample liquidity provision to financial institutions, the Government would like the Bank to devise other effective monetary easing measures that would improve both the quality and quantity of liquidity provision and to implement them, giving due consideration to the situation in the household and corporate sectors, so that the provision of liquidity would stimulate the flow of funds in the economy.

The representative also stated his personal view as follows.

(4) As the representative said in the previous meetings, the Bank's outright purchases of JGBs should be increased to, for example 2 trillion yen per month to promote rebalancing of financial institutions' portfolios, and to this end, the current ceiling on the Bank's outright purchases of JGBs of the outstanding amount of banknotes should be removed, for example until the end of fiscal 2003, and the role and the framework of outright purchases of JGBs should be reviewed again at that time.

(5) The Bank should increase its efforts to foster markets for asset-backed securities (ABS) and ABCP to secure smooth functioning of corporate financing for small firms. The Bank had taken measures, such as accepting ABS and ABCP as eligible collateral for its market operations, but the representative would like the Bank to deliberate on the feasibility of taking stronger measures. The representative would also like the Bank to consider underwriting Fiscal Investment and Loan Program (FILP) Agency bonds issued by government financial institutions.

The representative from the Cabinet Office made the following remarks.

(1) While movements of an incipient recovery could be seen in some areas of the economy, the state of the economy had weakened somewhat. The preliminary figure for the real GDP growth rate for the October-December quarter of 2002, released on February 14, 2003, was 0.5 percent on a quarter-on-quarter basis, an increase for the fourth consecutive quarter, due mainly to the large contribution of external demand to GDP. However, private consumption was weak, remaining virtually level with the previous quarter. The GDP deflator in the same quarter declined by 2.2 percent from the previous year, and this confirmed that the deflationary trend continued. Economic and financial developments would require close monitoring given the uncertainty surrounding the future of the world economy and the weak consumer sentiment.

(2) In order to realize sustainable growth led by private demand, the Government considered it important to make efforts to steadily implement the "Program to Accelerate Reforms" and the supplementary budget for fiscal 2002, which was formulated in accordance with the program, as well as to obtain as soon as possible the Diet's approval for the fiscal 2003 budget and tax reform measures and to implement them.

(3) The fiscal 2002 version of "Structural Reform and Medium-Term Economic and Fiscal Perspectives" stated as follows. Overcoming deflation was the most important task in the intensive adjustment period through fiscal 2004, and comprehensive measures, including ones to deal with the financial situation, were essential, and thus the roles of the Government and the Bank were vital. Based on this thinking, the Government would like the Bank to deliberate further on effective monetary policy measures from a wide range of options, including ones that might not be based on conventional frameworks, and implement them to make the inflation rate positive as soon as possible giving due consideration to the recent developments in financial institutions' lending and the money stock.

VII. Votes

Based on the above discussions, members considered that it was appropriate to maintain the current target for the outstanding balance of current accounts at the Bank. In addition, members agreed to indicate in the contingency clause of the guideline for money market operations that the Bank would provide more liquidity when necessary toward the fiscal year-end.

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

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

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

The Bank of Japan will conduct money market operations, aiming at the outstanding balance of current accounts held at the Bank at around 15 to 20 trillion yen.

For the time being, the Bank will provide more liquidity irrespective of the above target when necessary to secure financial market stability towards the end of a fiscal year.

Votes for the proposal: Mr. M. Hayami, Mr. S. Fujiwara, Mr. Y. Yamaguchi, Mr. K. Ueda, Mr. T. Taya, Ms. M. Suda, Mr. S. Nakahara, Mr. H. Haru, and Mr. T. Fukuma.

Votes against the proposal: None.

VIII. 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 unanimous vote, the Board decided to publish "The Bank's View" on February 17, 2003 in the Monthly Report of Recent Economic and Financial Developments (consisting of "The Bank's View" and "The Background").⁷

7The original full text, in Japanese, of the Monthly Report of Recent Economic and Financial Developments was published on February 17, 2003 together with the English version of "The Bank's View." The English version of "The Background" was published on February 18, 2003.

IX. Approval of the Minutes of the Monetary Policy Meeting

The Policy Board approved unanimously the minutes of the Monetary Policy Meeting of January 21 and 22, 2003 for release on February 19, 2003.

Attachment

For immediate release

February 14, 2003
Bank of Japan

At the Monetary Policy Meeting held today, the Bank of Japan decided, by unanimous vote, to set the following guideline for money market operations for the intermeeting period: