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Outlook and Risk Assessment of the Economy and Prices

(April 2001) *

  • As determined by the Policy Board at the Monetary Policy Meeting held on April 25, 2001.

April 26, 2001
Bank of Japan

Outlook for economic and price developments

  1. Looking back over fiscal 2000, Japan's economy was on a gradual recovery trend throughout 2000. However, the recovery started to decelerate around the end of the year, and the economy recently entered an adjustment phase against the background of a global economic slowdown since autumn 2000, notably a deceleration in the U.S. economy.
  2. The most likely scenario for economic developments in fiscal 2001 and early fiscal 2002 is as follows. In the first half of fiscal 2001, the global economic slowdown will probably continue to depress Japan's exports and production, and thus the economy is likely to remain sluggish as a whole. In the second half, although uncertainties still remain in the outlook of overseas economies, they are expected to bottom out and start recovering moderately led by progress in the adjustment in the U.S. economy, gradually reducing downward pressure on Japan's exports and production. In addition, the yen's depreciation since autumn 2000 is expected to have a positive effect on exports and corporate profits. However, persisting pressure on the economy arising from various structural problems, including the problem of firms' heavy debt burden and financial institutions' nonperforming loans, is likely to prevent firms from increasing their employment and fixed investment. Therefore, it is likely that it will take time for the economy to exhibit a clear recovery, although downward pressure from the global economic slowdown is expected to abate in the second half of fiscal 2001. Against the background of these developments in the economy, prices are likely to remain weak throughout fiscal 2001 affected by downward pressure from both the supply side and the demand side.
  3. Developments in each demand component are expected to be as follows. Currently available information suggests a decline in public investment in fiscal 2001 for the second year. Exports are expected to decrease in the first half of fiscal 2001, reflecting the slowdown in overseas economies, including the U.S. economy, but they are likely to improve gradually in the second half due to a moderate recovery of overseas economies and a weak yen. As a result of the decrease in exports and inventory adjustments, production is likely to follow a downward trend at least during the first half of fiscal 2001, causing corporate profits to start declining and business fixed investment to level off gradually. The recovery in private consumption is expected to continue to be slow reflecting the weakening of the income-generating mechanism starting from the corporate sector.
  4. On the financial front, conditions for corporate financing are likely to remain eased under the drastic policy measures adopted by the Bank of Japan. However, commercial bank lending is expected to remain weak because firms are keeping their capital spending below their cash flow and are continuing to reduce debt. In this environment, it continues to seem unlikely that the Bank's monetary easing will accelerate growth in money supply, which is anyway likely to maintain a relatively high growth rate compared to the sluggish economic activity.
  5. The following factors are likely to affect price developments. The output gap is expected to widen gradually during fiscal 2001 and is unlikely to start narrowing until fiscal 2002 against the background of the weak demand outlook described above, although the annual rate of growth in Japan's supply capacity is estimated to have declined to one percent-plus in the short run. Actual price indexes reflect not only the above supply-demand balance but also a variety of other factors. Such factors that are expected to continue exerting downward pressure on prices include (1) the downtrend in machinery prices due to technological innovation, (2) the fall in communications charges brought about by deregulation, and (3) streamlining of distribution channels. On the other hand, the yen's depreciation since autumn 2000 is likely to exert upward pressure. Reflecting the above, price indexes will continue to be weak; in fiscal 2001, the year-on-year rates of change in the domestic WPI and the CPI (excluding perishables) are likely to be marginally negative.

Risk assessment

  1. The above standard scenario is considered the most likely one to materialize, but both upside and downside risks need to be borne in mind in the conduct of monetary policy. Among these risks, first of all,developments in overseas economies, especially that of the United States, and in IT-related areas warrant attention. The long expansion until the first half of 2000 and recent rapid slowdown of the U.S. economy were driven by, among other things, the developments in IT-related areas. The bullish view of the prospects for these areas is waning. It is still unclear how this change in expectations will affect the duration and extent of U.S. economic adjustments. The standard scenario envisages a very slow recovery in the United States starting in the latter half of 2001. However, after such a long period of high growth, the U.S. economy may face a larger-than-expected adjustment and may not start recovering as soon as that. In that case, the world economy, especially East Asian economies, may be affected and if it is, downward pressure on Japan's exports and production may persist. It should be also noted that such developments could themselves delay recovery of overseas economies. In addition, an appreciation of the yen that may occur as a result of a large economic adjustment in the United States might adversely affect exports from Japan. On the other hand, if U.S. economic adjustments make rapid progress and a resulting recovery in the economy becomes clear in the second half of 2001, this will have positive effects on the world economy including East Asian economies and Japan's exports and production.
  2. The second risk factor relates to developments in asset prices. Global financial markets, especially the U.S. markets, are showing volatility centered on adjustments in IT-related stocks. This also applies to Japan, where stock prices are experiencing large fluctuations and are still unable to stabilize. In addition, land prices continue to decline as a whole. A further decline in asset prices might adversely affect the economy through a worsening of corporate and household sentiment and a tightening of commercial banks' lending stance.
  3. The third factor is the effects of structural adjustments. Japan's economy is, as already mentioned, still suffering from pressure arising from various structural problems such as a heavy debt burden of firms and nonperforming loans of financial institutions. The strength of such pressure and its effects on the economy are factored into the standard scenario. However, careful attention should be paid to the short-term negative impact on the economy of corporate bankruptcies and unemployment, both of which might increase as a result of further progress in disposal of nonperforming loans by financial institutions and in corporate restructuring. In this regard, progress in structural adjustments is indispensable for forming the foundation of medium- to long-term economic development, and thus should not be regarded merely as a downside risk. In addition, efforts to carry out structural adjustments may be received favorably by financial markets, and this might bring about positive effects on the economy before the effects of structural adjustment itself emerge. Furthermore, if an increase in productivity comes in prospect as a result of progress in structural adjustment and this generates upward momentum in the economy, economic recovery might accelerate and the decline in prices might come to a halt earlier than expected with the extremely accommodative monetary policy.
  4. The fourth risk is uncertainties felt by the public with respect to the future. The public in Japan is concerned about the future against the background of a number of problems including the social security system problems arising from the decline in the birthrate and the aging of the population, expansion of the fiscal deficit, and the nonperforming loan problem. This concern seems to be affecting households' spending. Should concern about expansion of the fiscal deficit and about a delay in disposal of nonperforming loans intensify, this might cause consumer sentiment to deteriorate and long-term interest rates to rise, eventually affecting the economy adversely. On the other hand, if efforts to tackle structural problems and consolidate the national budget become clear to the public and their anxiety wane, this might have positive effects on households' spending.

Forecasts of the Majority of Policy Board Members

Table : Forecasts of the Majority of Policy Board Members (Y/y % change)
  Real GDP Domestic WP CPI (excluding perishables)
Fiscal 2001 +0.3 to +0.8 -0.9 to -0.6 -0.8 to -0.4
  • Note: The forecasts of Policy Board members are based on the assumption that there will be no change in monetary policy. Forecasts of the majority of Policy Board members are shown as a range with the highest and lowest figures excluded. When two or more members forecast the same highest/lowest figure, the figure will be included in the range.

The forecasts of all Policy Board members are as follows:

Table : The forecasts of all Policy Board members are as follows (Y/y % change)
  Real GDP Domestic WP CPI (excluding perishables)
Fiscal 2001 -0.1 to +1.0 -1.5 to -0.5 -1.0 to -0.3

Actual figures for fiscal 2000 are as follows:

  1. (1) The year-on-year growth rate of real GDP is estimated to be +1.2 percent on the assumption that the level of GDP for January-March 2001 is unchanged from the previous quarter.
  2. (2) The year-on-year rate of increase in the domestic WPI is 0.0 percent.
  3. (3) The year-on-year rate of increase in the CPI (excluding perishables) for April 2000-February 2001 is -0.4 percent.