On November 6, 2023, The Bank of Japan’s (BOJ) Governor, Kazuo Ueda, gave a speech at a meeting with business leaders in Nagoya. His speech covers developments in Japan's economic activity and prices, and he explains the Bank's thinking on the conduct of monetary policy[i]. The following is a breakdown and summary of what his speech entailed.
What was said about Japan's economic development?
Currently, Japan’s economy is still recovering, with the BOJ projecting that the economy will grow at a rate of 2% for fiscal year[ii] 2023, then continue growing at a rate of around 1% for fiscal year 2024 & 2025; ultimately looking to return to its real GDP pre-pandemic level. This is a positive statistic because a growing GDP may reflect increased employment opportunities, or higher incomes leading to increased production and consumption within the country; this in turn can boost businesses, leading to higher profits and investments. Furthermore, it may attract foreign investment and enhance international trade relations; this influx of capital and trade opportunities can stimulate innovation, technology transfers, and industrial development.
Ueda reported that exports have overall risen, mainly due to a rise in automobile-related exports. One of the main features of Japan's exports is the large proportion of high-value-added products, with more than half of Japan's exports consisting of machinery and equipment, electronics, and vehicles. Since the mid-twentieth century, Japan has focused on export-oriented growth. This is because it was dependent on imports of natural resources, so needed export revenues to finance this. It has been exploiting its comparative advantages[iii] based on its skilled and hard-working population. According to the UN Comtrade, Japan was the 4th largest merchandise exporter in 2020; its industrial sector produced highly diversified products ranging from basic goods to sophisticated technologies.
Looking towards the corporate and household sector, Ueda is confident that the corporate sector will improve in a ‘virtuous cycle’ where higher corporate profits result in further business investments. These are beneficial to Japan’s economic development because business investments often have a positive multiplier effect[iv] on the economy. For instance, when a company invests in new machinery or facilities, it not only creates direct jobs but also generates demand for goods and services from other businesses, creating a ripple effect throughout the economy. Profitable businesses can position a country as globally competitive; as Japanese businesses thrive, they contribute to the nation’s reputation and reliability in international markets, attracting more business, foreign investments, and trade opportunities. Private consumption in the household sector has risen, where demand has been suppressed due to the pandemic. With the pace of the increase being moderate so far, wages are deemed to still firmly increase in reflection of the high prices.
What was said with regard to price developments in Japan?
Japan’s current year-on-year rate of increase in CPI[v] remains at 2.8% for Fiscal Year (FY) 2023 & 2024, which is then predicted to fall to 1.7% for FY 2025. To achieve its 2% inflation target, ex-board member, Goushi Kataoka, says that “the Japanese government and central bank must cooperate with each other in terms of monetary and fiscal policies”. A stable inflation environment has significant micro and macro-economic benefits to the economy of Japan; to say a few, there may be greater consumer purchasing power as incomes are not eroded by high inflation, thus supporting a sustained demand for goods and services. Businesses thrive in a stable and predictable environment. So, when inflation is in line with the target rate, firms can make more/are more incentivised to make accurate financial plans and decisions, thus boosting animal spirits[vi] within the economy. It also makes it easier for companies to engage in international trade, as they can better anticipate costs and price their products competitively in the global market. However, falling prices can lead to a deflationary spiral, where consumers delay purchases in anticipation of further price drops, thus leading to reduced economic activity. So, this emphasises the need to keep inflation close to the target to mitigate the risks associated with deflation.
Ueda mentions that there are two forces behind why inflation remains high in Japan: imported inflationary pressures & inflationary pressures associated with the interaction of wages and prices. The first force is predicted to die out because the imported inflationary pressures were said to have peaked in the middle of last year (2022), the rate of increase in producer prices has slowed down, and the rate of increase of essential items such as food and water has been deemed to have slowed down as well. Despite this, Ueda believes CPI will not proceed to fall to the 0-1% band but instead remain at around the 2% benchmark, due to the second force. With high uncertainties of how the second force will strengthen, the achievement of price stability cannot be imagined.
What has been the BOJ’s Monetary Policy conduct?
To summarise this section of the speech, Ueda expects the BOJ to actively manage interest rates along the yield curve to foster economic growth, address deflationary pressures, and achieve broader monetary policy objectives.
Yield Curve Control (YCC) is a monetary policy framework wherein a central bank (BOJ) sets targets for yields on government bonds[vii] across different maturities[viii]. In the case of the BOJ, this typically involves targeting the yield on 10-year Japanese government bonds (JGBs). While the Bank maintained the target level of 10-year JGBs at around 0%, it decided to conduct YCC with the upper bound of 1% (compared to 3.25% of the UK, and 4.5% of the USA). By maintaining lower interest rates, YCC can influence the exchange rate of the Japanese Yen. The BOJ may be able to discourage speculative inflows seeking higher yields, which decreases the demand for the Yen, thus depreciating the value of the currency - which is what the government ultimately want.
Footnotes:
[i] Monetary policy - the use of interest rates by the central bank to affect the economy as a whole.
[ii] Fiscal year - a year as reckoned for taxing or accounting purposes; a financial year.
[iii] Comparative advantage - when one country can produce a good with a lower opportunity cost than another country.
[iv] Positive multiplier effect - when an initial injection into the circular flow of income leads to a more than proportionate rise in national income.
[v] Consumer Price Index - a measure of the rate of inflation using weighted averages of price changes of a basket of goods.
[vi] Animal spirits - the human emotions that affect consumer and producer confidence.
[vii] Government bonds - a debt-based investment where one loans money to the government in return for an agreed rate of interest (coupon).
[viii] Maturity - time until the government must pay back the money borrowed through a bond.
Bibliography:
Japan's export specialization in 2000–2020 - ScienceDirect
Japan's Economy and Monetary Policy - BOJ
United Kingdom Rates & Bonds - Bloomberg
