Overcoming Deflation: The Bank of Japan’s Challenge

Thursday, October 10, 2013

Haruhiko Kuroda, governor of the Bank of Japan, discusses the challenges of overcoming deflation and Japan's economic policy.

This meeting is part of the C. Peter McColough Series on International Economics, which is presented by the Corporate Program and the Maurice R. Greenberg Center for Geoeconomic Studies.

MODERATOR: Good morning. We are very fortunate to have Governor Kuroda here today. This is the second time that he's appeared at the Council, and the first time as president of the Asian Development Bank.

Governor Kuroda is what we would call a pioneer. If you look at monetary policy in Japan, taking the balance sheet of the Bank of Japan taking the balance sheet of the bank of Japan to 60 percent of GDP is going to be an art form. And if you look at central banks around the world, increasingly they are being asked to do things that they have never done before.

So, Governor Kuroda, this is the C. Peter McColough Lecture Series. It is on the record. And we are very much looking forward to your comments. Thank you.


KURODA: Good morning. I am very much honored to be given an opportunity to speak this morning at the long-established Council on Foreign Relations. It is my first time to speak at the Council since February 2006, when I was president of the Asian Development Bank. At that time, I recall that the venue was a hole in the Council's Washington, D.C., office.

While I'm scheduled to visit Washington, D.C., later during my trip this time, I have stopped over in New York, knowing that I would be given an opportunity to speak to you.

Today, I will talk about Japan's deflation is all about—what Japan's deflation is all about and what challenges Japan is faced with, followed by how the Bank of Japan is trying to overcome deflation.

Japan has been mired in deflation since 1998, that is to say for the past 15 years. Let me bring up some figures. In Tokyo, the minimum fare for the subways of 160 yen, or $1.60, has not changed since 1995. During the same period, the fare in New York increased from $1.50 to $2.50. As fees for public services are not likely to be reduced as a rule, the minimum fare for the subways in Tokyo has not declined, but prices as a whole have declined moderately for a long period in Japan.

The feature of Japan's deflation is that it is moderate, but persistent. This is a phenomenon quite different from the deflation seen in the days of the Great Depression. In the period of deflation that occurred in the United States during the Great Depression, prices plunged in a short period. Prices declined significantly in the two years of 1931 and '32 by almost 10 percent annually, but deflation continued for only four years. In contrast, Japan's consumer prices have fallen 4.1 percent in the past 15 years from fiscal 1998 to fiscal 2012. This is merely a 0.3 percent decline on annual average basis.

However, the deflation in Japan has been extremely persistent. Young Japanese people have been born in a life of carrying the recognition that prices either will be constant or decline. The continuation of price declines, albeit moderate ones, for a protracted period has deprived Japan's economy of vitality. In a state of deflation, the holdings of cash or deposits will become a relatively better investment. In fact, cash and deposits held by Japanese firms have reached 230 trillion yen, close to 60 percent of nominal GDP.

Persistent deflation has created an environment in which the status quo is better than making investments in new initiatives and has brought a sense of stagnation to Japan. In an economy with few new challenges and investment, growth potential will decline gradually. Therefore, it is necessary to overcome deflation this time around and enhance people's willingness to take on new challenges.

There were economic cycles during the past 15 years. However, even when the economy recovered, prices did not increase in a sustainable fashion. The major reason for this is that, due to prolonged deflation, persistent deflation expectations—that is, the recognition that it is natural for prices not to increase—have become entrenched among people, and they look—they took actions based on such expectations. In such a situation, firms, households, and even labor unions will act on the assumption that prices will not increase, and thus it has become intrinsically difficult to increase prices.

In the past, the Bank of Japan took a variety of initiatives, including the adoption of unconventional measures ahead of other central banks, such as a zero interest rate policy, quantitative easing, and—in the latest wording—forward guidance. Nevertheless, while those policies were effective in terms of stimulating economic activity, they could not change people's persistent deflationary expectations. The greatest challenge in overcoming deflation this time is to raise people's inflation expectations.

The BOJ introduced the quantitative and qualitative monetary easing, or what we call QQE, in April this year, the new policy aimed at working directly on inflation expectations, with the goal of increasing inflation to the global standard of 2 percent. The question is: How?

The conclusion we reached was, first, to show our clear commitment to achieve the 2 percent inflation target in a stable manner as soon as possible and, second, to underpin this determination by launching massive monetary easing that's clearly different from the past policies.

Specifically, we declared that there would be a doubling in two years of the monetary base the BOJ provides. With this QQE, Japan's monetary base two years from now will become 270 trillion yen, or $2.78 trillion, reaching 56 percent of nominal GDP. For reference, the current monetary base in the United States is 329 trillion yen, or $3.39 trillion, which is 20 percent of nominal GDP.

To build the monetary base, on the asset side of the BOJ's balance sheet, the holding of long-term Japanese government bonds, JGBs, would be doubled. An associated massive purchase of JGBs would alter supply-and-demand conditions in the JGB market and put strong downward pressure on long-term interest rates.

However, there was a problem. The 10-year government bond yield in Japan was already less than 1 percent. How could we make additional room for monetary easing? The point was, the real interest rate, which is the nominal interest rate minus the expected inflation rate. In this regard, the situation facing in Japan, in which expected inflation rates were stagnant, fortunately provided a breakthrough to this question.

By raising inflation expectations, while containing a rise in nominal interest rates, we would be able to lower real interest rates, which affects decision-making with respect to business fixed investment and private consumption.

Let me elaborate on this. In the United States and Europe, amid stagnant growth, observed inflation rates have been hovering around central banks' targeted inflation rate of 2 percent, and firms' and households' medium- to long-term expected inflation rates have also been stable at around 2 percent. In other words, expected inflation rates are anchored at around targeted inflation rates.

In such cases, central banks cannot afford to raise expected inflation rates further. Therefore, to lower real interest rates, nominal interest rates need to be lowered. When long-term interest rates fall to the historic low level of less than 2 percent, room to further lower real interest rates becomes limited, as there is not much room to further lower nominal interest rates.

By contrast, in Japan, expected inflation rates have been anchored at too low of a level, some negative, compared with the 2 percent price stability target, and thus there is sufficient room to raise them. If a rise in nominal interest rates can be contained to a lesser extent than an increase in inflation expectations, then real interest rates can be lowered by that extent.

With such a decline in real interest rates, business fixed investment and private consumption are expected to be stimulated, thereby elevating economic activity. Observed prices are also expected to increase gradually. In addition, a rise in observed inflation will lead to an increase in inflation expectations.

There is little time today to explain all the transmission mechanisms or transmission channels of the QQE, but I have covered the core part. Through its effects, it is our aim to stimulate the economy, improve the output gap, and, above all, shift inflation expectations upward and achieve the 2 percent price stability target as soon as possible.

Now—now that six months have passed since the QQE was introduced, is it working? As it turns out, there have been improvements in financial markets, economic activity and prices, and people's expectations, and the QQE has been powerfully exerting its effects.

Let me point out some examples. In the financial markets, stock prices have risen by more than 30 percent since the beginning of the year. This substantially exceeds the rate of increase not only in Europe, of around 13 percent, but also in the United States, of around 16 percent.

On the real economy front, real GDP has marked high growth since the turn of the year of around an annualized 4 percent for two consecutive quarters. The unemployment rate has recently declined to the levels seen prior to the Lehman shock of around 4 percent.

People's expectations have also changed. Consumer confidence indicators clearly have tilted towards—tilted upward since around the end of last year. Looking at business confidence indicators, according to the BOJ's business survey, called the Tankan survey, the diffusion index for business confidence—or business conditions bottomed at minus 9 percentage points in the last December survey and has improved to plus 2 percentage points in the latest September survey, the same level as that in December 2007, prior to the Lehman crisis.

Turning to price developments, expected inflation rates have increased as a whole, according to market indicators and various surveys. The breakeven inflation rate has increased to close to 1.7 percent from around 0.7 percent a year ago.

In the Opinion Survey on the General Public's Views and Behavior conducted by the Bank of Japan, in which consumers are asked their views on the inflation rate one year from now, the proportion of consumers who answered that prices would increase was just over 50 percent in the last December survey, but increased to above 80 percent in the September survey.

In addition, the diffusion index for selling prices in the Tankan survey, which is calculated based on a question firms were asked of developments in selling prices of their own products and services, have improved for large firms from minus 15 percentage points in the last December survey to zero in the September survey this time.

Looking at the observed inflation rates, the CPI inflation rate turned positive in June for the first time in 14 months and accelerated to 0.8 percent in August. As explained, stock prices have been rising, and the real economy has been improving steadily. The inflation rate has turned positive, and inflation expectations have risen. Such improvements in economic activity, prices, and people's expectations could be factors in increasing interest rates.

Nevertheless, thanks to strong downward pressure stemming from the BOJ's JGB purchases, Japan's long-term interest rates have been slightly lower than those of a year ago, with 10-year JGB yields hovering at less than 0.8 percent.

In addition, while long-term interest rates have been rising since May in the United States and other overseas economies, those in Japan have been more or less flat or slightly declining. Commercial banks' lending rates on new loans—an average of loans to firms and individuals—have declined to a historic low of below 1 percent. Meanwhile, as people's inflation expectations have been increasing gradually on the whole, real interest rates have been declining. Thus, the situation we have aimed for has been generated.

This decline in real interest rates is likely to stimulate business fixed investment, housing investment, and private consumption, thereby bolstering the economy. In addition, the QQE and various measures by the government seem to have been gradually improving people's sentiment, making them proactive and igniting their animal spirits.

In fact, there are signs that firms' funding is becoming active. The year-on-year rate of increase in bank lending, which once declined to below 0.5 percent in the first half of fiscal 2012, has since been moderately expanding to slightly over 2 percent. The amount of corporate bonds issued in the April-June quarter reached a high level for the first time since the July-September quarter of 1998, which was coincidentally the quarter when deflation began. Initial public offerings by firms have also become active recently.

So far, the QQE has been exerting its intended effects, which is quite encouraging. By continuing to pursue the QQE with a strong determination to achieve the 2 percent price stability target, we are convinced that we will definitely overcome deflation.

Japan has a solid growth base. It has first-class technology and human resources. What has been lacking is positive sentiment—both the confidence in our ability to succeed and in our animal spirits, which were lost amid the sense of stagnation under persistent deflation. The overcoming of deflation will progress in line with a dispelling of this sense of stagnation. I'm a firm believer that Japan will regain confidence and grow with vigor again.

There is another tailwind for Japan. The recent decision to hold the 2020 Olympic Games in Tokyo is boosting the level of people's sentiment. At the time of the Olympics, seven years from now, we will welcome you to a Japan that has regained its brightness. However, I'm afraid that you may not be able to ride subways in Tokyo at a minimum fare of 160 yen at that time.


Thank you very much for your attention.


MODERATOR: Excellent. Very well done.

Thank you, Governor Kuroda, for those incredibly thoughtful remarks. I thought, in the 15 minutes that you and I have, we could talk about two major themes. First, you've tried QE in the past. You tried it between 2000 and 2005. Now, admittedly, you had a zero inflation target then, whereas now you have a 2 percent inflation target. But I'd like to spend a minute talking about why QE didn't work in the past.

And then I'd like to talk about, what are the risks and what are the possible midcourse corrections that you might be prepared to take if QE doesn't work this time?

So let's—let's go back, a little bit of history. Why didn't QE—because you increased the Bank of Japan balance sheet from 15 percent to 30 percent of GDP in that timeframe. Why didn't it work before?

KURODA: There may be a few factors which affected the Japanese deflation at that time. First of all, yes, at that time, the Bank of Japan introduced zero interest rate policy, or QQE, for the first time, aiming at eradicating deflation. But at that time, target was non-negative, positive inflation, not 2 percent inflation target, which is now almost global standard among central banks in the world.

If you aim at zero percent inflation rate, as you know, CPI has some element to overstating inflation real rate. So if it's zero CPI inflation, in reality, deflation will continue. And, also, around zero inflation rate, short-term interest rate would be quite low, close to zero. And once there's a shock to the economy, you cannot reduce short-term interest rates further, because already short-term interest rates are zero.

So the first problem was that, at that time, Bank of Japan aimed at zero inflation rate. It was not ambitious enough. And so at some stage, yes, inflation rate reached zero, or non-negative, and then quantitative easing was stopped. Thereafter soon, when the economy was affected, deflation resurfaced. So that is one—one point I could emphasize.

And compared with that, this time, we aim at 2 percent inflation. And we will continue the QQE to achieve the 2 percent inflation target and maintain that target in a stable manner. So that is a big difference. And the other difference is maybe, at that time—I mean, early 2000s, Japanese banking sector had still some residual problems, not huge problem like late 1990s, but, still, there were some banks with large non-performing assets, and eventually some of them were restructured and nationalized.

So the banking sector was not yet fully recovered. Then, this time, as you may know, the Japanese banking sector is one with the most...

MODERATOR: Very healthy.


KURODA: That's right, major banks in the world. So that is difference. So I think there are a number of differences between QEs the Bank of Japan pursued in the past and QQE now the Bank of Japan is pursuing.

Risks faced by the QQE, again, there are a few. One of them is external shocks. I mean, at this stage, the global economy is recovering, steadily but slowly. The strongest is, of course, the U.S. economy. It can grow by 3 percent soon, unless the ongoing fiscal stalemate delayed the economic recovery of the U.S.

Europe, apparently, has bottomed out, although it may continue to grow very slowly. China is likely to achieve 7.5 percent growth this year, as well as next year. So the global economy is recovering, steadily but slowly, but there are risks in the U.S., in Europe, in emerging economies in China. If those risks are materialized, that could help—that would affect the Japanese economy and—and affect our intention to achieve 2 percent inflation target as soon as possible with a view to achieving it in two years.

MODERATOR: Thank you. Your many years in the Ministry of Finance have given you, I think, a lot of perspective on Prime Minister Abe's three arrows, so you're the first arrow.


Obviously, fiscal policy is the second arrow. And, third, structural reform. Do you think that your early success has perhaps taken some of the pressure off of the Diet to do number-two and number-three arrows?

KURODA: This is a very complicated issue.


It's not purely economic issue. It's political economy issue.

MODERATOR: But you're also a professor. You're also a professor.

KURODA: Yeah, it's a bit complicated. But let me say like this. Yes, so-called Abenomics consists of three arrows. First is—it's monetary policy, to aim at achieving a 2 percent inflation target as soon as possible. Second arrow is flexible fiscal policy to support recovery, but to consolidate fiscal position in the medium term. And the third arrow is, of course, various structural reforms and TPP negotiations. All of them are aimed at reform the structure of Japanese economy.

These three arrows are, of course, intertwined, but in other sense, these three arrows are independent, independently pursued. First arrow is by the Bank of Japan, second and third arrows by the government. And—and, yes, successful eradication of deflation through QQE might make the government more complacent and so and so forth.

But on the other hand, as you know, structural reforms tend to affect economy and the general public seriously, particularly in the short run. Even if they would eventually raise growth potential and—and benefit all of the people, but in the short run, it could affect—like restructuring, structural reforms tend to have such short-term negative impact. And that makes structural reforms even more difficult. But when the economy is recovering, when prices are rising and wages are rising, structural reforms may become less difficult to implement.

So I'm of the view that—that three arrows are intertwined and, at this stage, first and the second arrows have been implemented, and the third arrow is going to be implemented in coming months and years. And I'm hopeful that the third arrow would raise potential growth rate of the Japanese economy in coming years toward 2 percent in real terms.

MODERATOR: In this country, we're always having the debate about the limit of central bank power to actually drive certain parts of the economy, when you're witnessing right now what's going on in Washington. And I've noticed, in terms of Bank of Japan balance sheet, you've purchased ETFs, equities. Would you be prepared, for instance, to purchase—and you've also purchased REITs—would you be prepared, for instance, to purchase real estate assets? Would you be prepared, if it doesn't look like this level of QE is working, to take 60 percent and say, oh, as a percent of GDP, and say let's go for 80 percent? In other words, what level of flexibility and willingness do you have to take this even further?

KURODA: As I said in my initial speech, the economy is on track. And, I mean, not only financial markets, but the real economy, prices, and expectations, all of them are improving as we intended. So at this stage, it's a bit premature what kind of additional measures Bank of Japan would and could take when necessary. Because in general terms, when necessary and if necessary to achieve the 2 percent inflation target in a stable manner, of course, the Bank of Japan is prepared to do anything necessary.

But at this stage, the economy is on track. And everything is going on as we intended. So I don't think it's appropriate for me to say some concrete, possible, additional measures Bank of Japan may take in the future.

You mentioned real estate, but as I said—or as you said—ETFs and J-REITs, Bank of Japan has been—has been purchasing. Actually, under QQE, we decided to double the amount of ETFs and J-REITs purchased by the Bank of Japan. And every month, we are implementing those purchase programs.

And so, in short, if necessary, the Bank of Japan will take any necessary measures to achieve 2 percent inflation target and maintain that target in a stable manner. But at this stage, the economy's on track, and I don't think I should say anything concrete about potential, possible, additional measures.

MODERATOR: If Mervyn—if Mervyn King were sitting in this room—and, in fact, he was here at the Council earlier this week—he is a fellow at the Council—you know, he has a very clear idea that he did not want the Bank of England to go beyond a very narrow, but it sounds like what you're saying is that you're not ruling out the possibility if it's not working.

Now, looking around the room, I see a number of market participants here. And anticipating a question about exchange rate policy, I have to anticipate some of the questions here. How do you view the utility of exchange rates, in terms of achieving some of your other goals?

KURODA: As we always argued, our monetary policy is aimed at achieving domestic goals, in particular 2 percent, plus stability target. And we do not target exchange rates or other financial variables. Of course, other things being equal, if one country loosens monetary policy, its currency tends to depreciate in the short run. But in the medium to long run, always, the exchange rate has tendency to come back to the normal range.

But, anyway, we do not aim at—we do not target exchange rate. Our monetary policy is purely domestic policy to achieve 2 percent price stability target as soon as possible.

MODERATOR: And then last question from me, and then I'm going to open it up. Coordination among central banks often is useful, particularly in a crisis. Do you think that there should be more coordination among central banks? And what advice would you give Janet Yellen if she was sitting here without the audience here?


KURODA: I think the international coordination is, in general, appropriate and desirable. But on the other hand, as you can see, monetary policy tends to affect your domestic economy most, although there may be some spillover effect affecting other countries in the world. But spillover effects tend to be far smaller than the impact on your economy.

So looking from those economies' standpoint of view, those affected through spillover effect, I mean, they have their own monetary policy or even some other policy tools, like capital flow, management policies, fiscal policies, macroprudential policies, and so on and so forth. And they can always counteract any negative spillover effect coming from a country like the U.S. or Japan or Europe.

So, yes, some coordination would be appropriate, particularly when the global economy is affected by a big shock, like oil shock or recently the Lehman shock, closer coordination among policymakers, including central bankers, was pursued and was actually implemented. Good. But in a more normalized situation, exchange of information, exchange of views would continue to be done, but close coordination of their monetary policies may not be so important as during the crisis period.

Now we are in a, more or less, if not completely normal situation, but not abnormal situation.


So in general, I agree that some policy coordination among central bankers would be appropriate and good, desirable, but basically U.S. monetary policy is directed toward the U.S. economy, and Japanese monetary policy is directed to the Japanese economy to improve in Japan, to achieve inflation target, eradicating deflation, and so on and so forth.

MODERATOR: And Janet Yellen's—the advice?

KURODA: I don't think she requires my humble advice.


She's much better experience than me.

MODERATOR: But she wasn't a professor at Hitotsubashi University, so—OK, let's open it up. And, please, in the front row here. And please identify yourself, and keep it to one question.

QUESTION: Michelle Caruso-Cabrera, CNBC. If the U.S. were to suffer a technical default on a one-month T-bill or a three-month T-bill, would it affect the Japanese central bank's willingness to accept U.S. Treasuries as collateral?

KURODA: First, I don't expect a U.S. default. Second, we—I mean, U.S. government default, if—even if it happens, does not affect our current-term policy.

MODERATOR: Please, in the front row here.

QUESTION: Paul Sheard from Standard & Poor's. First of all, thank you very much for a wonderful speech, and congratulations on a very successful six months in office. You've mentioned that you saw the three arrows as being intertwined, but independent. And I just want to probe a little bit on that, because your predecessor, Mr. Shirakawa, he had really argued strongly that the key to overcoming deflation was the third arrow, that is structural reform, in some sense, almost holding the end of deflation hostage to the structural reform agenda.

I read into what you're saying and the way that you've operated monetary policy that you don't really subscribe to that theory, that you believe that monetary policy can end deflation, independently of structural reform. Could you confirm your thinking around that point, please?

KURODA: Yeah. I think you have correctly summarized my position vis-a-vis former governor. I think monetary policy anywhere is the most important policy tools to influence rate of inflation. But at the same time, I can point out that, yes, if economy has greater growth potential, that would—that could make the task of a central bank—in this case, Bank of Japan—less difficult or less challenging.

But basically, I think it is the responsibility of a central bank to achieve price stability, irrespective of other policies pursued by the government.

MODERATOR: Just to follow up on that point, which is the consumption tax increase that's going to happen in April of 2014, you've raised the consumption tax twice before in this period of slow growth and deflation. How do you feel about that?

KURODA: On this particular issue, already our policy board has—has made it quite clear that consumption tax hike in two stages, from 5 percent to 10 percent, yes, could affect economic growth in coming years, but it would not undermine the growth trend in coming years so much.

And the policy board median forecast for economic growth in Japan is like this 2.8 percent this fiscal year and 1.3 percent next fiscal year and 1.5 percent year after the next. At this moment, Japan's potential growth rate is less than 1 percent. And this means that, in the three consecutive years, the Japanese economy will grow well above its growth potential, despite two-stage consumption tax hike.

So—and, also, recently the government decided to introduce some fiscal policy measures to ameliorate...

MODERATOR: Lower corporate taxes...

KURODA: ... and some additional expenditures, and so on and so forth, to mitigate the impact on the economy of consumption tax hike scheduled next fiscal year, as well as year after the next.

So, in short, I think the consumption tax hike, which is absolutely necessary to reduce deficit and to strengthen, improve sustainability of fiscal position in Japan, I think it's necessary and, as I said, it would not undermine the underlying growth trend of the economy.

MODERATOR: Thank you. Marty, you had a question?

QUESTION: Thanks. Marty Feldstein. How long do you think the interest rates on long-term bonds can continue to be as low as they are when you are convincing the public that you're heading to a 2 percent inflation rate?

KURODA: I must say, that is one of the most challenging questions...


... although I expected such a question would be raised.


As I argued in my initial statement, our QQE's, in some sense, quite similar to QEs or QE3 in the U.S. or QE of Bank of England. But the difference is—it's inflation expectations.

At this moment, inflation expectation is low, and so we are intending to raise to our 2 percent in about two years. And as you said, if we successfully raise inflation expectations to 2 percent, why bondholders accept low interest rates, like 0.7 percent 10-year government bond rate, it's irrational, probably you say.

Yes, we anticipate some such effect might eventually come, but for the time being, we continue something like 50 trillion yen JGB passes (ph) annually to suppress term premiums (ph) substantially. And so far, despite some rising deflation rate expectations, long-term interest rates stayed quite flat or even slightly declined, widening the negative real interest rates for some time (ph).

I think we can and we should continue this kind of a situation as much—as long as possible. But as I said, eventually, I mean, if economy improves and also the 2 percent inflation target is achieved and maintained in a stable manner, long-term interest rates may gradually rise. But even then, we—until we exit from the QQE, we intend to suppress, contain as much as possible long-term interest rates from rising. By so doing, we continue to have low or even negative real interest rate to—to achieve our target.

MODERATOR: In the third row, second in?

QUESTION: Thank you. Nick Bratt with Lazard. Governor Kuroda, thank you very much for your helpful comments. We have observed a very sharp recovery in corporate profits, which obviously partly explains the recovery in the stock market, but anecdotal evidence also suggests that companies are not raising wages. How concerned are you that wage increases are not coming through? Because that would presumably undermine the recovery in—in consumption.

KURODA: A few things. First, past records show that, when prices went up, wages also went up, and prices went down, wages also went down, although the extent of increase or decrease may have been somewhat different, but almost always wage increases and the price increases were synchronized, with some, of course, lag in some cases, but basically they moved in a synchronized manner. So since we are expecting prices rise gradually, wages also rise gradually.

Second, actually, wages—nominal wages are rising, largely because of increased bonus payment, and so on and so forth, rather than increasing the basic wages. Basic wages show still small negative here, but total nominal wages are increasing. And then employment is increasing quite rapidly. So small nominal wage increase, coupled with significant labor or employment increase, means that wage income is increasing steadily.

The third point is I share your concern to the extent that basic wages are not rising yet. But as you may know, in Japan, so-called Spring Offensives are wage negotiations between companies and trade unions, labor unions, made usually in the spring. And so we expect—we hope that next spring, even basic wages would rise.

But in the meantime, any way, nominal wages are gradually rising, largely because of increased bonus payments, and employment is increasing significantly, so that wage income, employer—employer's income is increasing, increasing more than price increase, so that their real income is increasing, supporting strong consumption. That would continue. And—but basic wages, yes, are not yet increasing.

MODERATOR: In the fourth row, please?

QUESTION: I'm Vincent Lauerman from Energy Intelligence. During your opening remarks, Governor Kuroda, you made mention of Japan's long period of economic stagnation. Recently, there's been an increasing political rivalry between China and Japan, you know, in particular the dispute over the Senkaku Islands. And the question I have is, what role, if any, you know—you know, does this budding rivalry play in your government adopting these more radical economic policies to kick-start your economy?

KURODA: First of all, I mean, central banks are politically neutral...


... but I think the Japanese economy and—and the Chinese economy are really interdependent. China is the biggest export market for Japan, and Japan is the biggest trading partner for—for China, if not the biggest export market for China. So Japan and China, from economic point of view, are really interdependent of each other. And that means that, by trading and investing, both economies are benefiting, and that benefit is quite substantial.

And I don't think—and I don't want any—any deterioration of economic relationship between the two. And I also think that, since the gains from trade and investment are so huge, hopefully the two countries will continue to be engaged in mutual trade and investment.

Chinese investment in Japan is increasing. And Japanese investment in China has been bit a flat for some time. But I sincerely hope that increased trade and investment relationship between the two countries could be realized in coming years.

MODERATOR: In the fifth row on the aisle, please.

QUESTION: David Waddill, Moore Capital.

MODERATOR: Please stand up.

QUESTION: Governor Kuroda, I understand your reluctance today to commit to further additional monetary action, because it looks like it's working right now. But let's say we get through the basic wage round next spring and we haven't seen decisive increases among the majority of firms. At that point, would you have to say to yourself, "Uh-oh, this isn't going to work. We do need to commit to additional bold monetary action"? Or would you still want to consider and give it more time to see if, you know, the current steps will still bring about the positive inflation result you're trying to achieve?

KURODA: As I said, prices and wages usually move in a synchronized manner, so we expect wages would increase in tandem with prices in coming months, and that follows the basic wages concern (ph), anyway, during the next Spring Offensive season, they would be raised.

Your question is, if basic wages are not raised, does it mean that the Bank of Japan would introduce additional measures to stimulate the economy or not? The question is a bit abstract, difficult to answer. But in general, as I said, our policy is aimed at achieving 2 percent inflation target, basically within a two years' time span, and—and if that becomes difficult to achieve, we may strengthen our QQEs.

But as I said, we're on track, and we expect even the basic wages would start to rise during the Spring Offensive next year, though at this stage, such a hypothetical question is difficult to answer.

MODERATOR: Going back to a comment you made earlier about your banking system being in very good shape, if you went back, whether it's 10 years, 15 years, 20 years, and could replay the hand in terms of dealing with zombie banks in Japan, would you have any advice that you would be both giving yourselves and the rest of the world? I mean, look at right now in Europe, between 1 and $2 trillion dollars of bad assets on the banks and—as opposed to, in the United States, the stress tests and the forced liquidations. Is there any—would you replay your hand in any way?

KURODA: Yeah, I think, by hindsight, we should have dealt with non-performing asset problems in the banking sector much earlier and much faster. That is true.

On the other hand, the U.S. government, after the Lehman shock, dealt with financial sector problem quite...

MODERATOR: Aggressive.

KURODA: ... aggressively and swiftly. And that created good basis for the strong economic recovery being made. That is true.

But on the other hand, one thing you have to recall is the difference between the U.S. banking system and Japanese and European banking system. American banks, commercial banks cannot own—cannot hold—cannot invest equities. So they do not have basically any unrealized capital gains. So when problems arise, they are immediately in danger. Unless they decapitalize, their business would be faced with...

MODERATOR: Insolvency?

KURODA: Yeah. But on the other hand, Japanese banks and European banks are allowed to hold large amounts of stocks and shares. And during the 1990s, non-performing asset increased in the Japanese banking system, but at that time, still Japanese banks held a huge amount of unrealized capital gains in—not shown in the balance sheet, but unrealized capital gains. And they used steadily unrealized capital gains in the 1990s, up until 1997.

So the asset market bubble burst in early 1990s, but the Japanese banking system sustained, survived until 1997, because they have huge amounts of unrealized capital gains that they used and gradually reduced their non-performing assets.

But non-performing assets continued to increase. And eventually, we have 1997 financial crisis, and a few large banks failed. And that forced the government to think about capital injection, and a capital injection was made in 1998 and 1999, and the worst crisis was over. But still there were some banks with a large (inaudible) and final, final solution had to wait until 2003, by that time completely solved.

Why it took so many years? Well, one reason is the Japanese banking system owned stocks and shares and had a lot of unrealized capital gains. European banks are like that, French banks, German banks. They are allowed to hold large amounts of stock and shares, and they—they may still have some unrealized capital gains, because some shares they—they acquired 20, 30, 40 years before.

So in that situation, it's not so easy for the government to inject capital, because, yes, if the trend continues and situation continues to become worse and worse, eventually your unrealized capital gains would disappear and the government has to inject money, but until that time, it's not so easy for the government to inject money to the banking sector.

I'm not quite sure what kind of situation with Europe, but it was the situation faced by the government in Japan. But as I said, I think we should have dealt with this problem squarely and much earlier than we did, so that swiftly the problem would be resolved and the economy started to recover. And the U.S. government in that sense made appropriate quite good decisions.

MODERATOR: Well, Governor Kuroda, I can why the stock market is up 30 percent in Japan year to date. Thank you. This has been very informative. And we very much appreciate your being with us, so thank you.


Very well done, Governor Kuroda, really.

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