Masaaki Shirakawa

Governor of the Bank of Japan

Toward Strengthening the Competitiveness and

Growth Potential of Japan's Economy

Speech at the Executive Member Meeting of the Policy Board

of Nippon Keidanren (Japan Business Federation) in Tokyo

Bank of Japan

February 28, 2013

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Introduction

It is a great honor to have this opportunity to address the executive member meeting of the

Policy Board of Nippon Keidanren today. Before I start, let me express my deepest

appreciation for the information and views on current developments in economic and

financial activities as well as on policy conduct provided to us by all the member firms.

Today's speech is the last one I will give as Governor of the Bank of Japan. However, it

was not difficult for me to decide today's main topic, "toward strengthening the

competitiveness and growth potential of Japan's economy," because it is the most pressing

issue for Japan at present. It is also a very important theme for the Bank of Japan. As

you know, at the Monetary Policy Meeting in January, the Bank decided to introduce a

"price stability target" and set it at 2 percent.1 This target was introduced based on the

recognition that progress would be made by a wide range of entities in their efforts toward

strengthening the competitiveness and growth potential of Japan's economy (Chart 1). For

this reason, it is extremely important in conducting monetary policy whether such efforts

will actually make progress. In the following, I would like to talk about this theme while

paying due regard to the perspectives of macroeconomics, corporate behavior, and

economic policymaking.

I. The Aim of Economic Policy

While there has been active discussion regarding the conduct of economic policies in Japan,

I will first consider the aim of economic policy and the kind of situation we expect Japan's

economy to attain. Needless to say, the ultimate aim of economic policy is to raise the

living standard of each citizen. While there is no single indicator for gauging people's

quality of life, if we were to put this in approximate terms, the key aim of macroeconomic

policy is to raise the per capita consumption level, or to raise the real gross domestic

product (GDP), which is closely related to the former, in a sustainable manner (Chart 2).

Having said this, a more detailed discussion is necessary when considering the various

1 For details on decisions made at the Monetary Policy Meeting on January 22, 2013, including the

introduction of the "price stability target," please see Masaaki Shirakawa, "The Roles, Missions, and

Challenges of the Central Bank" (Speech at the Japan National Press Club in Tokyo), January 25,

2013.

http://www.boj.or.jp/en/announcements/press/koen_2013/data/ko130130a.pdf

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options regarding economic policy on the basis of the situation facing Japan's economy.

First, there is a need to consider the effects of the decline in the labor force due to the rapid

aging of Japan's population. Japan's current real GDP remains below the level seen prior

to the Lehman shock. Looking at per capita real GDP figures, the drop for Japan is

relatively small compared with countries such as those in Europe (Chart 3). Furthermore,

in terms of the level of real GDP per working-age person, Japan has exceeded the pre-crisis

level, which is a better performance than that of the United States. While "population

decline" is one of the clichés used in discussing Japan's economy, this fundamental fact is

oftentimes disregarded when discussing economic developments. Of course, figures do

not differ significantly within short time periods of a quarter or a year, but when considering

Japan's economic policy in the medium to long term, it is important to think in terms of

changes in per capita or per worker data.

Second, we need to take account of the progress in economic globalization. Specifically, it

is necessary to look not only at real GDP but also at real gross national income (GNI).

Real GNI is a concept of income that results from making the following two adjustments to

real GDP. One source of adjustment is the overseas income of Japanese nationals.

Looking at figures for 2012, overseas income amounts to 14.3 trillion yen -- that is, 3.0

percent of nominal GDP. In recent years, profits from outward direct investment have

been increasing in addition to profits from outward portfolio investment (Chart 4). The

other source of adjustment is the change in real purchasing power due to changes in the

foreign terms of trade. Japan's terms of trade have been deteriorating in recent years,

mainly due to the rise in commodity prices against the background of high growth in

emerging economies. Trade gains/losses -- in other words, real purchasing power arising

from changes in the terms of trade -- have thus been on a declining trend (Chart 5). Terms

of trade undergo changes, not only due to commodity prices but also in response to the

pricing power of Japanese firms through the non-price competitiveness of exports.

Fluctuations in foreign exchange rates, for example depreciation of the yen, will raise real

GDP through an increase in exports but may at times adversely affect trade gains/losses.

Effects on real GNI depend on the net result that takes into account these two adjustments

(Chart 6). Setting 2000 as the base year, real overseas income increased by about 2.5

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times in 2012, pushing up real GDP for 2012 by 1.9 percent compared with that in 2000.

On the other hand, the trade gains pushed real GDP downward by 5.8 percent.

Third, another topic for discussion is how to treat nominal GDP and real GDP in

considering economic policy. On this point, both of these increase when the economy

grows in a sustainable manner, suggesting that the direction of medium- to long-term policy

is not all that different depending on which figure we take into account. What I must

mention here is the cause-and-effect relationship between the two. The basic causal

relationship is that, as real GDP rises, the output gap tightens and prices subsequently rise,

resulting in a rise in nominal GDP (Chart 7). There are situations, of course, where prices

fluctuate first, as seen during the time of the oil crises. In such a situation, however,

economic conditions deteriorate, and this is different from what we wish to see. What we

are trying to achieve through economic policy is to raise real GDP, as a result of which

nominal GDP will rise.

In relation to this, the results of the Opinion Survey on the General Public's Views and

Behavior that the Bank conducts on individuals on a quarterly basis provide some

interesting findings. The survey results reveal that approximately 80 percent of the

respondents -- irrespective of their sex, age, and occupation -- have consistently viewed the

price rise as "rather unfavorable" throughout the past surveys (Chart 8). Underlying the

survey results is the concern that wages may not rise even if prices rise. A considerable

portion of the Japanese public is not simply looking for a situation in which prices rise. In

the phrase "overcoming deflation," people are looking for a situation in which one's salary

rises, employment is secured, and profits increase; in other words, a situation characterized

by a well-balanced improvement in economic conditions and consequent rise in prices.

The fourth point involves the problem of how to distribute the fruits of economic growth.

While market mechanism plays a key role in order for the economy to grow, this requires a

perspective of society as a whole that accepts such mechanism at large. On this point, the

situation surrounding income distribution is one of the crucial factors. In the United States,

during the period of economic expansion preceding the Lehman shock -- from 2002 to 2007

-- the real incomes of the highest-income households in the top 1 percentile increased by 86

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percent and household average income increased by 20 percent. In contrast, the "median"

household income -- that is, the income that represents the middle of a series of all

household incomes arranged in order of size -- increased only by 10 percent, which amounts

to just half the growth of the average income (Chart 9). The situation surrounding income

distribution partly depends on the proportion of the elderly that does not have any earnings,

and reviewing this through a single indicator can therefore be challenging. Japan's case

may not be as extreme as that in the United States. Nevertheless, awareness of the need to

achieve well-balanced economic growth, especially for the middle class, has increased

around the globe.

II. The Need to Strengthen Competitiveness and Growth Potential

Bearing these issues related to the aim of economic policy in mind, let me now move on to

the need to strengthen competitiveness and growth potential.2

Looking at developments in a country's economic growth rate over the longer term, factors

affecting it can be broken down into real or supply-side factors -- namely, capital stock,

labor force, and technological innovation. Explaining this within the framework of

so-called growth accounting, the growth rate can be broken down into growth in the number

of workers and that of value-added per worker, in other words, the labor productivity

growth rate (Chart 10). Mechanically estimating future growth in the number of workers,

based on the assumption of the most recent labor participation rate by gender and age, the

number of workers in Japan will change at a rate of -0.6 percent per annum in the 2010s and

-0.8 percent in the 2020s. Meanwhile, the labor productivity growth rate for the years

2000 through 2008 -- a period characterized by relatively favorable economic conditions --

was 1.4 percent on an annual basis. Adding this to the aforementioned growth in the

number of workers, the average growth will become 0.8 percent for the 2010s and 0.6

percent for the 2020s. This will merely amount to maintaining positive growth over the

next two decades. Japan's economy faces a considerably strong headwind in the form of a

decline in the labor force, and we need to more seriously acknowledge its implications.

2 The importance of strengthening growth potential and of the supply side is something many

central banks emphasize. Please see, for example, Speech given by Mervyn King, Governor of the

Bank of England, at the CBI Northern Ireland Mid-Winter Dinner, Belfast, 22 January 2013.

http://www.bankofengland.co.uk/publications/Documents/speeches/2013/speech631.pdf

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Raising the labor productivity growth rate further will alleviate the problem, of course.

Japan has achieved a growth rate slightly exceeding the average for the G-7 countries for

the past 10 years, however, and it is not very plausible to think that we can raise it by 1

percent or more at once (Chart 11).

At any rate, raising Japan's growth potential continuously into the future requires work,

especially strenuous work, on both the number of workers and the labor productivity growth

rate. While efforts by a wide range of entities are necessary in such case, the main actors

here, above all, are private firms. The corporate sector has consistently had a savings

surplus, together with households, since 1998 (Chart 12). A significant savings surplus by

the corporate sector is a phenomenon now observed outside of Japan as well: it has spread

to major advanced countries since the start of the 2000s. In terms of the amount of savings

surplus relative to GDP, figures for the United Kingdom, Japan, and the United States are

6.1 percent, 4.6 percent, and 4.1 percent, respectively. The most significant underlying

cause of this savings surplus is the lack of attractive investment opportunities at home amid

expanding investment opportunities in the emerging markets. Recently, other causes have

also been pointed out, including the securing of funds to offset additional costs that may

arise from a lack of funds for corporate pensions mainly resulting from a decline in interest

rates.

I presume that in your day-to-day decision making, you cannot muster enough confidence

to invest at home despite having ample liquidity on hand (Chart 13). In fact, on-hand cash

and deposits at Japanese firms has been increasing steadily: the proportion of Japanese

firms listed on the First and Second Sections of the Tokyo Stock Exchange (TSE) holding

cash and deposits exceeding the amount of interest-bearing debt -- in other words, firms

without net external borrowings -- has recently become as high as 43 percent.

Of course, firms' ample on-hand liquidity itself is reasonable up to some level, taking into

account experiences such as the post-bubble financial crisis and the aftermath of the failure

of Lehman Brothers -- that is, the shortage of U.S. dollar funds and the decline in the

functioning of the CP market. The current level of on-hand liquidity, however, appears to

go well beyond the amount of such precautionary demand. As for the use of excess funds,

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there are only three options: making real or financial investments at home and abroad;

disbursing funds to employees in the form of wages; and returning them to stockholders

through dividend payments and share buybacks. The economy will not see positive

outcomes unless some kind of change is brought about to the increased liquidity via one of

the aforementioned routes. In that sense, it is extremely important to change the business

environment, thereby modifying firms' incentives. That is why in achieving sustainable

growth with price stability, efforts toward strengthening the competitiveness and growth

potential of Japan's economy are necessary as much as monetary policy is indispensable in

this regard.

III. Outline of the Course of Future Measures

Next, I would like to outline the course of future efforts toward strengthening the economy's

competitiveness and growth potential.

Capturing Increasing Overseas Demand

The first course is to capture increasing overseas demand in the form of expanding Japanese

firms' overseas business activities. It is inappropriate to negatively describe such efforts as

the "hollowing-out" of industries in an environment where overseas economies -- mainly

emerging economies -- have grown much faster than Japan. With regard to international

division of labor, while manufacturing and assembly overseas expands, increasing the

export of intermediate goods from Japan and reinforcing domestic R&D activity, whose

value-added is relatively higher, will contribute to raising Japan's real GDP. In addition, if

surplus funds that have accumulated in the corporate sector are being used for overseas

investment with high returns, the benefit of such investment will be passed back to Japan in

the form of interests and dividends. This will not directly contribute to raising real GDP,

but it does raise real GNI. While globalization of the economy continues, it is deemed

imperative to make balanced efforts as a nation by combining domestic production with

exports as well as with foreign direct investment, or local production overseas.

Indeed, overseas investment by Japanese firms has been increasing, especially in Asia.

Such a trend has spread from large manufacturing firms to nonmanufacturing ones, as well

as small and medium-sized enterprises (Chart 14). Nevertheless, the outstanding amount

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of Japan's foreign direct investment remains at a low level compared with that of other

advanced countries (Chart 15). Similarly, in terms of the profitability of foreign

investment, which is the combination of portfolio investment and direct investment, Japan

falls a little behind countries such as the United States, partly because of its small share of

direct investment, which has a high rate of return (Chart 16).

Huge potential demand exists in emerging economies, particularly Asia, in the area of

building core infrastructure for transportation systems, energy supply, and communication

systems. According to the estimates of the Asian Development Bank, such demand will

amount to approximately 8 trillion U.S. dollars from 2010 to 2020 (Chart 17). There are

ample business opportunities for Japanese firms to make use of their globally recognized

cutting-edge technologies and wealth of experience -- such as upgrading metropolitan

infrastructure and implementing environmental and energy-saving technologies, as well as

deploying factory automation systems to address labor shortages and wage rises -- that have

been nurtured in Japan over the years. It has become increasingly apparent that Japanese

firms in such sectors as retail, healthcare, and education, which have focused mainly on the

domestic market, are able to formulate sweeping business strategies in large Asian markets,

where consumer demand is increasing briskly as these countries' middle-income

populations continue to expand.

Responding to the Aging Population

The second course is to respond to the rapidly aging population. The long average life

expectancy of the Japanese people implies that health, the condition most vital to well-being,

is being fulfilled at a high level. Having said that, it is necessary to adjust the economic

structure and social infrastructure as the population continues to age. Otherwise, it

becomes difficult to maintain the current high quality of life. While this is sometimes

misunderstood, the demographic change of population aging itself is not triggering the

problem for Japan's economy; the real issue is that Japan's economic structure and social

infrastructure have not sufficiently caught up with such demographic changes.

The aging of the population brings about various changes to the economy. First, it will

become a downside factor for economic growth via the economy's supply side -- namely, a

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decline in the labor force. In order to counter this trend, it is most important to increase

labor participation, particularly of the elderly and women.3 The labor participation rate of

60-69 year-olds has increased continuously over the last few years (Chart 18). The labor

participation rate of women is also increasing, but remains at a relatively low level

compared with other advanced economies (Chart 19).

Aging will also substantially change the demand structure of the economy. The area of

medical and nursing care is one worth mentioning. In the United States, the elderly

population aged 65 and older increased by 13 percent in the ten years from 2000, and as a

result, the expenditure in medical and nursing care rose by 82 percent. By contrast, in

Japan, while the elderly population increased by 29 percent, such expenditure only rose by

17 percent (Chart 20). In relation to this, it has often been pointed out that, in Japan, due

to a number of regulations and a shortage in the workforce, sufficient service in this sector

has not been provided relative to demand. While one should be mindful of the fiscal

implications, appropriate system design and regulatory reforms are likely to turn the

potential demand in medical and nursing care, as well as in medical equipment and

infrastructure, into actual demand. At the same time, medical and nursing care could

become one of the most promising domestic employers as Japanese firms expand their

overseas operations (Chart 21).4

Population aging also brings about an expansion in demand in the housing market. For the

child-raising generation, potential demand for larger housing is believed to be high, but

such demand has not been satisfied, particularly in the metropolitan areas. On the contrary,

members of the elderly generation continue to live in large houses that had been acquired

during their working age. Indeed, in Japan, the share of second-hand dwellings in the total

housing market (i.e., combining new and second-hand dwellings together) is only 12

3 For details on the importance of raising the labor participation rate of women, please see Chad

Steinberg and Masato Nakane, "Can Women Save Japan?" IMF Working Paper 12/248.

International Monetary Fund, 2012.

http://www.imf.org/external/pubs/ft/wp/2012/wp12248.pdf 4 In the United States since 1990, while the number of employees in manufacturing has decreased

by about 6 million, mainly due to an acceleration in the shift of production overseas, that in the

healthcare industry has increased by 6 million.

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percent, far less than the 79 percent in the United States and 86 percent in the United

Kingdom (Chart 22). Once the housing market is reorganized, potential demand for

housing will be cultivated by meeting the different needs in different stages of life, and this

will eventually invigorate related markets, such as electric home appliances and other

household items, as well as remodeling. Change is also desirable on the financial front.

It is often pointed out that, in Japan, household financial assets are concentrated in cash and

deposits. This partly reflects that the share of residential assets, that is, real assets with

large price fluctuations and low liquidity, among total household assets tends to be high

(Chart 23). If household assets start flowing into financial assets other than cash and

deposits, we might enjoy an increase in the supply of long-term risk money.

Promoting Smooth Transfer of Resources

The third course is to promote the smooth transfer of resources. In the medical care and

housing areas that I just talked about, not a shortfall in demand but the mismatch between

demand and supply has become the essence of the problem in the sense that potential

demand and actual supply do not correspond to each other. In recent years, sales of

pre-packaged tours to the elderly and sales in health-related industries have shown marked

increases. This suggests that firms have succeeded in cultivating potential demand by

making efforts to develop new products through shifting their human resources and capital

to those businesses.

Changes will surely create new demand and promote the introduction of new goods and

services. It is imperative to realize the optimal resource allocation by shifting labor and

capital resources within a firm, as well as among firms, industries, and regions, in

accordance with a changing demand structure. In short, the metabolic process is also

crucial in achieving economic growth. Looking at the founding years of the top 300 firms

in terms of market capitalization, there are more firms with long corporate histories in Japan

than in the United States (Chart 24). This is evidence that firms themselves have made

efforts to self-transform and have successfully managed to cope with a series of

environmental changes. It can also be said that dynamism is absent in terms of birth of

firms. Changes are surely taking place, however. For instance, looking at developments

in the stock market after the Lehman shock, comparatively small firms have recently been

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performing relatively well (Chart 25). The number of initial public offerings -- which

showed a large decline in recent years -- is gradually on a recovery trend, and such

movements are now also being observed outside large metropolitan areas. I am quite

encouraged by this development.

IV. Regulatory and Institutional Reforms, Corporate Governance Reform, and

Social Values

So far, I have talked about the outline of the measures toward strengthening competitiveness

and growth potential. In principle, this should happen in an economy as a result of

individual firms' rational choice. The fact that this is not happening in reality must be the

result of economic, institutional, or social factors. Accordingly, there is a need to improve

the economic environment, i.e., remove those obstructing factors.

Regulatory and Institutional Reforms

First, there needs to be an improvement, promoted by the government, in the environment

that will serve to back firms' efforts aimed at bringing about change. More specifically, it

is necessary for the government to carry out bold regulatory reform in order for firms to

broaden the areas in which they may embark on new challenges, and to make institutional

improvements to the labor market so as to allow workers to move more smoothly into

businesses and industries with high growth potential. In order to avoid an increase in

excessive social friction arising from responses to changes in the economic environment, it

is also necessary to provide support for career changes and to enhance the safety net.

Corporate Governance Reform

Second, it is necessary to ensure the appropriate functioning of corporate governance by

stockholders and investors.5 On this issue, Germany is a good source of reference. Until

the beginning of the 2000s, Germany was named as a country putting off essential structural

reforms, and the country indeed suffered from slow economic growth in the first half of the

5 For details on the effects of various legal institutions including corporate governance on corporate

profits, please see Nobuyuki Kinoshita, "The Institutional Background to Characteristics of Japanese

Firms' including Low Profitability" (available only in Japanese), IMES Discussion Paper Series

2012-J-12, Institute for Monetary and Economic Studies, Bank of Japan, 2012.

http://www.imes.boj.or.jp/research/papers/japanese/12-J-12.pdf

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2000s. Under such circumstances, however, it engaged in various reforms surrounding

corporate activity, including institutional reforms that allowed for flexible adjustments to

employment as well as enhanced information disclosure to investors. On this point, Japan

falls behind Germany, especially when it comes to reforming enterprise law in such areas as

corporate rehabilitation, as well as mergers and acquisitions. This is said to hinder

dynamic corporate restructuring, thereby eroding the international competitiveness of

industries across the board. It is also said that such an environment has accentuated the

anxiousness over legal liquidation or removed the fear of being taken over, and encouraged

to some extent the excessive accumulation of cash and deposits at firms.

Social Values

Third, society needs to face possible trade-offs between stability and change. Japan has

been somewhat dominated so far by a perspective that stressed the importance of stability.

The method of adding gradual "improvements" to one's company's products in accordance

with consumer needs in the existing domestic market can be considered a business

management style that puts importance on stability. Merely making improvements

focused on the domestic market amid a population decline, however, carries the risk of the

economy falling into a shrinking cycle. Corporate profits will suffer even more in the long

term if firms continue to keenly compete in terms of prices while maintaining their

commitment to securing employment. If I may make a sweeping generalization, firms are

facing a judgment call of choosing between "improvement," which represents continuity,

and "innovation," which represents discontinuity. If the shock against the economy is

temporary, there may be a point to overcoming any difficulties in the immediate future via

"improvements," thus prioritizing stability in the long term. Confronting long-lasting

shocks such as globalization and population aging by means of the same "improvement" as

before, however, may delay responses to significant changes.

Reform cannot proceed without public consensus. Bringing about innovation requires

firms' willingness to take on challenges as well as the transfer and reallocation of necessary

resources. Frictions may well be experienced in the process. While this is not

necessarily an issue with one indisputable solution, if environmental change is long-lasting,

I find it extremely important for society as a whole to accept such changes and adopt a view

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that encourages any and all efforts to take on new challenges, in order to successfully carry

out reforms toward strengthening growth potential.

V. Relationship with Prices

So far, I have talked about the efforts to strengthen the economy's competitiveness and

growth potential. Next, getting slightly off track, I will touch upon the relationship

between economic growth and prices.

The year-on-year rate of change in the consumer price index (CPI) is currently around 0

percent, but is expected to reach 0.9 percent in fiscal 2014, according to the Bank's forecasts.

This is based on the view that Japan's economy will continue to grow above its potential

growth rate and the output gap will be filled, assuming that overseas economies moderately

improve. However, considering the fact that the output gap has narrowed significantly

compared with its peak, and given the sensitivity of prices to the gap, the closing of the gap

alone will not allow us to reach the target of 2 percent right away. What is the general

image of an economy that achieved 2 percent inflation, and what is the mechanism behind

the process leading up to this state? In theory, one can come up with several cases.

The first involves a push from rising import prices as a result of the yen's depreciation or

rising international commodity prices. The second is related to rising wages. In the

medium to long term, wages and prices are closely correlated. The third sees rising

inflation expectations. Finally, the fourth corresponds with rising growth expectations of

firms and households.

Which case are we looking for? In the case where import prices push up inflation,

household real income is squeezed. The ideal situation is that a rise in wages, a rise in

inflation expectations, and a heightening of firms' and households' growth expectations take

place at the same time. What should be noted here is the relationship between wages and

prices. One of the main factors behind low inflation rates in Japan relative to other

economies is Japan's employment practice. Specifically, Japanese society since the second

half of the 1990s has prioritized securing employment, and it effected reductions in costs

largely by cutting back wages; consequently, prices fell (Chart 26). Looking at

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development patterns of corporate profits, wages, and prices during economic recovery

phases, these three indicators moved together in the same direction during the high-growth

era in the 1970s (Chart 27). At present, neither wages nor prices have changed materially

even in the economic recovery phase, as corporate profits have acted as a buffer to absorb

shocks, with the labor distribution rate rising during economic recession phases and

declining during recovery periods. The primary cause for this is the decline in firms'

profitability, which in turn reflects the decline in the potential growth rate. On this point,

looking at the relationship between medium- to long-term inflation expectations and

potential growth rates, there is a clear positive correlation in Japan (Chart 28). If firms'

and households' growth expectations improve, this will have a positive effect on wages and

prices in a sustainable manner. Consequently, "deflationary expectations" that had taken

hold over a prolonged period will fade away.

VI. The Will to Reform

While it generally has been recognized that there is a need to work toward strengthening

competitiveness and growth potential, and that meeting these challenges is essential in

overcoming deflation and achieving sustainable growth with price stability, why is it that

such efforts have not made progress? On this point, the key lies in the sense of urgency

regarding the need for reform. The problems currently facing Japan's economy, namely,

the rapid aging of the population and accompanying issues, are not temporary. They are

steadily affecting the economy in the manner of a chronic illness. Deterioration of fiscal

conditions is a textbook example of such problems. In order to maintain fiscal

sustainability, it is necessary to reform the structure of expenditures and revenues as well as

strengthening growth potential. Unless the growth rate rises, a modest increase in the rate

of inflation alone will barely improve the fiscal balance. While such chronic symptoms

exist in Japan, acute ones have not appeared. The biggest reason for this lies in the fact

that Japan holds a massive amount of external net assets reflecting the current account

surplus that has continued over a prolonged period. Because of this, Japan tends to

experience inflows of capital that search for a safe haven, even in the event of a global

economic shock, and enjoy stable long-term interest rates while facing an appreciation of

the yen. Japan has not experienced any sell-off of its currency in a crisis.

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In this regard, I would like to make reference to recent developments in financial markets.

The keywords to understanding movements in the global financial markets over the last

several years are risk-on and risk-off. When faced with a great amount of uncertainty

about the future, investors stay away from risks -- in other words, they become risk-off --

but when such uncertainty is judged small, they become risk-on (Chart 29). The basic

background to the yen's appreciation that lasted until summer 2012 was investors'

preference for safe assets as the European debt problem intensified. Indeed, it was in late

July that the yen hit its recent peak in the nominal effective exchange rate and the Spanish

and Italian sovereign rates reached the most elevated levels. After that, a variety of safety

valves to cope with the European debt problem were put in place in Europe and the fiscal

cliff was avoided in the United States. Against the background of these developments,

global investors' risk aversion has substantially receded. Broadly speaking, the yen's

recent depreciation and rise in stock prices in Japan are also taking place amid such changes

in those investors' risk aversion. Put differently, investors' attitude toward risk may

influence market conditions. I believe this could be easily understood by looking back at

the fact that yields on government securities of member states of the euro area had remained

at practically the same levels for nearly ten years. What ultimately drives market

developments is economic fundamentals. Over the last 15 years in Japan, there were

several phases when the yen depreciated. Although exports and production increased

during those phases, we regrettably did not succeed in raising the potential growth rate

(Charts 30 and 31). The important thing is to make use of the current favorable conditions

and make steady efforts to strengthen the competitiveness and growth potential of the

economy.

VII. Conduct of Monetary Policy by the Bank of Japan

Lastly, I would like to go over the recent monetary policy measures by the Bank of Japan.

As I mentioned at the outset, the Bank recognizes that the inflation rate consistent with

price stability on a sustainable basis will rise as efforts by a wide range of entities toward

strengthening competitiveness and growth potential of Japan's economy make progress.

Based on this recognition, at the Monetary Policy Meeting held in January, the Bank set and

announced the "price stability target" at 2 percent in terms of the year-on-year rate of

change in the CPI. As stated in the Bank of Japan Act, the Bank conducts monetary policy

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based on the principle that the policy shall be aimed at "achieving price stability, thereby

contributing to the sound development of the national economy." Put differently, the Bank

aims at achieving price stability with which Japan's economy will grow in a sustainable and

balanced manner, and under such a principle, the Bank has been pursuing aggressive

monetary easing with the aim of achieving this price stability target at the earliest possible

time. The Bank, under the Asset Purchase Program, will additionally purchase financial

assets amounting to about 36 trillion yen, mainly JGBs, by the end of this year.

Furthermore, from January 2014 onward, it will purchase about 13 trillion yen worth of

assets, 2 trillion yen of which will be JGBs, every month without setting any termination

date. The Bank is committed to pursuing, without loosening the reins, aggressive

monetary easing with the aim of achieving the "price stability target."

Efforts by the government, in parallel with appropriate monetary easing measures, are

important in order to overcome deflation early and achieve sustainable growth with price

stability, for the following reasons.

First of all, if the government's efforts to strengthen competitiveness and growth potential

make progress, economic agents will take further advantage of the accommodative financial

conditions and the effects of monetary easing will be increasingly amplified. At present,

money, or liquidity that the Bank has been supplying, is increasing significantly; however,

prices have not been responding accordingly (Chart 32).6 Private financial institutions

have been increasing their government bond holdings rather than lending (Chart 33). On

this point, the government has stated its intention to advance structural reform of the

economy by making use of all possible decisive policy actions, including carrying out bold

regulatory and institutional reforms. The Bank expects that forceful efforts will be

forthcoming in this regard.

Meanwhile, the Bank itself has established a "Loan Support Program" through which to

6 On this point, Chairman Bernanke of the Federal Reserve stated during the press conference on

December 12, 2012 that "there's no effect on inflation expectations from the size of our balance

sheet." For details, please see Federal Reserve Board, "Transcript of Chairman Bernanke's Press

Conference," December 12, 2012.

http://www.federalreserve.gov/mediacenter/files/FOMCpresconf20121212.pdf

16

encourage proactive efforts by firms and financial institutions, using the levers of finance.7

Together with the aforementioned Asset Purchase Program, the Bank will supply additional

funds amounting to over 60 trillion yen in the next two years. The amount outstanding

will exceed 130 trillion yen, which is about 30 percent of nominal GDP (Chart 34). While

monetary easing by the central bank has a stimulating effect on current economic conditions

by bringing forward tomorrow's demand to today, so to speak, such effect will wane once it

becomes tomorrow and unless demand for the day after is brought forward. At any rate,

the size of the demand brought forward depends on future growth potential. This makes

efforts to raise the potential growth rate itself all the more important. If such efforts by the

Bank on the financial side and those by the government to strengthen the growth potential

could instigate a virtuous cycle and bring about synergies, the policy effects are likely to be

amplified.

Second, in order to pursue aggressive monetary easing, ensuring confidence regarding fiscal

policy is also important. As part of its monetary easing, the Bank has been purchasing a

substantial amount of government bonds. Given the severe fiscal conditions, however, if

such purchases were regarded as monetizing government debt in the markets at home and

abroad, there is a risk that long-term interest rates would rise. In particular, if efforts to

strengthen the growth potential do not make progress and the Bank's holding of JGBs

continues to increase, that risk becomes more imminent. Were this to occur, not only

would the effects of monetary easing weaken, but there would also be adverse effects on the

real economy through the impacts on the businesses of financial institutions holding a large

amount of government bonds. 8 In that sense, discipline is expected of both the

government and the Bank. Discipline within the Bank is stipulated by the purpose

imposed on the central bank, that is, contributing to sustainable growth through price

stability and financial system stability. Meanwhile, the government is required to uphold

7 The Bank established the "Loan Support Program" by integrating the "Growth Supporting Funding

Facility" introduced in June 2010 and the "Stimulating Bank Lending Facility" introduced in

October 2012. 8 On the relationship between fiscal sustainability and financial system stability, as well as price

stability, please see Masaaki Shirakawa, "The Importance of Fiscal Sustainability: Preconditions for

Stability in the Financial System and in Prices" (Remarks at the Banque de France Financial

Stability Review Launch Event in Washington D.C.), April 21, 2012.

http://www.boj.or.jp/en/announcements/press/koen_2012/data/ko120422b.pdf

17

fiscal discipline. On this point, the government stated clearly that it "will steadily promote

measures aimed at establishing a sustainable fiscal structure with a view to ensuring the

credibility of fiscal management." Once credibility is eroded and the economy falls into a

state of confusion, there will be limited room for maneuver by the central bank.

Economists generally refer to this kind of situation as "fiscal dominance." In order to

prevent such a situation from materializing, it is important to engage in efforts to achieve

fiscal reform, thereby maintaining fiscal discipline in the medium to long term.

Final Remarks

While there is active discussion regarding the conduct of economic policy in Japan, I

personally feel there is a need to earnestly discuss what it is that we truly want to achieve

when referring to "overcoming deflation," and what it is that we must carry out in order to

accomplish this. The opportunity is right in front of us now. Once we find what we want,

we must take action.

The Bank will continue to do its utmost toward overcoming deflation early and achieving

sustainable growth with price stability. The purpose of the central bank is to lay stable

economic and financial foundations that support the sustainable growth of the economy.9

In doing so, it goes without saying that the Bank will thoroughly examine the outlook for

economic activity and prices and risk factors to sustainable growth. Independent central

banks are obviously expected to explain the effects as well as costs of measures in the

longer term. I believe this is what accountability means.

As the experience of the global credit bubble in the mid-2000s suggests, time and again, the

seeds of new problems and unexpected crises have already been sown as authorities respond

to a problem. This provides us with a renewed sense of awareness of the importance of

humility to learn from history and of stability from a medium- to long-term perspective.

The Bank of Japan will continue to listen to a variety of views and conduct monetary policy

appropriately on the judgment and under the responsibility of its Policy Board with the aim

9 For more on this point, please see Masaaki Shirakawa, "The Roles, Missions, and Challenges of

the Central Bank" (Speech at the Japan National Press Club in Tokyo), January 25, 2013.

http://www.boj.or.jp/en/announcements/press/koen_2013/data/ko130130a.pdf

18

of overcoming deflation early and achieving sustainable economic growth with price

stability. I ask for your continued support.

Thank you for your attention.

Toward Strengthening the Competitiveness andGrowth Potential of Japan's Economyp y

Speech at the Executive Member Meeting of the Policy Boardof Nippon Keidanren (Japan Business Federation) in Tokyoof Nippon Keidanren (Japan Business Federation) in Tokyo

February 28, 2013

Masaaki ShirakawaGovernor of the Bank of Japan

ContentsContents

IntroductionIntroduction

I. The Aim of Economic Policy

II The Need to Strengthen Competitiveness and Growth PotentialII. The Need to Strengthen Competitiveness and Growth Potential

III. Outline of the Course of Future Measures

IV Reg lator and Instit tional Reforms Corporate Go ernance ReformIV. Regulatory and Institutional Reforms, Corporate Governance Reform,

and Social Values

V Relationship with PricesV. Relationship with Prices

VI. The Will to Reform

VII Conduct of Monetary Policy by the Bank of JapanVII. Conduct of Monetary Policy by the Bank of Japan

Final Remarks

The Bank of Japan introduced the "price stability target" and set it at 2 percent,based on its recognition that efforts to strengthen the competitiveness

Chart 1

based on its recognition that efforts to strengthen the competitivenessand growth potential of Japan's economy will make progress.

The Bank recognizes that the inflation rate consistent with price stability on a

Introduction of the "Price Stability Target" (Jan. 2013)g p y

sustainable basis will rise as efforts by a wide range of entities toward strengthening competitiveness and growth potential of Japan's economy make progress Based on this recognition the Bank sets the price stability target at 2progress. Based on this recognition, the Bank sets the price stability target at 2 percent in terms of the year-on-year rate of change in the consumer price index (CPI).

Under the price stability target specified above, the Bank will pursue monetary easing and aim to achieve this target at the earliest possible time. Taking into g g p gconsideration that it will take considerable time before the effects of monetary policy permeate the economy, the Bank will ascertain whether there is any significant risk to the sustainability of economic growth including from thesignificant risk to the sustainability of economic growth, including from the accumulation of financial imbalances.

1

Chart 2 The key aim of macroeconomic policy is to raise real GDP in a sustainable manner.

Japan's Real GDP

CY 1990=100

130

135CY 1990 100

120

125

110

115

105

110

95

100 Real GDP Real GDP per capita Real GDP per working-age person

2

Notes: 1. Working-age person refers to those from 15 to 64 years old.2. Population figures for 2012 are extrapolated using the growth rates for 2011.

Sources: Cabinet Office; World Bank.

90 91 92 93 94 95 96 97 98 99 00 01 02 03 04 05 06 07 08 09 10 11 12CY

When adjusting for the effects of the population decline, a different picture emerges from developments in real GDP following the Lehman shock.

Chart 3

Real GDP Real GDP per CapitaReal GDP

per Working-Age Person

106CY 2007=100

106CY 2007=100

106CY 2007=100

104

106

104

106

104

106

100

102

100

102

100

102

96

98

96

98

96

98

92

94

92

94

92

94

90

9

Japan UnitedStates

Euroarea

UnitedKingdom

90

9

Japan UnitedStates

Euroarea

UnitedKingdom

90

9

Japan UnitedStates

Euroarea

UnitedKingdom

3

Notes: 1. Figures are for 2012/Q4 calculated on the assumption that the average for 2007 is 100. 2. Population figures for 2012 are extrapolated using the growth rates for 2011. 3. Working-age person refers to those from 15 to 64 years old.

Sources: Cabinet Office; BEA; ONS; Eurostat; World Bank.

States area Kingdom States area Kingdom States area Kingdom

Chart 4

Profits from outward investment by Japanese firms have been increasing.

Amount Outstanding of Outward Investment Assetsand Income Balance Income Balance

tril yen tril yen tril yen25

600

700Foreign exchange reserves

Other investment

Portfolio investment

tril. yen tril. yen

Gross income received

(right scale)

25Others

Portfolio investment income

tril. yen

20

500

Portfolio investment

Direct investment

Income balance(right scale)

15

20 Direct investment incomeIncome balance

10

15

300

400

( g )

10

15 Gross income received

5

10

200

5

10

0

5

0

100

0

5

4Source: Bank of Japan.

00

00 01 02 03 04 05 06 07 08 09 10 11 12CY

0

00 01 02 03 04 05 06 07 08 09 10 11 12CY

Chart 5Japan's terms of trade have been deteriorating.

Changes in the Terms of Trade

170CY 2000=100

150

160

70

Export price index

Import price index

f d ( i /i i )

130

140Terms of trade (export prices/import prices)

100

110

120

80

90

100

60

70

80

5Note: Both export and import price indices are based on the GDP deflator.Source: Cabinet Office.

00 01 02 03 04 05 06 07 08 09 10 11 12CY

Chart 6 Real GNI depends on developments both in net income from the rest of the world and in trading gains/losses.

115

450

500real, CY 2000=100

net income from the rest

real, CY 2000=100

Figures for 2012/Q4 (CY 2000=100)

(1) Real GDP: 109

110

300

350

400

(1)

(2) of the world(1) Real GDP: 109(2) Real GDP+net income

from the rest of the world: 111(3) Real GDP+net income

from the rest of the world+ trading gains/losses: 105

105

200

250

300(3)

+ trading gains/losses: 105

tradinggains/losses

100100

150

950

50

00 01 02 03 04 05 06 07 08 09 10 11 12CYNet income from the rest of the world (left scale)(1) Real GDP (right scale)(2) Real GDP + net income from the rest of the world (right scale)(3) Real GDP + net income from the rest of the world + trading gains/losses (real GNI, right scale)

6

Note: Trading gains/losses are changes in real income (purchasing power), reflecting changes in the terms of trade (export prices / import prices).For example, when commodity price rises cause import prices to rise more than export prices, trading gains decline in reflection of deteriorated terms of trade.To be specific, the definition of trading gains/losses is "nominal net exports / weighted average of export and import deflators – real net exports."

Source: Cabinet Office.

Chart 7

Tightened demand-supply conditions resulting from economic improvementcause prices to rise not the other way aroundcause prices to rise, not the other way around.

Cross Correlation between CPI and Output Gap

104y/y, % % 1.0

time-difference correlation coefficient

6

8

10

2

3

4

0.8

0.9

.0

0

2

4

0

1

2

0 5

0.6

0.7

-4

-2

0

-1

0

0.3

0.4

0.5

Output gap leading CPI leading

-8

-6

-3

-2CPI (all items less fresh food, left scale)

Output gap (right scale) 0.1

0.2

Notes: 1. Figures for the CPI are adjusted to exclude the effects of the consumption tax introduction in 1989 (3 percent) and the consumption tax hike in 1997

-10-485 87 89 91 93 95 97 99 01 03 05 07 09 11

CY

0.0

-10 -9 -8 -7 -6 -5 -4 -3 -2 -1 0 1 2 3 4 5 6quarters

7

(from 3 to 5 percent).2. The output gap is estimated by the Research and Statistics Department, Bank of Japan. 3. Shaded areas indicate recession periods.4. Figures for the cross correlation are calculated using data between 1990/Q1 and 2012/Q3.

Sources: Ministry of Internal Affairs and Communications; Cabinet Office, etc.

Chart 8 A considerable portion of the Japanese public is not simply looking for a situation in which prices rise alone.

80%

100%Comments of Households on the Price Rise

40%

60%

0%

20%

Jun 04 05 06 07 08 09 10 11 12Jun. 04 05 06 07 08 09 10 11 12Rather favorable Neither favorable nor unfavorable Rather unfavorable

79 2Self-employed,

Difference by Sex Difference by Age Difference by Job

85 8

84.0

F l

Male

85.5

87.1

40 - 59

20 - 39

86.3

86.2

79.2

Non-regularemployee

Regularemployee

Se e p oyed,agriculture, etc.

85.8

0% 20% 40% 60% 80% 100%

Female83.3

0% 20% 40% 60% 80% 100%

60 or older 85.0

0% 20%40%60%80%100%

Others

employee

Notes: 1. Surveys were conducted in March, June, September, and December. Results of the questionnaires were obtained via the in-home survey method through June 2006,

8

Notes: 1. Surveys were conducted in March, June, September, and December. Results of the questionnaires were obtained via the in home survey method through June 2006, thereafter via the mail survey method.

2. Figures for differences by sex, by age and by job are newly calculated using raw data of the December 2012 survey.3. "Self-employed, agriculture, etc." includes agriculture, forestry, fisheries, self-employed, working for a family business, and professional worker. "Others" includes full-

time homemaker, student, unemployed, etc.Source: Bank of Japan.

Chart 9

Awareness of the situation surrounding income distributionhas increased around the globe.

Average Income and Median Income of U.S. Households

has increased around the globe.

125CY 2002=100

120

115

120

Average income

Median income

110

105

110

Median income

95

100

85

90

75

80

9

Notes: 1. Median income is household income that represents the middle of a series of all household incomes arranged in order of size.2. Figures for income are adjusted to exclude price fluctuations, transfers from the government to households, and taxes.

Source: Congressional Budget Office (CBO), "Trends in the Distribution of Household Income Between 1979 and 2007."

85 86 87 88 89 90 91 92 93 94 95 96 97 98 99 00 01 02 03 04 05 06 07CY

Chart 10

A decline in the labor force population represents a considerably strong h d i d f i J 'headwind facing Japan's economy.

6avg., y/y % chg.

4

5Labor productivity growth (the rate of growth in real GDP per worker)

Rate of change in the number of workers

R l GDP h

3

4 Real GDP growth rate

Forecast

+0.9%

+0.8%1

2

+0.5%-0.2%

0 6%1

0

-0.6%-0.8%

-1.2%-2

-1

1970s 1980s 1990s 2000s 2010s 2020s 2030s

10

Note: The rates of change in the number of workers from 2013 onward are calculated using the projected future population (medium variant) and the projected labor force participation rates (assuming that the labor force participation rates in each age/sex group remain the same as those in 2012).

Sources: Cabinet Office; Ministry of Internal Affairs and Communications; National Institute of Population and Social Security Research.

1970s 1980s 1990s 2000s 2010s 2020s 2030s

Chart 11Japan's labor productivity growth rate is comparable

with those for the G-7 countries.

Productivity Growth (Average after 2000)2.0

y/y % chg.

1.5

G-7 average after 2000: 0.9%

1.0

0.5

0.0

-0.5 Japan United Germany United France Italy Canada G7

Notes: 1. Productivity = GDP / number of employees.2. The productivity growth rate of the G-7 refers to the average of the seven countries.

Source: OECD.

p UStates

y UKingdom

y

11

Chart 12

A savings surplus by the corporate sector is a phenomenon now observed in other advanced countries as well

Savings Surplus of the Corporate Sector

12% of nominal GDP

a phenomenon now observed in other advanced countries as well.

8

10

JP: 4.6%US: 4 1%

UK: 6.1%

4

6

US: 4.1%

DE: 1.1%0

2

-4

-2

Japan United States

-8

-6

Japan United States

United Kingdom Germany

12Note: The corporate sector is calculated by removing two sectors -- general government and households -- from the domestic sector.Sources: Cabinet Office; BEA; Eurostat; ONS.

8

95 96 97 98 99 00 01 02 03 04 05 06 07 08 09 10 11CY

Chart 13 While their on-hand liquidity has increased,firms cannot muster enough confidence to invest at home.

ROA

90

100

1.4

1.5Business fixed investment / cash flow ratio

times %45210 Amount of cash equivalent

held by companies

tril. yen %12Japan United States

Germany France

%

70

80

90

1.2

1.3

. / cash flow ratio

Company savings / net operating surplus

35

40

190

200Proportion of firms withoutnet externalborrowings(right scale)8

10Germany France

50

60

1.0

1.1

30

35

180

190 (right scale)

6

20

30

40

0.7

0.8

0.9

25170

2

4

0

10

20

0.5

0.6

0.7

15

20

150

160

0

2

CY2000 2005 2010

Notes: 1. The ROA for each country is weighted by the market capitalization of sample firms (excluding financial institutions) which are composed of each index (TOPIX for Japan, S&P for the United States, DAX for Germany, and CAC40 for France).

2. Sample firms for the middle and right-hand graphs are of all industries excluding finance and insurance.3. Company savings/net operating surplus for up to 2000 refers 2000 base figures.

90 95 00 05 10FY 95 00 05 10CY-end

CY2000 2005 2010

13

p y g p g p p g4. Cash flow = depreciation expense + ordinary profit/25. Sample firms in the right-hand graph consist of 1,260 firms listed on the First or Second Section of the Tokyo Stock Exchange, with March year-ends, and for which

data can be obtained consecutively from fiscal 1995 onward (excluding financial institutions). Firms without net external borrowings are those for which cash, deposits, and cash equivalents exceed their interest-bearing debt. Cash equivalents are short-term assets such as CP, CD, and bond investment trusts.

Sources: Bloomberg; Ministry of Finance; Cabinet Office.

Chart 14

Expansion of Japanese firms' overseas business activities has spread to small and medium-sized enterprises

Number of Overseas Affiliates Number of Overseas Employees

to small and medium sized enterprises.

303.0

Small firms

Medium-sized firms

thous. thous.6000400

thous. thous.

252.5 Large firms (right scale)

5250350

202.0 4500300

151.5 3750250 Small firmsMedium-sized firms

101.0

FY06 07 08 09 10

3000200

FY06 07 08 09 10

Large firms (right scale)

14Source: Ministry of Economy, Trade and Industry.

Chart 15The outstanding amount of Japan's foreign direct investment remains at a low

level compared with that of other advanced countries.

Outward Direct and Portfolio Investment Position Japan's Rate of Returnon Outward Direct Investment (by Region)%

p

tril. dollars, as of end-2011

15

18%

ChinaAsia (excluding China)WorldNorth America8

10

12

Portfolio investment

Direct investment

tril. dollars, as of end 2011

12

North AmericaEU

4

6

8

9

0

2

4

6

% of nominal GDPDirect

UnitedStates

UnitedKingdom

Japan Germany France Italy Canada

0

3Directinvestment

42 133 57 67 85 59 18

Portfolioinvestment

36 70 17 46 51 36 31

T t l 78 203 74 113 136 95 49

15Note: Rates of return on outward direct investment are calculated by dividing the amount of total direct investment income by the direct investment position for the previous year-end.

Sources: OECD; IMF; Bank of Japan.

06 07 08 09 10 11CYTotal 78 203 74 113 136 95 49

Chart 16In terms of the profitability of foreign investment,

Japan falls somewhat behind the United States.

Rate of Return on Outward Investment(Direct and Portfolio Investment)

Rate of Return on Direct Investment Rate of Return on Portfolio Investment

Japan falls somewhat behind the United States.

(Direct and Portfolio Investment)

12%

12%

12%

8

10

8

10

8

10

4

6

4

6

4

6

2

4

2

4

2

4

0

Uni

ted

Stat

es

Can

ada

Japa

n

Uni

ted

ingd

om

erm

any

Fran

ce

Ital

y

0

Uni

ted

ingd

omU

nite

dSt

ates

Can

ada

Japa

n

erm

any

Ital

y

Fran

ce

0

Japa

n

Can

ada

Fran

ce

erm

any

Uni

ted

Stat

es

Ital

y

Uni

ted

ingd

om

16Note: Figures are for 2011. Rates of return are calculated by dividing the amount of total investment income by the investment position for the previous year-end.Source: IMF.

C U Ki

Ge U Ki C

Ge C

Ge U Ki

Chart 17

Huge potential demand in the area of building core infrastructure exists in Asia.

Share of Companiesin Infrastructure Order (CY2011)

Investment Demand on Infrastructure in Asia

Japanese5

tril. dollars

Japanese firms9%

South Korean firms4%Others

4Replacement

B kd

Total: about 8 trillion dollars

4%

U.S. or Canadian

firms

Others9%

3

demand

New demand

Breakdownof transportation

Chinese firms20%

13%2

European firms45%

1

45%0

Ene

rgy

Ele

ctri

city

)

nspo

rtat

ion

mun

icat

ions

ater

sup

ply

/hyg

iene

Roa

ds

Seap

orts

Rai

lway

s

Air

port

s

17Note: Figures for investment demand are the accumulated value from 2010 to 2020. Sample countries are 30 countries or regions located in the Asia-Pacific region.Sources: Ministry of Economy, Trade and Industry; Asian Development Bank.

(E

Tra

n

Com

m Wa /

Chart 18

The labor participation rate of the elderly has increased in recent years.

Labor Participation Rate of the ElderlyLife Expectancy of 60 Year-Olds

60

65%

28

30years

55

60

24

26

28Female

Male

45

50 60 to 64 years old

65 to 69 years old22

24

35

4018

20

30

35

05 06 07 08 09 10 11 12CY

14

16

1960 65 70 75 80 85 90 95 2000 05 10CY

18Sources: Ministry of Internal Affairs and Communications; Ministry of Health, Labour and Welfare.

Chart 19

The labor participation rate of women remains at a relatively low level compared with other advanced economies

Labor Participation of Women in 2010

compared with other advanced economies.

%

90

100

60

70

80

40

50

60

Sweden

Germany

20

30

40 United Kingdom

United States

Japan

0

10

20

19Sources: Ministry of Internal Affairs and Communications; OECD.

015-19 20-24 25-29 30-34 35-39 40-44 45-49 50-54 55-59 60-64 over 65

Age

Chart 20

Expenditure in medical and nursing care has increased at a pace lower than that of population aging in Japan.

Population Aging and Expenditure in Medical and Nursing Care

Japan GermanyUnitedStates

FranceUnited

Kingdom

Population aged 65 and over(Change from 2000 to 2009, percent)

29 24 13 9 9

Expenditure inmedical and nursing care

(Change from 2000 to 2009, percent)

17 31 82 98 49( g , p )

20Sources: United Nations; OECD.

Chart 21

The service sector, including medical and welfare industries,are offering increased employment opportunities

Employees of Service Industries Employees of Medical and Welfare Industries10 thous. 10 thous 10 thous. 10 thous.

are offering increased employment opportunities.

4500

4550

6450

650010 thous. 10 thous.

800

850

4500

4550Service industries

Medical, health care and welfare i d t i ( i ht l )

10 thous.

4400

4450

6350

6400

700

750

4400

4450

industries (right scale)

4350

4400

6300

6350

650

700

4350

4400

4250

4300

6200

6250

All industries550

600

4250

4300

4150

4200

6100

6150

All industries

Service industries (right scale)

450

500

4150

4200

21Note: Service industries include all industries other than the manufacturing, agriculture, forestry and fisheries, mining, and construction industries.Source: Ministry of Internal Affairs and Communications.

41506100

02 03 04 05 06 07 08 09 10 11 12CY

4504150

02 03 04 05 06 07 08 09 10 11 12CY

Chart 22

Japan's secondary housing market is smaller than other countries.

70010 thous.

500

600Second-hand dwellings transactions

502.2 (78.8%)400

500New housing starts

300

15.1 (12.4%)137.9 (85.5%)100

200

106.1 (87.6%) 135.5 (21.2%)

23.4 (14.5%)

( )

0

Japan United States United Kingdom

22

Notes: 1. Figures are for 2007. Those in parentheses represent each share.2. For the United Kingdom, the number of second-hand dwellings is derived by subtracting the number of new dwellings from the total

housing market.Sources: Ministry of Land, Infrastructure, Transport and Tourism; U.S. Census Bureau; U.K. Department for Communities and Local Government.

Japan United States United Kingdom

Chart 23

The share of residential assets among Japanese household assets tends to be high.

Breakdown of Household Assets

73.5Japan

27 2United

27.2States

66.6Euro area

0 20 40 60 80 100Currency and deposits Government and Corporate BondMutual fund Equity

d i f d h fi i l

%

Note: Figures are as of end-2010.Sources: Ministry of Internal Affairs and Communications; FRB; Eurostat. 23

Insurance and pension fund reserves Other financial assetsFixed assets

Chart 24

Compared with the United States, Japanese large-cap firms have longer corporate histories

Establishment Year of Top 300 Large-Cap Firms

have longer corporate histories.

number of firms

60

70number of firms

40

50United States

Japan

30

40

10

20

0

-1889 189099

190009

1019

2029

3039

4049

5059

6069

7079

8089

9099

200009

2010-CY

24

Note: Figures are based on the top 300 large-cap firms as of end-2012. Those for Japan for 2000 onward, however, exclude the establishment of stock-holding companies.Source: Thomson Reuters.

-99 -09 -19 -29 -39 -49 -59 -69 -79 -89 -99 -09

Looking at developments in the stock market after the Lehman shock,comparatively small firms have been performing relatively well.

Chart 25

Difference in Market Capitalization Developments by Size

p y p g y

Market capitalization declinedMarket capitalization increased

29.4 70.650 billion yen

or above(762)

5 billion yen or above and

(762)

44.9 55.1or above and

less than50 billion yen

(1,440)

58.7 41.3Less than

5 billion yen(1,153)

0 10 20 30 40 50 60 70 80 90 100

(1,153)

%Notes: 1. Sample firms are those that were listed on stock exchanges in Japan as of end-August 2008 and which remained so through January 2013.2. Figures are comparisons of market capitalization from August 2008 to January 2013.3. Firms are categorized based on their market capitalization as of end-August 2008.4. Figures in parentheses represent the number of firms that apply to each category.

Source: Bloomberg. 25

%

Japan has prioritized securing employment,reducing costs largely by cutting back wages

Chart 26

8y/y % chg.

12%

reducing costs largely by cutting back wages.

Hourly WagesUnemployment Rates

6

8

Japan United States10

12

Japan United States

48

26

04

-4

-2

0

2

85 87 89 91 93 95 97 99 01 03 05 07 09 11CY85 87 89 91 93 95 97 99 01 03 05 07 09 11CY

26Sources: Cabinet Office; Ministry of Internal Affairs and Communications; BLS.

Chart 27 As firms' profitability has been declining recently,neither wages nor prices have changed materially.

Developments in Corporate Profits, Wages, and Prices following Cyclic Peaks1986/Q4 ~ 90/Q41971/Q4 ~ 73/Q3

200latest peak=100

200Wages

latest peak=100

120

140

160

180 Wages

CPI

Corporate profits

120

140

160

180 Wages

CPI

Corporate profits

80

100

120

-15 -12 -9 -6 -3 0 3 6 9 12 15

80

100

120

-12 -9 -6 -3 0 3 6 9 12 15 18T hP k

180latest peak=100

140latest peak=100

2002/Q1 ~ 07/Q4 2009/Q1 ~

quartersTrough:71/Q4

Peak:70/Q3

quartersTrough:86/Q4

Peak:85/Q2

100

120

140

160 Wages

CPI

Corporate profits

60

80

100

120

Wages

CPI

60

80

100

-5 0 5 10 15 20 25

20

40

60

-12 -9 -6 -3 0 3 6 9 12 15 18

CPI

Corporate profits

5 0 5 10 15 20 25

quartersPeak:00/Q4

Trough:02/Q1

quartersTrough:09/Q1

Peak:08/Q1

27

Note: "Wages" refers to hourly cash earnings (monthly labour survey base, establishment with 30 or more employees, all industries). "CPI" refers to CPI for all items. "Corporate profits" refers to operating profit figures in "Financial Statements Statistics of Corporations by Industry, Quarterly" (all size, all industries).

Sources: Ministry of Health, Labour and Welfare; Ministry of Internal Affairs and Communications; Ministry of Finance; Cabinet Office.

There is a clear positive correlation betweeninflation expectations and potential growth rates in Japan.

Chart 28

5

3

4y/y % chg. y/y % chg.

3

3

4 Potential growth rate (per capita, left scale)

y/y % chg. y/y % chg.Japan United States

3

4

1

2

3

2

1

2

3 Medium- to long-term inflation expectations(6 to 10 years ahead, right scale)

1

2

-1

0

1

0

1

-1

0

1

CY90 92 94 96 98 00 02 04 06 08 10 12CY90 92 94 96 98 00 02 04 06 08 10 12

54y/y % chg. y/y % chg.

54y/y % chg. y/y % chg.

United KingdomEuro Area

4

2

34

2

3

2

3

0

1

2

3

0

1

1-1CY90 92 94 96 98 00 02 04 06 08 10 12

1-1CY90 92 94 96 98 00 02 04 06 08 10 12Sources: Cabinet Office; Consensus Economics Inc., "Consensus Forecasts"; CBO; OECD, etc. 28

Changes in global investors' risk aversion significantly affect developments in financial markets.

Chart 29

Long Term Yield Spreads%

Beginning of 2011

July 24, 2012 Recent

Equity PricesLong-Term Yield Spreads

over German Government Bond YieldsBeginning of 2011

July 24, 2012 Recent

1.8 5.4 3.4

2.5 6.4 3.9

Italy

Spain

+3.6 -1.9

+3 9 2 5

10,398.1 8,488.1 11,254.0

11,670.8 12,617.3 13,900.1

Japan(Nikkei 225)

United States(Dow Jones)

-18.4% +32.6%

+8.1% +10.2%

9.6 26.8 9.7

Spain

Greece

+3.9 -2.5

+17.2 -17.1

2,839.4 2,151.5 2,570.5

100.0 85.3 95.4

Euro area(Euro STOXX)

Emergingeconomies

-24.2% +19.5%

-14.7% +11.9%

% chg., "+" means appreciation, "-" means depreciation

January 2011 → July 2012 July 2012 → January 2013

Equity Funds Inflows/OutflowsNominal Effective Exchange Rates

0 4

0.8 %

Yen + 6.3 - 13.9

U.S. dollar + 3.2 - 2.6

E 4 8 5 4 -0 4

0.0

0.4

Euro - 4.8 + 5.4

Pound sterling + 4.4 - 2.3

Korean won - 1.2 + 6.5 -1.2

-0.8

-0.4

Emerging economiesAdvanced economies

29

Notes: 1. Figures for equity prices for emerging economies are taken from the MSCI Emerging Markets Index, adjusted such that the figure for the beginning of 2011 is 100.2. Figures for "Equity Funds Inflows/Outflows" are calculated using each fund's net money flow data divided by its total assets.

Sources: Bloomberg; EPFR Global; BIS.

11 12 13CY

Exports and production increasedduring the mid-2000s when the yen depreciated.

Chart 30

110

120

120

140Real exports (left scale)Industrial production (right scale)

s.a., CY 2005=100s.a., CY 2005=100

80

90

100

80

100

p ( g )

60

70

40

60

90 91 92 93 94 95 96 97 98 99 00 01 02 03 04 05 06 07 08 09 10 11 12CY

60Nominal effective exchange rate

CY 2005=100, reversed

80

100

Nominal effective exchange rateReal effective exchange rate

Yen'sdepreciation

120

140

160

depreciation

Yen'sappreciation

30Sources: Ministry of Economy, Trade and Industry; Bank of Japan; BIS.

16090 91 92 93 94 95 96 97 98 99 00 01 02 03 04 05 06 07 08 09 10 11 12 13CY

The medium- to long-term growth rate has not risen.Chart 31

Foreign Exchange Rates, Exports, and Real GDP Growth

606y/y % chg. CY 2000=100, reversed

70

80

4

90

1000

2

100

110-2

0

Contribution to real GDP growth from net exports Yen's

120

130-4

Contribution to real GDP growth from domestic demand

Nominal effective exchange rate (right scale)

Yen s depreciation

Y '

Notes: 1. The nominal effective exchange rate is an indicator that measures the overall value of individual currencies. It is derived by calculating the weighted average of

140-6

00 01 02 03 04 05 06 07 08 09 10 11 12

Real effective exchange rate (right scale)

CY

Yen's appreciation

31

each currency's exchange rate against other currencies using the annual value of each country's trade with its counterparties as its weights.2. The real effective exchange rate is an indicator of a country's overall international competitiveness, calculated as follows. First, each of the exchange rates of the

country's currency against other currencies (i.e., nominal exchange rates) is deflated by the price indices of those countries to calculate the real exchange rate. Then, the weighted average of the real exchange rates is calculated using the annual value of each country's trade with its counterparties as its weights.

Sources: Cabinet Office; BIS.

Money is increasing.Chart 32

Relationship between Money and Prices200140

Real GDP CPIMoney stock Amount outstanding of lending

CY 2000=100 CY 2000=100

150

175

120

130 Monetary base (right scale)

125110

75

100

90

100

00 01 02 03 04 05 06 07 08 09 10 11 12CY 00 01 02 03 04 05 06 07 08 09 10 11 12CY

1

2

CPI (less fresh food)

y/y % chg.

-1

0

1 CPI (less fresh food)

32Sources: Cabinet Office, Ministry of Internal Affairs and Communications; Bank of Japan.

-2

00 01 02 03 04 05 06 07 08 09 10 11 12CY

The Bank of Japan has provided considerable funds through large-scale purchases of JGBs.Private financial institutions have been increasing their JGB holdings rather than lending

Chart 33

Private financial institutions have been increasing their JGB holdings rather than lending.

Deposit-Taking Financial InstitutionsAssets

Bank of JapanAssets Liabilities and Net Assets

1 600tril. yen

160tril. yen

160tril. yen

1,400

1,600

140

160

140

160

1,000

1,200

100

120

100

120

600

800

60

80

60

80

200

400

20

40

20

40

0

200

1998/12 2007/12 2012/9

0

20

1998/12 2007/12 2012/9

0

20

1998/12 2007/12 2012/9

33Note: Figures are as of end of month.Source: Bank of Japan.

LendingJGBsCurrent deposits at the BOJOthers

Banknotes Current deposits

Others

JGBs

Others

The Bank of Japan will supply additional funds amounting to over 60 trillion yen in the next two years.

Chart 34

Amount Outstanding of "Asset Purchase Program" and "Loan Support Program"

130

140tril. yen

110

120

130Loan Support Program (schedule)

Loan Support Program (actual)

h ( h d l )

80

90

100Asset Purchase Program (schedule)

Asset Purchase Program (actual)Aiming to achieve the price stability target, the Bank will continue a virtually zero interest rate policy

60

70

80 and purchases of financial assets as long as the Bank judges it appropriate to continue with each policy measure respectively.

30

40

50policy measure respectively.

For some time, the Bankwill purchase financial

10

20

30assets of about 13 trillion yen, 2 trillion yen of which is JGBs, every month.

34

0CY2010 2011 2012 2013 2014