The following is the provisional minutes of the Forum #1 made by Secretariat of ESRI Economic Policy Forum(for details see the whole record of the discussion in our Japanese HP).

Date: March 1, 2001, 14:00- 17:00
Panelists: Prof. Kikuo IWATA, Gakushuin University (Keynote Speech)
         Mr. Kagehide KAKU, Daiwa Institute of Research Ltd.
         Prof. Yutaka KOSAI, Japan Center for Economic Research
         Prof. Koichi HAMADA, ESRI

At the beginning of the discussion, Prof. Iwata made a keynote speech to propose quantitative relaxation of monetary policy. That was followed by comments from Mr. Kaku, who is cautious about the quantitative relaxation. Discussions were then made between the panelists and finally the floor was opened up to the general audience.

1. Outline of the keynote speech by Prof. Iwata:"A proposal of inflation-targeted monetary operations of purchasing the long-term government bonds without repurchase contracts" (for details see in the memorandum circulated in the discussion (Japanese only))
1) Current economic and monetary conditions
 The Japanese economy has fallen into a vicious spiral of flow and stock deflation. In other words, the fall in asset prices have weakened private demand, which creates negative impacts both on the goods and services prices and on business conditions. Consequently, asset prices have fallen further. This can be called an "asset deflation trap".

2) Influence path of monetary policy
 Monetary relaxation can affect the economy in the following ways to save it from the asset deflation trap:
- by lowering real interest rates to stimulate investment and consumption
- by raising asset prices to induce investment and consumption
- by improving the balance sheets of lenders and borrowers, which will lead to the increase in investment and consumption
- by weakening the yen to stimulate exports

3) Options for monetary relaxation
 At this stage, there seem to be the following three ways to carry out monetary relaxation, among which I propose the third one. Notice that all the three options are accompanied by inflation targeting, which improves the transparency and persuasiveness of monetary policy and consequently restrains the volatility of asset prices.
(1) the zero-interest policy with an inflation target
(2)a provisional fixed exchange rate regime with an inflation target (intervention in the foreign exchange markets by selling yen and buying dollars)
(3)inflation-targeted monetary operations of purchasing long-term government bonds without repurchase contracts

 In addition, if the quantitative relaxation of monetary policy successfully brings about a moderate inflation, it is expected that the nominal value of bank profits will increase and that the land and stock prices will rise with the expectation of economic recovery. These may make it easy for the banks to write off their bad loans. Furthermore, the adverse spreads of life insurance companies are also expected to disappear while the banks are expected to shift their money to lending. In these ways, monetary relaxation should stabilize the financial system.

2. Comments made by Mr. Kaku (for details see the memorandum circulated in the discussion)
1) Basic stance
 If the economy becomes weaker, there might be a need for further relaxation of monetary policy. However, to save the Japanese economy from its long-lasting stagnation, structural reform is considered to be essential while the role of monetary policy is considered to be only auxiliary. It is misleading to expect monetary policy to have drastic effects of transforming the Japanese economy. In addition, there is doubt whether the Japanese economy is in a vicious spiral of deflation as there are some positive signs of recovery including the increasing trend of enterprise profits.

2) Some comments on Prof. Iwata's proposal
 It is considered that there are three possible ways to carry out further monetary relaxation: 1) cutting interest rates, 2) purchasing those assets with relatively low substitutability with monetary base, such as long-term government bonds, and 3) affecting market expectations.
 As for 1), there obviously remains very little room for further interest rate cuts.
 Turning to option-2, the effects of such operations, including purchasing long-term bonds proposed by Prof. Iwata, are uncertain and quite difficult to forecast. What is more, to make some noticeable difference, substantial operations seem necessary while the accompanying costs or side effects of the operations would increase according to the expansion of the operation size. For example, an operation of substantial size may aggravate the balance sheet of the Bank of Japan and might ultimately contain the risk of enforcing the Bank of Japan to undertake newly issued government bonds.
 As for 3), while Prof. Iwata seems to presume that inflation targeting can change people's expectations, only very a limited number of tools to can be used to realize this effect.
 To sum up, while further monetary relaxation should not be ruled out, it should be considered as only an auxiliary measure. But, if we should appeal to it, one cannot pay too much attention to the balance of its costs and benefits as well as the background of the long stagnation of the Japanese economy.

3. Panel discussions
1) Falling prices
 As Prof. Iwata insisted that the Japanese economy is in a vicious spiral of flow and stock deflation in his keynote speech, the following discussions were made on the fall of asset and goods prices.
 Prof. Kosai, who considers the effects of monetary policy on prices to be rather limited, argued that the fall of prices can be considered as a movement toward equilibrium prices and that it is therefore doubtful whether monetary policy can stop the fall.
 On the other hand, Prof. Hamada argued that it is money and monetary policy that determine the prices and that, given the falling prices, monetary policy should be relaxed.

 Related to these discussions, it is suggested by one from the audience that there might be more than one equilibrium price in the asset markets and that the difference of the equilibrium prices between the bubble era and now is considered to have caused the fall in prices. Prof. Kosai replied that, even if one calls the land prices at the bubble era equilibrium prices, such a kind of equilibrium must be an unstable one, and that the current land prices are obviously much lower than the ones during the bubble era and are still considered to be above equilibrium levels not only in the current Japanese economy, where the financial intermediary functions are imperfect, but also in the economy where the functions have recovered.

2) Relations between structural policy and monetary policy
 While all the discussants emphasized the importance of structural policies, there are differences in their views on the relations between structural policies and monetary policies, as outlined below.

 Prof. Iwata and Prof. Hamada emphasized the role of monetary policy to alleviate the pains caused by structural reforms as the structural polices can have deflationary effects and, under the situations of assets deflation, financial intermediary functions may be hampered due to the fall of collateral values. Prof. Hamada added that it is analogous to forcing a traveler to keep walking with a heavy burden to resolve the bad loan problems under a deflationary environment.

 On the other hand, Mr. Kaku, Prof. Kosai, and others who consider the role of monetary policy as only auxiliary pointed out the risk that the dependence on monetary policy may delay the structural reforms. They argued that the structural problems cannot be resolved by inflation and emphasized the importance of thorough structural resolution of the bad loan problems. In addition, Prof. Kosai also argued that it is difficult to restrain frictional unemployment yielded by structural reforms by causing moderate inflation and that even moderate inflation may strengthen the expenditure pressure and aggravate fiscal conditions, as was experienced in the United States in the 1970s.

3) Effectiveness and possible (alternative) monetary policy
A. On the purchase of long-term government bonds without repurchase contract

 From the cautious side, Mr. Kaku argued that purchasing long-term government bonds without a repurchase contract may not have certain or substantial effects of increasing the money supply as the high-powered money supplied by the operations may remain in the banking sector. Supporting him, Prof. Kosai suggested that, given the current high level of the Marshall's k, which had risen during the bubble era and kept rising even after that, it does not seem easy to increase the money supply further by monetary relaxation. Moreover, Mr. Kaku added that it may be necessary to restrain banking loans to resolve the so-called over-banking problems, or the fact that their lendings are too big, and that the consistency between this long-term requirement and the measures for quantitative relaxation at this moment should be considered further.
 However, among those who made these cautious arguments, Prof. Kosai confessed that he does not exclude the purchase without a repurchase contract as an alternative in case further monetary relaxation becomes necessary.

 From the positive camp, Prof. Iwata and Prof. Hamada suggested that the costs or the risks of the purchase may not be very big and insisted that the purchase should be implemented quickly under the current severe economic conditions even if the quantitative evaluation of the effects is difficult. Prof. Iwata suggested that the banks, which are supplied with more high-powered money by the purchase, would first buy corporate bonds and CPs, and then shift to lending due to the balance sheet effects of the operations.

B. Whether monetary policy can lower real interest rate by raising inflation expectation

 From those who are skeptical about quantitative relaxation, Prof. Kosai suggested that even if the inflation expectation can be raised, real interest rates might not be lowered because nominal interest rates might also rise unless the expectation formation in the financial markets was not as quick as that in the goods market. In other words, whether real interest rates will rise or not when monetary conditions are relaxed depends on the relative speed of expectation formation in financial vis-a-vis goods market.
 On the other hand, Prof. Iwata argued that nominal interest rates may not rise to the same extent as the inflation expectation rises in the economy which has unemployment, and that real interest rates can be lowered there.

C. Monetary relaxation by intervention in the foreign exchange markets

 From the cautious side, Prof. Kosai suggested that it may not be easy to weaken the yen by the intervention as the current balance is in surplus and there are huge foreign credits. This was echoed by the remark from the floor, which suggested the possibility of trade friction in the case of a weak yen.
 Prof. Iwata and Prof. Hamada, however, pointed out that the huge short-term volatility of the foreign exchange rates suggests the possibility to make the yen weaker by intervention and added that the consequent recovery of the Japanese economy should have positive effects on foreign economies.
 In this context, Prof. Iwata added that it might be an idea that the government itself, rather than the Bank of Japan, intervenes in the foreign exchange market since the intervention with exchange rate target may not be justified under the current Bank of Japan Law.

4) On the inflation targeting proposed by Prof. Iwata
 Prof. Kosai cast skepticism on inflation targeting and urged that it is important for effective monetary policy to make a preemptive and surprising action rather than to stick to such pre-determined targets.