Place: Economic and Social Research Institute
Date: September 18, 2003
 

Session 1: "Elucidation of the Causes of a Deflationary Economic Slump"

 1,Presentations

 

   (1)Koichi Hamada, "The Heisei Recession: An Overview"

  This paper tries to explain the relevance of policy discussion on the prolonged Heisei recession to economic theory and empirical evidence. First, the causes of recession are real factors, such as Japan's slowing potential growth ability, mal-adaptation of Japanese organizations to the changing environment, and the impact of the sharp monetary contraction in the first half of the 1990s. Second, the remedy is primary monetary policy; unconventional methods and inflation targeting are especially effective. Finally, the reasons that appropriate policy have not been undertaken are lack of understanding of the macroeconomic mechanism and vested interests.
(The Heisei Recession: An Overview(PDF-Format 383KB))
 

   (2)Masahiro Hori and Satoshi Shimizutani, "What Changes Deflationary Expectations? Evidence from Japanese Household Data"

  This paper analyzes the effect of deflation on consumption, and the measures necessary to reverse deflationary expectations. Since 2001, average price expectations have been ranging from minus 0.5 percent to 0 percent. These deflationary expectations discourage household consumption, especially consumption of consumer durables. In addition, a quantitative easing policy was not very effective in altering deflationary (inflationary) expectations. In other words, more aggressive policy measures should be implemented to reverse deflationary expectations.
(What Changes Deflationary Expectations?-Evidence from Japanese Household Data-(PDF-Format 193KB))
 

 2,Comments of Panelists

 

    David Weinstein

  Professor Hamada's paper gives a rational explanation of the relevance of the ongoing policy debate and empirical evidence. It stresses the necessity of improvement of serious structural problems and monetary policy.
  I agree with the opinions of Professor Hamada, except for one point. I cannot accept that Japanese workers will suffer loss because of international trade, as written in the paper. Japanese workers are almost all skilled; thus, their real wages will increase through international trade. Besides, whether the fiscal policy succeeded or failed deserves to be considered more thoroughly. Japanese expenditure increased greatly, but since interest payments and social welfare also increased, this spending has had little effect in expanding the economy.
  The paper of Mr. Shimizutani points out that past expectations and present expectations are closely related, and that the alteration of monetary policy by the Bank of Japan has little effect. Improvement of the survey method and elucidation of the mechanism of impact of alteration of monetary policy on expected prices are expected.

 

    Hamada

  It is commonly thought that real wages tend to converge, and that a wage gap remains nevertheless. In connection with the small impact of fiscal policy, the households think that the government implements Ricardian-type policies.
 

    Shimizutani

  Such a survey had no precedents; we are proceeding by trial and error. We are planning to conduct more formal analyses in the future.
 

 3,Question- and- Answer Session

 

    Speaker

  There is a large budget deficit triggered by lower tax revenues caused, in turn, by the economic slowdown, but fiscal policy works as a built-in stabilizer.

    Speaker

  Judging from the fiscal situation, I do not think the debt will decrease.

    Speaker

  Some research indicates that men and women have different inflation expectations. I find it interesting to pursue this issue. I think the Bank of Japan should clarify its position on the present situation to enhance the effectiveness of monetary policy. The commitment of the Bank of Japan to curbing deflation is the most important issue.

    Speaker

  An increase in Japan's budget deficit is an increase in social expenditure. It is necessary to use the correct figures while considering future debt. We also should always keep in mind the enormous amount of future debt.
 
 

Session 2: "The Effects of Monetary Policy in a Zero Interest Rate Economy"

 

 1-1,Presentation of Reporter

 

    Michael Woodford "Optimal Monetary Policy in a Liquidity Trap"

  Quantitative monetary easing policy is ineffective if it does not change expectations about the future conduct of policy. On the other hand, the most essential thing is credible commitment to a sufficient increase in price level. Foreign exchange market intervention may be effective.
(Optimal Monetary Policy in a Liquidity Trap(PDF-Format 453KB))
 

 1-2,Comments of Panelists

 

    Tsutomu Watanabe

  The paper of Professor Woodford provides a framework for analysis of monetary policy in Japan. If we could have seen this paper three to five years earlier, we could have avoided much of the confusion connected with different disputes.
I would like to talk about the relationship between monetary and fiscal policies. This paper assumes that fiscal policy follows monetary policy. It assumes Ricardian fiscal policy. Under ordinary circumstances, there are no problems with such assumptions. However, when the interest rate zero bound constraint is binding, implementation of the optimal monetary policy means significant fiscal adjustment behind the scenes. One point stressed by the authors in the paper is that fiscal adjustment reduces fiscal surplus. However, it is clear that actual fiscal policy was not conducted in this way. In this sense, the assumptions of the paper are not satisfied. More, this state of affairs is highly likely to have aggravated deflation in Japan.
Over the past five years, the Bank of Japan has promised to keep the overnight rate at zero until the deflationary concerns are dispelled, and to commit to quantitative easing. I cannot say whether this commitment was enough to avoid deflation, but there is clearly a problem regarding whether the position of the Bank was explained correctly. In October 2002, the market thought that the zero interest rate would continue for four years. It can be said that the position adopted by the Bank of Japan was transmitted to some extent. Nevertheless, there is different evidence. In August 2000, the Policy Board of the Bank of Japan announced that the deflationary concerns were dispelled, and decided to stop the zero interest rate policy. In this way, the Bank of Japan betrayed its own commitment. This led to a loss of confidence in the policy of the Bank of Japan. Behind the increase in interest on debt from June of this year was concern that the Bank might break its promise and stop the quantitative easing. The failure of August 2000 has had a long-lasting effect.
(Comments on " Optimal Monetary Policy in a LiquidityTrap" by G. Eggertsson and M. Woodford(PDF-Format 33KB))
 

1-3,Question- and- Answer Session

 

    Speaker

  The Bank of Japan is afraid that deflation will turn into hyperinflation.

    Speaker

  In connection with price level targeting, please explain the criteria for choosing the optimal policy. Are there definite rules? Moreover, how do you evaluate the fact that the present base money would increase if targeting of the price level that predominated before deflation existed?

    Speaker

  I think that fiscal policy is non-Ricardian. The government should clearly state the targets on income and nominal GDP growth. I think the fluctuation in natural interest rate is important. The natural interest rate fluctuates on the same level as the potential growth rate.
 

    Woodford

  First is a question whether it is assumed that the Ricardo proposition holds with regard to fiscal policy. In the presented paper, the Ricardo proposition is not assumed. The paper is based on the assumption that the financial authorities do their best to achieve the optimal equilibrium, and that there are no constraints. The commitment of the Bank of Japan to the further easing exerts a positive effect. The Bank of Japan announced that it would not abandon immediately its zero interest rate policy, but nothing further has been made clear. It is important to continue to clearly express commitments to the nation. The most difficult problem in Japan is that the commitment is not announced in advance. I think it is correct to commit to a higher price level than today's. It is important to make clear the announcement that the expected price level will be targeted.
 

 2-1,Presentations

 

    Alan Auerbach "The Case for Open-Market Purchases in a Liquidity Trap"

  Even in the case of a liquidity trap, monetary policy is still efficient as a macroeconomic and fiscal tool. In addition, if the future short-term interest rate is positive, monetary expansion will lead to welfare improvement and price and productivity increases.
(The Case for Open-Market Purchases in a Liquidity Trap(PDF-Format 146KB))
 

 2-2,Comments of Panelists

 

    Makoto Saito,"Comments on'The Case for Open- Market Purchases in a Liquidity Trap' by A.J.Auerbach and M.Obstfeld"

  According to the argument of Professor Auerbach, if the market participants expect the short-term nominal interest rate to increase from zero in a certain point of time in the future, they restore a quantitative theory of money through backward induction even under a zero nominal interest regime. Active purchases of government bonds by the Bank of Japan help to reduce tax distortions significantly. In addition to such a positive microeconomic effect, they also exert favorable macroeconomic impact on output, though this impact is temporary. I completely agree with this theoretical logic.
  In connection with reductions in tax distortion, I think that the Japanese government has already exploited such an effect. I would like to make comments not about the model itself, but about its relevance to the current situation in the Japanese economy. In particular, I would like to point out that the term structure is determined endogenously through the interaction of the government and market participants; it is not exogenous. Besides, the initial zero interest rate and quantitative easing policies were revised several times under political pressure into a more aggressive direction. In this sense, commitment is weak and lacks credibility. The term structure is flattening out. In such an environment, the market participants have become more convinced of a long-run continuation of a zero nominal interest rate policy and have started to speculate on further interest rate declines.
  Since 1999, when the zero interest rate policy was implemented, swap spreads have been declining substantially. Such phenomenon in swap markets is an exception, not a rule in the developed countries, but the above short-term speculative behavior of the market participants was a logical consequence of their consideration of the policy of the Bank of Japan. This aggressive speculation was based on the expectation of the continuation of the zero interest rate policy.
  The forward-looking phenomenon restoring the quantitative money theory is unlikely to occur under such myopic expectations of the market participants. A logical consequence of the limited impact on prices and enormous money supply is serious excess supply in money markets. Even a slight interest rate increase will force the Bank of Japan to absorb excess supply. Consequently, the commitment of the Bank of Japan to a permanent increase in money supply turns out to be not credible.
  The present commitment of the Bank of Japan is "price increase first and then interest rate increase." The difference is subtle, but it contradicts the logic of Professor Auerbach. To enhance the effectiveness of the policy commitment of the Bank of Japan, it is necessary to clarify the schedule of the future interest rate increase and to decrease the excess reserves to adequate levels. This is one way to apply the mechanism of Professor Auerbach to the Japanese economy. Regardless, I think that a reduction in tax distortion through monetization is a more important issue than the spillover effect on prices.
(Comments on "The case for open-market purchases in a liquidity trap"by Auerbach, A. J. and M. Obstfeld(PDF-Format 57KB))
 

 2-3,Question- and- Answer Session

 

    Speaker

  Once inflation begins, excess liquidity will not be maintained. Will it mean an increase in spending by economic agents?

    Speaker

  I would like to look into the relationship of optimal commitment and inflation. The optimal commitment will be "interest rate increase first." The permanent keeping of the money supply means a continuance of the zero interest rate. A commitment to a lower interest rate will become an important issue.

    Speaker

  Judging from the interest term structure, Japan makes myopic investments. Recently, the price of government bonds has begun to change.

    Speaker

  I agree with the buying operations. Moreover, I agree with Professor Woodford. The fiscal effects of the monetary policy are important. Japan tends to ignore this point.
 

    Auerbach

  I would like to make a remark on the reversion of the policy. The Bank of Japan should commit to an increase in money supply. The present policy did not become sufficient monetary stimulus.
 

    Speaker

  The Bank of Japan has enough political power to trigger deflation. Why must we consider the political pressure on inflation?

    Speaker

  I cannot say that I disapprove of the ongoing framework of the Bank of Japan, but from the standpoint of the credibility of policy, the amount of excess reserves is a problem. Excess reserves worth of 25 trillion yen are too big, and can hardly be justified. Excess reserves of less than 1 trillion yen are adequate.
 
 

Session 3: "Theory and Policy for Corporate Revitalization"

 

 1,Presentations

 

   (1)Tomoo Tasaku, "Corporate Revitalization in Japan"

  The paper concerns the change in framework of corporate revitalization since 1990, and improvements in legislation. In the 1990s, restructuring used to be settled through out-of-court workouts under the main bank system. However, at present, early recognition and quick action toward financial difficulties among companies have been enhanced due to adoption of the new legislation (the Civil Rehabilitation Law and the amended Corporate Reorganization Law). The paper also explains the functions and role of the Industrial Revitalization Corporation of Japan, established in April 2003, that can be positioned as an asset management company (AMC).
(Corporate Revitalization in Japan(PDF-Format 54KB))
 

   (2)Douglas Baird, "Corporate Revitalization in the United States and Its Application to Japan"

  The response of the market to bankruptcy has improved because of observation of the recent experience of large-scale companies that filed Chapter 11 of the U.S. Bankruptcy Code. For this reason, the role of Chapter 11 as coordination of creditors became less important. Besides, in a service-driven economy, not all companies have substantial value as a going concern set up by Chapter 11. In this sense, the role of Chapter 11 is changing.
(Revitalization of Enterprise in Chapter 11(PDF-Format 51KB))
 

   (3)Hyoung-Tae Kim, "Corporate Restructuring in Korea and Its Application to Japan"

  This paper examines the key points of Korean corporate restructuring experiences, and makes the following propositions: 1) The Japanese government should shift the main emphasis from disposal of the non-performing loans to corporate revitalization; 2) the government should establish corporate restructuring vehicles in order to promote corporate reconstructing; and 3) it also needs to consolidate its bankruptcy laws.
(Corporate Restructuring in Korea and its Application to Japan - Corporate Restructuring Vehicles-(PDF-Format 60KB))
 

 2,Comments of Panelists

 

    Jenny Corbett"Comments on "Corporate Restructuring in Japan,Korea,and the United States"

  Mr. Tasaku's paper offers tools for corporate restructuring in Japan. In the past there was no option other than debt forgiveness, but now the usage of new tools is increasing. The new Civil Rehabilitation Law allowed debtor-in-possession (DIP) finance, but it is likely to preserve "zombie" firms that should be closed. In addition, I am skeptical about the reasons behind the creation of prompt corporate restructuring guidelines by the Ministry of Economy, Trade and Industry.
  In contrast to the Resolution and Collection Corporation (RCC), the Industrial Revitalization Corporation of Japan (IRCJ) was apparently aimed at the restructuring of large-scale companies, since creditor coordination is difficult under out-of-court workouts. Nevertheless, it is crucial to consider the reasons why the government agency is necessary, and what the nature of the problem is with the Japanese market.
  The problems of Japan are information asymmetry and difficulties involved in the valuation of assets. Moreover, since there are missing markets on the present stage, the courts are useful in implementing an optimal restructuring policy.
  The paper of Mr. Kim is easily comprehensible, but I have some questions. In Korea, corporate restructuring vehicles were established under the government's initiative. Is the government's role still essential? Where was the professional knowledge obtained? Why was the usage of out-of-court compositions avoided? However, I agree that the Japanese government should place more focus on corporate restructuring.
  According to Professor Baird, the allocation of corporate supervision rights is stressed when writing a contract. Going-concern value is getting lower. This is true for Japan as well. Besides, the methods of corporate restructuring have changed not because of changes in law, but because of changes in the economy. It is extremely easy to understand. It became easier for creditors to proceed with out-of-court procedures of corporate restructuring.
  What we learned today about the bankruptcy laws and corporate restructuring is that Japan and Korea promote formal rather than informal procedures. It is necessary to investigate the situation in different countries.
(Comments on Corporate Restructuring in Japan, Korea and the US(PDF-Format 54KB))
 

 3,Question- and- Answer Session

 

    Mr.Kim and Mr.Tasaku gave the following answers to the questions posed by Professor Corbett and other participants.
 

    Tasaku

  The guidelines of the Ministry of Economy, Trade and Industry concerning prompt corporate restructuring say that it is essential to take steps on corporate restructuring as soon as possible. In connection with the positioning of industrial revitalization organizations, the promotion of the disposal of non-performing loans and corporate restructuring is the best thing. I do not know whether private or public organizations are better, but it is necessary to avoid prolongation of so-called zombie companies.
 

    Kim

  The importance of the private sector in corporate restructuring is growing. In Korea, private asset management companies, corporate restructuring corporations, and banks have developed corporate restructuring abilities. Banks can hardly take charge of corporate restructuring; after all, if a bank makes high-risk investments, it would be difficult for it to maintain the capital adequacy ratio required by the BIS.
 
 

Round Table Discussion: "Overcoming Deflation and Revitalizing the Japanese Economy"

 

 1,Presentation

 

    Haruhiko Kuroda, "Policy Issues and Prospects: Toward Overcoming Deflation and Revitalizing the Japanese Economy"

  The first step is the defeat of deflation and promotion of economic revitalization through the aggressive use of monetary policy, research and development, more effective allocation of fiscal spending into environment, and other measures. After several years of intensive structural adjustment, Japan will return to a sustainable economic growth path.
(Policy Issues and Prospects:Toward Overcoming Deflation and Revitalizing the Japanese Economy(PDF-Format 19KB))
 

 2,Round Table Discussion

 

    Speaker

  Is inflation control a sufficient condition for recovery? In connection with fiscal rehabilitation, why is it possible to maintain aggregate demand?

    Speaker

  In regard to yen depreciation, if the government makes a commitment to macroeconomics, this will affect the exchange rate and, as a result, lead to yen depreciation. Some argue that an intentional policy of letting the yen fall in value on foreign exchange markets is a beggar-thy-neighbor tactic. However, Japan may have no choice but to launch such a policy, if certain conditions arise. This will not mean the depreciation of the yen to all currencies.

    Speaker

  Since the appointment of Fukui as governor, the supply of the base money has been approximately equal to the amount of foreign exchange market intervention. Consequently, non-sterilized intervention was implemented. This affected the U.S. market that, in turn, exerted a spillover effect on Japan. This had a stronger effect than ordinary monetary easing did. The Bank of Japan continues its quantitative easing policy. The output gap has narrowed, and turned into surplus. The conditions for curbing deflation have been met. On the other hand, since the aging of the population and population diminishing will continue, land prices are falling. This is likely to bring about yet more non-performing loans.

    Speaker

  Because modest economic growth is continuing in the United States, it is quite natural to assume that the growth will continue in the future. On the other hand, in Japan the recent revitalization of economic growth rate is discussed as if it will continue into the future. The dispute about the future prospects is not based on firm ground. Until the government implements large-scale monetary stimulus packages, the prospects are considered to be bleak.

    Speaker

  Even economists do not know how to stimulate expectations. It is difficult to revitalize the real economy, but several good signs were seen this quarter. Under the new administration, the Bank of Japan continues to give good messages. Profits from the private sector have begun to improve. At least, something began to change. Regardless of the expectations of a price decrease, many companies are confident in predicting an increase in profits. The income of the large-scale manufacturing companies has improved by about five percent. Some have criticized that the subcontracting companies are being sacrificed, but both investment increases and bonuses reached record levels. Furthermore, deflation in China has turned into inflation.

    Speaker

  Improvement in business performance is possible even under mild deflation. On the one hand, companies continue their efforts toward restructuring. On the other hand, the savings rate of households decreased. So the aggregate demand level has been maintained. Consequently, I believe that business performance will continue to improve for the time being. Although Japan's recent export performance has not been good, private consumption and capital investment are following a sound expansion. This does not guarantee a sustainable recovery, but since the recovery of exports is expected in the nearest future, sustainable growth is highly likely to occur.

    Speaker

  I would like to confirm that to push the economy on a sustainable growth path, it is absolutely necessary to overcome deflation. Macroeconomic policies to curb deflation and the restructuring of the banking sector are complementary. Since the decline of (Knut Wicksell's) natural interest rate lies at the root of the serious problem, a policy to increase it should be implemented.

    Speaker

  The budget deficit is increasing, but it cannot increase permanently. Some day in the future, Japanese policymakers-driven into a corner-will have to choose among several options. The first is the necessity of monetary easing, since excessive public debt and loss of independence of the Bank of Japan will result. Second is government spending reductions and welfare spending cuts by the Ministry of Finance. Third is a tax increase, and the last option is default. All these options are negative ones. The future prospects of Japan are bleak.

    Speaker

  I think a decrease in the savings rate has a positive short-term effect. It is not easy to redress ineffective economic situations. Technological progress and economization are the best, but the government can hardly play a leading role.

    Speaker

  I would like to ask about the relationship between stock and land prices. Is the transfer of funds between stocks and real estate nothing more than portfolio reallocation? Or is it a foreign factor, one more relevant to the United States? Will it lead to recovery?

    Speaker

  The fact that corporate investment has recently remained steady exerts a positive impact on the economy. Profits increased and a nominal amount of sales recovered. Although deflation continues, the efforts of management are starting to bear fruit in the form of business performance recovery. In addition, domestic demand began to show good signs. The effect of the change in real estate prices is not very serious. The Bank of Japan and the Ministry of Finance should work in collaboration, since precautions should be taken against a sharp increase in long-term interest rate above the natural level. For stability of the long-term interest rate, we should consider put options on new deficit-covering national bonds.
 

    Speaker

  I think that the policy to curb deflation is too little and too late. Next year the new issue of government bonds is likely to exceed tax revenues. The policy switchover of the Bank of Japan was delayed for three years. Substantial liquidity and exchange intervention were too late. The nationalization of Resona Bank was a correct decision, but it was taken too late as well. Consequently, unless there are fundamental changes, a recovery will be unsustainable.

    Speaker

  I think that ESRI should study the problem of indices in more depth. Furthermore, research based on microeconomic data should be conducted.

    Speaker

  The Management and Coordination Agency can hardly supply microeconomic data with rigorous standards. The government itself does nothing to use microeconomic data.

    Speaker

  Today's topic is whether sustainable recovery in Japan is possible. I am optimistic, but I think we need to be careful. There are some substantial improvements that allow bright prospects for the future. Nevertheless, it is still necessary to combat deflation. In addition, structural reform is not over. Curbing deflation is the task of the highest urgency.

    Speaker

  I think that the growth of the GDP deflator is too low, and the growth rate of real GDP is high. I would like ESRI to examine this point.

    Speaker

  In connection with the deflator, the result of estimation greatly depends on the method. I cannot say that the ongoing method of estimation is wrong, but since the economy is going through drastic transformation, the deflator needs to be examined more thoroughly.

    Speaker

  To recover fiscal sustainability, it is necessary to conduct large-scale open market operations and to decrease the outstanding balance of government bonds held by sectors other than government.

    Speaker

  With regard with fiscal sustainability, it is necessary to privatize the present two-step system to secure the sustainability of the public pension scheme.

    Speaker

  Many people believe that Japan's pension scheme needs revision; it is actually on the edge of bankruptcy. Despite compulsory enrollment, 40 percent of benefit receivers do not pay because of absence of penal provisions. The key reform of the next year is a reform of the pension system, but the policy varies from government agency to agency.

    Speaker

  Japan has a medium-term policy plan for fiscal restructuring. This plan aims at the elimination of the fiscal primary balance deficit, and to reduce it as much as 50 percent within five years. The absolute necessity of pension system reform to fulfill sustainable public finance is a common perception. Not all problems will be solved by this reform, but rational decisions will be found in the medium term.
 

    Speaker

  Judging from the different public opinion surveys concerning fiscal restructuring, it's astonishing that so many people agree to the necessity of fiscal restructuring.
 
 

Question- and- Answer Session with the Press

 

    Question

  I think the difficulties of overcoming deflation in Japan stem from Japanese policymakers trying to shift responsibility and blame one another, making a consensus on policy conduct impossible to attain.

    Answer

  The Bank of Japan and the government have begun to cooperate and coordinate their actions, or at least more so than previously. The differences in opinion of policymakers, however, are not a solely Japanese problem: they are unavoidable in democratic countries. What is of paramount importance is to find rational solutions in a timely manner. Mr. Baird seems to indicate that this problem is unique to Japan, but differences in opinion are quite natural.
 

    Question

  It is said that the amount of monetary easing and foreign exchange intervention was the same by coincidence. Wasn't there any agreement between the Bank of Japan and the Ministry of Finance?

    Answer

  I believe that there was no explicit agreement.