Japan's Economy and Monetary Policy

February 4, 2015

Kikuo Iwata

Deputy Governor of the Bank of Japan

Speech at a Meeting with Business Leaders in Miyagi

Projections for Major Economies Real Exports by Region

Chart 1World Economy and Exports

Notes: 1. Projections for major economies are made by the IMF as of January 2015. Figures in parentheses are the difference from the October 2014 WEOprojections.

2. Figures in angular brackets for real exports are shares of each region in 2013. NIEs consist of Korea, Taiwan, Hong Kong, and Singapore. ASEAN4consists of Thailand, Indonesia, Malaysia, and the Philippines. Figures for 2014/Q4 are those of October-November averages converted into quarterly amount.

Sources: IMF, “World Economic Outlook"; Ministry of Finance, "Trade Statistics"; Bank of Japan, "Corporate Goods Price Index."

y/y % chg.

2015 2016

3.5 3.7(-0.3) (-0.3)

2.4 2.4(0.1) (0.0)3.6 3.3

(0.5) (0.3)1.2 1.4

(-0.2) (-0.3)0.6 0.8

(-0.2) (-0.1)4.3 4.7

(-0.6) (-0.5)6.4 6.2

(-0.2) (-0.3)6.8 6.3

(-0.3) (-0.5)5.2 5.3

(-0.2) (-0.1)1.3 2.3

(-0.9) (-0.5)

World 3.3 3.3

Advanced Economies 1.3 1.8

2013 2014Projections

Emerging Market and

Developing Economies4.7 4.4

United States 2.2 2.4

Euro Area -0.5 0.8

Japan 1.6 0.1

ASEAN 5.2 4.5

Latin America and

the Caribbean2.8 1.2

Developing Asia 6.6 6.5

China 7.8 7.4

y/y % chg. s.a., q/q % chg.

2012 20132013

Q4

2014

Q1 Q2 Q3 Q4

13.0 2.8 -0.4 0.9 -2.3 -0.0 5.9

-13.0 -3.6 2.2 0.6 0.5 -0.1 -4.2

-2.6 -3.0 2.5 -1.5 -1.5 1.9 4.2

China

<18.1>-8.1 -1.7 5.7 -3.9 -0.7 1.2 3.2

NIEs

<21.9>-4.7 -1.0 1.1 1.0 -3.1 3.8 6.9

ASEAN4

<10.9>12.5 -8.5 -0.0 -2.1 0.3 -0.9 0.4

1.7 -5.0 -2.0 0.2 1.4 2.4 1.2

Real Exports -1.0 -1.9 1.5 -1.0 -1.2 1.6 4.0

Others

<20.6>

East Asia

<50.9>

EU

<10.0>

United States

<18.5>

Effects of the Consumption Tax HikesSales of Department Stores (Nominal)New Passenger-Car Registrations

Synthetic Consumption Index Housing Starts

Notes: 1. Month 0 represents April 1997/2014, concurrent with the rise in the consumption tax rate.2. Figures for new passenger-car registrations include small cars with engine sizes of 660cc or less.

Sources: Japan Automobile Dealers Association, “Domestic Sales of Automobiles”; Ministry of Economy, Trade and Industry, "Current Survey of Commerce"; Cabinet Office, "Synthetic Consumption Index"; Ministry of Land, Infrastructure, Transport and Tourism, "Statistics on BuildingConstruction Starts," etc.

Chart 2

70

80

90

100

110

120

130

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

Hike in 2014

Hike in 1997

months

s.a., CY 1996/2013=100

94

96

98

100

102

104

106

108

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

s.a., CY 1996/2013=100

months

80

90

100

110

120

130

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

s.a., CY 1996/2013=100

months

60

70

80

90

100

110

120

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

s.a., CY 1996/2013=100

months

Inflation ExpectationsHouseholds

(Consumer Confidence Survey) Economists

Notes : 1. Figures for the Consumer Confidence Survey are for all households. The weighted average is calculated based on the following assumption: survey

responses chosen by households as their expected inflation rates -- "-5% or below," "from -5% to -2%," "from -2% to 0%," "from 0% to +2%," "from

+2% to +5%," and "+5% or above" -- indicate inflation rates of -5%, -3.5%, -1%, +1%, +3.5%, and +5%, respectively.

2. Figures for the Consensus Forecasts are compiled every January, April, July, and October. Those up through April 2014 are compiled every April and

October. Figures for the ESP Forecast are compiled every June and December, and exclude the effects of the consumption tax hikes.Sources: Cabinet Office, "Consumer Confidence Survey"; Consensus Economics Inc., "Consensus Forecasts"; JCER, "ESP Forecast."

Chart 3

0.0

0.5

1.0

1.5

2.0

2.5

05 06 07 08 09 10 11 12 13 14 15

2 to 6 years ahead (ESP Forecast)

7 to 11 years ahead (ESP Forecast)

6 to 10 years ahead (Consensus Forecasts)

CY

ann. avg., %

0

25

50

75

100

0

1

2

3

4

05 06 07 08 09 10 11 12 13 14

1 year from now (weighted average)

Ratio of "go up" (right scale)

Ratio of "go down" (right scale)

y/y % chg. %

CY

Chart 4

Note: Figures indicate the median of the Policy Board members' forecasts (point estimates).Source: Bank of Japan.

Outlook for Economic Activity and Prices(as of January 2015)

y/y % chg.

Excluding the effects of

the consumption tax hikes

-0.5 +2.9 +0.9

Forecasts made in

October 2014+0.5 +3.2 +1.2

+2.1

Forecasts made in

October 2014+1.5 +2.4 +1.7

Forecasts made in

October 2014+1.2 +2.8 +2.1

+1.0

+2.2

Real GDPCPI

(all items less fresh food)

Fiscal 2014

Fiscal 2015

Fiscal 2016 +1.6

Regime Change to Inflation Targeting

Chart 5

What does the term "regime" mean in economic policy?

Inflation and deflation are ultimately "monetary phenomena"

⇒ Price stability can be achieved through monetary policy

Setting the price stability target

"2 percent in terms of the year-on-year rate of changein the consumer price index (CPI)"

Tangibility of "Policy Regime Change"Chart 6

CommitmentActions

・Increase in QuantityIncrease the monetary base* at an annual pace of about ¥80 trillion

(particularly through purchases of JGBs).

・Change in QualityPurchases of riskier assets

(JGBs with longer remaining maturities,ETFs and J-REITs).

Clear commitment that the BOJ "will achieve the price stability target of

2% at the earliest possible time, with a time horizon of about 2 years."

Quantitative and QualitativeMonetary Easing

* Money supplied directly from the central bank to the financial system.

Expansion

Expansion

Lowering Expected Real Interest Ratesthrough Working on Inflation Expectations

Chart 7

Expected real interest rates ＝ Nominal interest rates － Expected rates of inflation

Subjective forecast based on respective

price projections

Visible in financial markets or over the

counter

Real costs of borrowing, taking into account price changes

(Borrowers' subjective expectations)

Downward pressure

by the QQE

Stock Prices and U.S. Dollar/Yen Exchange RateChart 8

Source: Bloomberg.

8,000

9,000

10,000

11,000

12,000

13,000

14,000

15,000

16,000

17,000

18,000

19,000

70

80

90

100

110

120

130

1 4 7 10 1 4 7 10 1 4 7 10 1

U.S. dollar/yen

Nikkei 225 Stock Average(right scale)

yen yen

Introduction of the QQE

Expansionof the QQE

2012 2013 2014 2015

" + 30 trillion yen "Increasing the Bank's JGB holdings at an annual pace of about 80 trillion yen:

Accelerating the pace of purchases of ETFs and J-REITs:

Expansion of the Quantitative and Qualitative Monetary Easing

Extending the average remaining maturity of JGB purchases to about 7-10 years: " + 3 years "

Pre-empt manifestation of a risk that conversion of deflationary mindset, which has so far been progressing steadily, might be delayed

Maintain the improving momentum of expectation formation

Accelerating the annual pace of increase in the monetary base from about 60-70 trillion yen to " 80 trillion yen "

" Tripled "

Chart 9

Consumer Prices and Crude Oil PricesChart 10

Note: Figures for the CPI from April 2014 onward are calculated to adjust the direct effects of the consumption tax hike. Sources: Ministry of Internal Affairs and Communications, "Consumer Price Index"; Bloomberg.

-0.5

-0.9

50

60

70

80

90

100

110

-1.0

-0.5

0.0

0.5

1.0

1.5

2.0

7 9 11 1 3 5 7 9 11 1 3 5 7 9 11

CPI (all items less fresh food)

CPI (all items less food and energy)

Crude oil prices (WTI, right scale)

y/y % chg. monthly avg., U.S. dollars/barrel

Introduction of the QQE Expansion of the QQE

2012 2013 2014

Chart 11

Sources: Ministry of Internal Affairs and Communications, "Labour Force Survey"; Ministry of Health, Labour and Welfare,"Report on Employment Service."

Labor Market Conditions

0.2

0.4

0.6

0.8

1.0

1.2

3.0

4.0

5.0

6.0

00 01 02 03 04 05 06 07 08 09 10 11 12 13 14

Unemployment rate

Active job openings-to-applicants ratio (right scale)

s.a., % s.a., times

CY

1.15 times(Dec. 2014)

3.4%(Dec. 2014)

0.82 times(Nov. 2012)

4.1%(Nov. 2012)

3.6%(July 2007)

5.5%(July 2009)

1.08 times(July 2006)

0.43 times(July 2009)

Real Wages and Hourly WagesChart 12

Full-Time Employees Part-Time Employees

Note: Figures for real wages are nominal wages deflated by the CPI (all items). Those after adjusting consumption tax are nominal wagesdeflated by the CPI (all items), which was calculated to adjust the direct effects of the consumption tax hike.

Sources: Ministry of Health, Labour and Welfare, "Monthly Labour Survey"; Ministry of Internal Affairs and Communications, "Consumer Price Index."

-3

-2

-1

0

1

2

3

4

5

1 4 7 10 1 4 7 10 1 4 7 10

Monthly cash earnings

Monthly cash earnings (real, consumption tax adjusted)

Monthly cash earnings (real)

y/y % chg.

2012 20142013

-3

-2

-1

0

1

2

3

4

5

1 4 7 10 1 4 7 10 1 4 7 10

Hourly cash earnings

Hourly cash earnings (real, consumption tax adjusted)

Hourly cash earnings (real)

y/y % chg.

2012 20142013

Real Employee IncomeChart 13

Notes: 1. Figures for "employee income" are calculated as the "number of regular employees" times "total cash earnings."Notes: 2. Figures for real employee income are nominal employee income deflated by the CPI (all items). Those after adjusting consumption

tax are nominal employee income deflated by the CPI (all items), which was calculated to adjust the direct effects of the consumption tax hike.

Sources: Ministry of Health, Labour and Welfare, "Monthly Labour Survey"; Ministry of Internal Affairs and Communications, "Consumer Price Index."

-3

-2

-1

0

1

2

3

4

5

1 4 7 10 1 4 7 10 1 4 7 10

Employee Income

Employee Income (real, consumption tax adjusted)Employee Income (real)

y/y % chg.

2012 20142013

Transmission Channels of the QQE to Real WagesChart 14

Monetary Easing

Improved Output Gap

Prices ↗

Real Wages ↘

Real Wages↗

Production ↗NominalWages

＞ Prices ↗

＞ ↗

NominalWages

Labor Demand

Labor Productivity ↗

↗

↗