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Figure 7. Supply-side influences on inflation

Figure 7. Supply-side influences on inflation

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OECD Economic Surveys: Japan



32



Figure 7. Supply-side influences on inflation (cont.)

C: Effects of deregulation on the CPI



Cumulative changes from 1995 to 2002 in per cent 1



Fixed telephone charges

(1.8)

Rice (1.0)



Regular gasoline (1.4)

Electricity charges (2.9)



All items excluding

fresh food (95.5)



-16



-14



-12



-10



-8



-6



-4



-2



0



2



D. Percentage of items in the CPI whose prices are falling

Per cent



Per cent



80



80



70



70



Decrease of 1% or less

Decrease of 1 to 2%

Decrease of 2% or more



60



60



50



50



40



40



30



30



20



20



10



10



0



1998



1999



2000



2001



2002



0



1. Based on the 2000 weights for the CPI, which are indicated in parentheses.

Source: Bank of Japan.



– Deregulation has led to falling prices for a number of goods and services. For example, prices of fixed telephone services, rice, gasoline and

electricity have dropped substantially since 1995 (Panel C).

While imported goods and deregulated items have led price declines,

deflation has become broadly entrenched over time. The proportion of goods experiencing price declines has risen from 40 per cent in 1998 to 60 per cent in 2002

(Panel D). Moreover, the extent of the decline exceeded 2 per cent for more than a

quarter of products that year. While deflation has negative implications for growth

(see below), gradual price declines of the magnitude recorded during the past

decade are not the underlying cause of Japan’s economic stagnation but rather a

symptom of weak demand, as well as the supply-side factors discussed above.



© OECD 2004



Macroeconomic developments and key economic challenges



33



An overview of progress in implementing the reform programme

The Koizumi government that took power in April 2001 launched a wideranging reform programme aimed at revitalising the economy (see 2002 Survey).

Since the programme was outlined in June 2001, the government has been actively

implementing structural reform aimed at the fundamental goal of promoting economic growth by supporting the shift of power from the government to private

agents and from central to local government. Consequently, the reform programme should lead to a smaller and more efficient government, while improving

the allocation of resources. The major areas of reform include:

– Deregulation.

– Financial-sector reform.

– Improving human capital and enhancing flexibility in the labour market.

– Stronger competition and encouraging openness and entrepreneurship.

– Social security reform.

– Improvement of the budget process and better public management

(including privatisation).

– Devolution of power from central to local government.

Progress during the past two years has been uneven across these areas

(Figure 8),11 reflecting political pressures that have forced compromises in some

areas of the government’s plans. Notwithstanding the general impression thus

created that the reform process has stalled, there has been significant progress in

some areas, notably deregulation and reform of the labour market. The financial

sector shows mixed results, with the October 2002 programme including important

steps forward in a number of areas, notably the provisioning for and disposal of

non-performing loans. However, some important issues, such as the treatment of

banks’ deferred tax assets, remain unresolved. While improvements have been

made in the health care system, pension reform to cope with the rapid ageing of

the population is still under consideration. Although some significant changes

have been made in the budget process, progress in reforming the public sector,

notably by privatising the government special status corporations and introducing

competition in network industries, has been disappointing, reflecting strong political

resistance in this area. In sum, there is a tendency for most reform measures to be

implemented only partially and ineffectively, in contrast to the original, more

ambitious, policy goals. This suggests the need to strengthen political commitment

to achieving the specified outcomes of the reforms.

The stance of macroeconomic policy

The policy of quantitative monetary easing introduced in March 2001 has

been aggressively implemented by the Bank of Japan. The target for the current



© OECD 2004



OECD Economic Surveys: Japan



34



Figure 8.



The structural reform programme

Progress in fulfilling goals



Deregulation

3



Devolution



2



Financial-sector reform



1



Fiscal reform

Human capital

and labour



Social security fund

Competition, openness



Source: See Annex II for details.



account balances at the central bank was raised progressively from 5 trillion yen

initially to a range of 27 to 32 trillion yen in October 2003, with the central bank

purchasing about 1.2 trillion yen of government bonds per month to finance this

operation. The Bank has promised to continue this policy, which has substantially

increased the monetary base, until the growth in the consumer price index

(excluding fresh food) registers zero or positive in a stable manner. The quantitative approach has been successful in reducing the yield on ten-year government

bonds from 135 basis points before the introduction of the new policy to below

50 basis points in the spring of 2003 before stabilising at around 150 basis points

in September (Figure 9). Meanwhile, the short-term rate has been kept close to

zero, while remaining stable at around 1½ per cent in real terms, as measured by



© OECD 2004



Macroeconomic developments and key economic challenges



35



Figure 9. The stance of monetary policy

A. The yield curve

2.0



2.0



1.8



1.8



1.6



1.6



1.4



1.4



1.2



1.2



1.0



1.0



0.8



0.8



0.6



0.6



0.4



0.4



0.2



0.2



28 Oct. 2003

4 June 2003

5 Feb. 2002

5 Jan. 2001



0.0



(before introduction

of quantitative

easing)



0.0

3M



6M



1Y



2Y



3Y



5Y



7Y



10Y



B. Monetary conditions index

180



10

Real effective exchange rate



170



(Left scale)



160

150



5



140

130

Real interest rate

120



(Right scale)



0

Tightening



110

100



Monetary conditions index 1



Easing



(Left scale)



90



1993



1994



1995



1996



1997



1998



1999



2000



2001



2002



2003



-5



1. The monetary conditions index is defined as the level change in the three-month deposit rate deflated by the fourquarter percentage change in the private consumption deflator (adjusted for the 1989 and 1997 tax hikes) plus

one-quarter of the percentage change in the real effective exchange rate of the yen (unit labour cost definition)

against 29 OECD and 12 non-OECD trading partners. The weight (one quarter) was derived from INTERLINK

model simulation properties.

Source: Datastream, Bank of Japan and OECD.



© OECD 2004



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