their formation mechanism ; ( 2 ) reasons for low expectations in japan ; ( 3 ) the relationship with japan's financial crisis ; and ( 4 ) the relationship with labor market reform. ii. issues regarding long - term inflation expectations a. formation mechanism in economics theory, long - term inflation expectations are irrelevant to the potential growth rate. however, i doubt that this holds true in reality, in light of what is happening in japan. rather, i think that long - term inflation expectations and the potential growth rate do have a correlation, although it may not be strong ( chart 3 ). long - term inflation expectations declined sharply in japan, before and after the financial crisis in the late 1990s. economic fundamentals already had been weak before the crisis because of the negative interaction between demand and supply conditions ; specifically, a negative financial accelerator on the demand side due to the dire asset price deflation, and ( 2 ) the impairment of the financial intermediary function, as well as the distortion of economic resource allocation caused by the bubble economy on the supply side. the financial crisis triggered further weakening of economic fundamentals ( chart 4 ). in this situation, pessimism about the future led to a decline in people's expectations for mediumto long - term growth, and the potential growth rate remained low over a long period of time. as a result, people's perception of prices became excessively conservative. in other words, long - term inflation expectations turned downward. b. reasons for low expectations in japan next, let us take a look at developments in survey - based measures of expected long - term inflation in japan. a survey - based rate marked a sharp decline during the period of the financial crisis in the late 1990s, and then leveled out at around 1 percent. since then, even throughout the period of the global financial crisis and the european sovereign debt crisis, it has been more or less unchanged at around 1 percent ( chart 5 ). however, i am somewhat doubtful about this figure. 3 i believe that it is more persuasive to say that long - term inflation expectations in japan have actually declined to around 0 percent, for the following four reasons. 4 first, the frequency of micro - level price changes suggests that the mode value remains zero. in other words, the year - on - year rate of increase in the prices of sample items concentrated on 0 percent. therefore, people are likely to consider that zero inflation is a steady and constant state. it is helpful to

##ties. the most significant risk is, of course, the impact of the european sovereign debt crisis on our economy through its effects on international financial markets and the global economy. although the economic outlook is important, i have already discussed it on various occasions. today, instead, i would like to give my thoughts on the challenges facing japan ’ s economy and its central bank from a medium - to long - term perspective, as i believe the end of the year is good timing for doing so. i. japan ’ s economy during the past 15 years progress in globalization in order to understand the medium - to long - term challenges that lie ahead for japan ’ s economy, i will first compare how it is today to how it was back in 1995. i have chosen that particular year as a comparison point because of its similarities with this year, as in 1995 bis central bankers ’ speeches japan experienced the great hanshin - awaji earthquake ( or kobe earthquake as it is also known ) and an appreciation of the yen, which peaked that year at under 80 yen against the u. s. dollar. there have been many changes over the past 15 years. first, we saw further globalization of goods, capital, and people ( chart 2 ). for goods, global trade volume in real terms after excluding the effects of price fluctuations is expected to rise from an index level of 100 in 1995 to 253 by 2011. this implies that global trade volume continued to expand at an annualized rate of 6. 0 percent, a pace much faster than the real gdp growth rate of 3. 7 percent during the period. this increase was essentially caused by the end of the cold war and subsequent transition of regions worldwide to market economies. this increased opportunities for an international division of labor, which led to more optimal production by combining the technology and capital of advanced economies with the ample labor forces of emerging economies. emerging economies, particularly china, india, and brazil, grew rapidly in this process ( chart 3 ). for capital, the average amount of daily transactions in foreign exchange markets worldwide was 1. 5 trillion dollars as of 1998 – which is as far back as we can go in making such a comparison – and grew to 4 trillion dollars, corresponding to almost 20 times world gdp per day, in 2010 ( chart 2 ). for people, tourists traveling abroad have increased substantially from 530 million in 1995 to 940 million in 2011. the number of first - generation immigrants has also increased from 170 million in 1995 to 210 million in