bank prevented japan ’ s economy from falling into a 1930s - style deflationary spiral of sharply falling prices and economic contraction. however, none of these monetary policy measures were sufficiently strong to overcome deflation. why was this the case? to understand the reasons, we should start with the mechanisms through which monetary easing affects the economy. a key concept in this context is the so - called “ natural rate of interest, ” which is the real interest rate at which the economy neither accelerates nor decelerates. monetary easing aims to push real interest rates in financial markets below the natural rate of interest through a lowering of the policy rate and / or increase in the supply of funds in order to stimulate economic activities such as business fixed investment and housing investment. this is the main channel through which monetary easing seeks to boost economic activity. although the determinants of the natural rate of interest are the subject of considerable debate, it is widely thought that the potential growth rate of the economy plays a major role. the conceptual framework i just outlined allows you to easily see that japan ’ s monetary policy under deflation faced two major challenges. the first was that real interest rates remained high. nominal short - term interest rates – the policy tool of traditional monetary policy – already were close to 0 percent after the introduction of the zero interest rate policy in 1999. this means that short - term interest rates already faced the so - called “ zero lower bound ” in the sense that nominal interest rates cannot be lowered below 0 percent. at the same time, with the economy stuck in a deflationary equilibrium, inflation expectations remained low. as a result, real interest rates – that is, nominal interest rates minus inflation expectations – remained high. the second major challenge that made it more difficult to overcome deflation is the decline in the natural rate of interest reflecting a deceleration in japan ’ s growth potential. with the benefit of hindsight, we know that deflation has coincided with a decline in the productive population as a result of rapid population aging, reducing japan ’ s growth potential. another factor contributing to the deceleration in growth potential was sluggish capital accumulation reflecting the prolonged deflation. specifically, while japan ’ s potential growth rate in the early 1990s was around 3 – 4 percent, it subsequently followed a declining trend and recently has been under 1 percent ( chart 4 ). given that, as mentioned, the potential growth rate likely is a key determinant of the natural rate of interest, it is

range of 1, 7 % - 1, 9 %, i. e. broadly in line with the ecb ’ s definition of price stability, a year - on year increase of the euro area hicp close to, but below, 2 % over the medium term. this could be interpreted as the sign of the ecb ’ s credibility and as an illustration of its ability to anchor inflation expectations at a fairly low level, consistent with price stability. however, since the third quarter of 2003, the break - even inflation rate has hovered at around 2. 2 - 2. 3 %, breaking the ceiling defined by the governing council of the ecb. in a context of rising oil prices and soaring commodity prices, this may reflect concerns about future price developments in the euro area and thus accelerating inflationary expectations. however, there is also anecdotal evidence that the demand for indexed government bonds by insurance companies, pension and hedge funds, has increased slightly over the recent months, pushing the prices of indexed bonds up and, consequently, their real yields down. as a result, break - even inflation rates may have been distorted upward, for some reasons not directly related to changes in expected inflation. this latter point raises the issue of the drawbacks and potential biases affecting indexed yields, increasing the difficulty to interpret correctly and decipher the movement behind the changes in the nominal yields. i will constitute the second point to my presentation. 2. the biases in the break - even inflation rate. the break - even inflation rate may be a good measure of expected inflation. it should however be cautiously interpreted and analysed as it may also be severely biased. when i previously introduced the concept of the break - even inflation rate, i assumed both efficient and arbitraged markets but also perfect foresights and no risk or liquidity premia. since this seems unlikely to hold in practice, we should then consider that the break - even inflation rate is only related to, but not equal to, inflation expectations. let me briefly outline some of the biases we need to take into account in the context of our economic and financial assessment. for the sake of simplicity, i will distinguish two main categories of biases : technical biases and institutional biases, leaving aside the treatment of risk aversion considerations, which tends to introduce an upward bias in the break - even inflation rate. technical biases the compound and the convexity biases : the definition of the break - even