level, and the inventory to shipment ratio is following a similar pattern as in 1995 ( chart 1 ). thus, inventory investment is expected to increase as production and shipments rise. in the united states, inventory is also at a low level, and inventory investment is expected to increase, thus offsetting the slowdown in the growth of final demand until mid - 2004. third, the business fixed investment cycle in the current recovery is following a similar pattern as in the second recovery from january 1999 through october 2000. according to the september tankan, business fixed investment plans of large manufacturers for fiscal 2003 are expected to increase 11 percent in nominal terms. this rate of increase is almost the same as that of large manufacturers for fiscal 2000. the 11 percent increase in business fixed investment is quite high in real terms when we consider the decline in prices of fixed investment goods. in fact, the deflator for business fixed investment fell 5. 8 percent year on year in the july - september quarter. this deflator may overstate the decline in prices of fixed investment goods, as i will discuss later. if we assume that the true extent of price decline is half of the observed data, the 11 percent increase in business fixed investment in nominal terms will be translated into an approximate 15 percent increase in real terms. the current expansion of business fixed investment centers on it - related investment as was the case in the second recovery, though the range of products is much wider. such investment is related to not only semiconductors but also new household electronic products, including digital cameras, plasma display panel television sets, and dvd recorders. an increase in renewal investment is also being planned in the steel and chemical as well as transportation industries. this is against the background that exports to china are increasing not only in the it - related goods area but also in heavy industries such as steel and chemicals, and that equipment in the manufacturing sector has become obsolete. current business fixed investment has declined to roughly the same as that of fixed capital consumption. if we apply the business cycle theory of hicks, japan's business fixed investment has bottomed out and is starting to expand. furthermore, it is an encouraging sign that a number of small firms, among both manufacturers and non - manufacturers, plan to increase fixed investment reflecting the recent improvement in business sentiment. the current recovery is similar to the previous two recoveries in that it greatly depends on the recovery of the world economy, particularly the economies of the united states and china. however, it seems

we may say that the size of a downward bias in the private consumption deflator, which is a paasche price index, is roughly a half of one percent. if the difference of decline between the business fixed investment deflator and the price index for business fixed investment goods in the cgpi was 3 to 4 percent, a downward bias in the business fixed investment deflator would be about half of this difference. 5 accordingly, both the downward bias in the gdp deflator in national income statistics and upward bias in real gdp growth lie between 0. 5 percent and 1 percent. personally, i think both of these biases are closer to 0. 5 percent. the potential gdp growth rate is estimated from observed real gdp data in national income statistics. roughly speaking, the trend of real gdp growth rates in the past is used as the potential growth rate. in the white paper on economic and fiscal policy management for fiscal 2003, the potential growth rate is estimated at around 1 percent, which has an upward bias. it should be noted that the qualitative improvement in products due to technological innovation has been captured more appropriately and reflected in gdp data since 2000 when the wholesale price index ( wpi ) was changed to the cgpi. however, from 1995 to 2000, the wpi was still used in national income statistics, and the improvement in quality and productivity due to technological innovation was not captured as well as it has been since 2000. if the increase in productivity were substantial during this period, the potential growth rate would be understated. considering an upward bias due to the paasche price index and understatement due to the wpi, we should use the current estimate of the potential growth rate as it is until structural adjustment is complete. when structural adjustment has ended, the effect of productivity improvement due to the it revolution may materialize, raising the potential growth rate to 1. 5 percent to 2 percent as recently asserted by jorgenson ( 2003 ). to summarize, we will have better prospects of overcoming deflation as the output gap narrows if the following two conditions are fulfilled : ( i ) the real growth rate exceeds the potential growth rate by 1 percent after taking account of the paasche price index bias for the two years of structural adjustment period, designated by the government ; and ( ii ) the output gap remains around 1 percent. 6 in addition, the higher - value - added new products in the manufacturing industry, the recovery of pricing