labor. c. expectations for a rise in potential growth rate accompanying the expansion of supply capacity business fixed investment is one of the components that make up a nation's gdp. in addition to short - term demand, it expands supply by increasing production capacity and improving productivity in the medium to long term. as supply capacity has expanded in japan along with the structural change of a continuous expansion of business fixed investment, there is the possibility that a moderate increase in the potential growth rate will be induced hereafter, with some time lag. looking at recent developments in the potential growth rate, while the contribution of labor input has been decreasing, that of capital stock and total factor productivity ( tfp ) has started to bottom out ( chart 13 ). the expansion of business fixed investment, which has continued for the past three years, is starting to induce a supply - side structural change. together with an increase in r & d investment with an eye toward promoting innovation, if the potential growth rate rises in the future - - in which case the natural rate of interest will also rise, causing real interest rates to fall below the natural rate of interest - - the same level of policy rate will have a greater easing effect. d. increased robustness to changes in external demand another structural change i should point to is the increased robustness of the economy to changes in external demand. given the established global supply chains, japanese manufacturers have divided their production at home and abroad as follows : ( 1 ) overseas sites producing for their own local market and for export to third countries, and ( 2 ) japanese sites producing for japan's domestic market. this division has likely resulted in a mitigated adverse effect that a slowdown in external demand would have on japan's gdp through a decrease in exports. given the geopolitical background to the u. s. - china trade conflict, it is entirely possible, depending on future developments, that existing global supply chains may be reorganized, particularly with respect to china. nonetheless, i expect that such reorganization will not greatly affect the decision making of japanese firms regarding where to establish their production sites - - whether in japan or abroad, whether for export or for local production. this is because the division of work among production sites at home and abroad has already been established to a certain extent, and it is difficult to imagine any significant decline in domestic business fixed investment, even if overseas production were relocated to a different country. moreover, it is highly likely that domestic business fixed investment will

hiroshi nakaso : the conquest of japanese deflation – interim report remarks by mr hiroshi nakaso, deputy governor of the bank of japan, at the athens symposium “ banking union, monetary policy and economic growth ’ ’, athens, 19 june 2014. * * * introduction it is my great pleasure to be able to take part in these discussions with such distinguished panelist. i hope you will forgive my presumption in borrowing the title of my remarks today from nobel laureate thomas sargent ’ s influential book, ‘ ‘ the conquest of american inflation ’ ’. 1 i would like to talk about the most important challenge facing the bank of japan at the moment, which is how to conquer deflation in japan. however, before doing so, let me spend some time considering how we came to be struggling with this mild but persistent deflation. i. deflationary equilibrium japan ’ s cpi began to dip into negative territory in 1998, and remained there on the whole for the next 15 years. this deflation has two distinctive features. one is its long duration, which clearly sets it apart from the usual business cycle frequency. the other is its mildness. for most of the time, deflation has remained at less than minus 1 percent on a year - on - year basis, except for very short spells such as the period just after the lehman crisis. given the length of this deflation, some economists naturally argue that this is not a temporary disequilibrium phenomenon, but an indication that the equilibrium itself has shifted so that deflation prevails ( chart 1 ). 2 i am inclined to believe that this is the case, and that the equilibrium shift was triggered by the two huge shocks that hit japan simultaneously in 1997 : the banking turmoil and the asian currency crises. the combination of two such shocks would be a severe challenge to any monetary authority trying to protect its economy from the threat of serious deflationary pressures. the banking turmoil was a particularly severe blow in that the ability of the credit intermediary function of the banking sector to support economic recovery was seriously impaired, and this in turn exacerbated the deflationary threat. worse still, there was very little room to cut the interest rate : the policy rate was already as low as ½ percent prior to these shocks hitting japan. given the magnitude of these negative shocks, the question arises as to why deflation was so mild in japan. there may be several determining factors3 but i believe that a decline