Prices continued to decline principally because a large shock brought by the financial crisis affected Japan’s economy and the output gap widened. Nowadays, there is no need to explain how a financial crisis damages the real economy through erosion of financial intermediation. However, at the time, this mechanism seems to have been grossly underestimated.
After entering the 2000s, the downward pressure was compounded by a new shock of a declining labor force, and this has been putting further downward pressure on the economy. However, deflation ought not to continue if a central bank is able to sufficiently lower nominal interest rates in the face of such large shocks.