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.