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 likely that the latter also followed a declining trend.