Macroeconomic Developments and Key Economic Challenges

The economic upturn that began in early 2002 faltered during the course of the year but gained a second wind in the spring of 2003. With six consecutive quarters of positive growth, this upturn has already matched the length of the previous expansion, which started at the end of 1999 (Figure 1). However, the pace of output growth, at an annualised rate of nearly 3 per cent since the beginning of 2002, has not been strong enough to reduce the unemployment rate markedly from its record high of 5½ per cent, while deflation, as measured by the GDP deflator, was running at an annual pace of 3 per cent in the first half of 2003. Consequently, nominal GDP has now fallen about 4 per cent from its 1997 peak. The key question is whether this upturn will prove more durable, ending the pattern of mild expansions following shallow downturns that have resulted in average growth of only 1 per cent a year over the past decade. Japan’s poor performance, despite expansionary macroeconomic policies, reflects the impact of the collapse of the asset price bubble, failure to adequately address banking-sector problems, weak competition and outdated regulations in many sectors that limit business-sector dynamism...