The economic expansion, the longest in Japan’s post-war history, remains on track, though at a slower pace. The upturn is driven by business investment and exports, while other components of demand remain sluggish. Although growth is projected to continue at a 1½ to 2% rate through 2009, Japan must address a number of problems to sustain the expansion over the medium term. This chapter identifies five key challenges: i) ensuring a definitive end to deflation under the new monetary policy framework; ii) achieving progress in fiscal consolidation in the context of high public debt and rapid population ageing; iii) implementing a comprehensive tax reform to increase government revenue, while promoting economic growth, addressing rising income inequality and improving the local government tax system; iv) enhancing productivity growth in the service sector; and v) reforming the labour market to reverse rising dualism and boosting labour force participation to offset demographic trends.