Asset-bubble collapse and the onset of deflation in the 'Lost Decade'

After Japan's land and stock-price bubble burst in the early 1990s, impaired bank balance sheets weighed on credit growth and investment for years, ushering in what Bank of Japan Deputy Governor Hiroshi Nakaso, in a 2014 retrospective speech, described as the 'lost decades' for Japanese growth. Prices began falling outright during the 1990s as a large negative shock widened the output gap, and the deflationary pressure was compounded after 2000 by a structural decline in the labor force that further weighed on demand. Nakaso argued candidly that whether deflation persists depends critically on whether a central bank can still cut nominal rates or instead becomes constrained by the zero lower bound, and that the BOJ's own communication was not always helpful in fighting deflationary expectations; he specifically pointed to the Bank's August 2000 decision to raise interest rates in the midst of deflation as a serious policy mistake that reinforced expectations of continued price declines. This combination of balance-sheet damage, demographic headwinds, and policy missteps left Japan anchored near zero growth and falling prices for most of the following two decades.