Potential Growth in Japan: Issues on Its Relationship with Prices and Wages

This paper looks back on the background of the sluggish potential growth and the slowdown in labor productivity growth since the 1990s in Japan, and raises some issues on their concepts and measurement, as well as on their relationship with prices and wages. Specifically, we point out that (1) there is a great deal of uncertainty in estimating the potential growth rate due to differences in approaches; (2) a decline in the potential growth rate could be accompanied by an even sharper decline in aggregate demand, leading to a worsening of the output gap; (3) the slowdown in labor productivity growth, combined with the decline in the labor share and the deterioration in the terms of trade, has exerted downward pressure on real wages; (4) the slowdown in labor productivity growth has also led to upward pressure on prices through rising unit labor costs; and (5) the prolonged deflation and low inflation themselves might have adversely affected productivity through suppressing demand for capital investment and other factors. While the sluggishness of potential growth and the slowdown in labor productivity growth are serious problems in themselves, monitoring these trends is also necessary for conducting monetary policy with the aim of maintaining price stability. It is also important to look at the relationship between productivity, prices, and wages from a variety of perspectives, while being mindful of the uncertainties in these estimates.