How much spare capacity is left?

If Japan is to succeed in escaping deflation, growth will have to pick up sufficiently to eliminate the margin of spare capacity - the so-called output gap - that has kept price pressures subdued. There is ample evidence - both from business surveys as well as from the labour market – that spare capacity has shrunk over the past year. Nonetheless, there is probably still too much slack in the economy for inflation to reach the Bank of Japan’s 2% target on a sustainable basis. The central bank therefore has more work to do.