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In this working paper, Gunther Schnabl analyses together with Thomas Mayer the reasons for Japans persistently low inflation since the bursting of the Japanese bubble economy (low inflation conundrum). It is shown that Japan experienced a structural break in the inflation from a high-growth period with relatively high inflation to low growth with exceptionally low inflation since the early 1990s. The authors show based on a stylized accounting model, how funds are created in a country open to international capital flows by domestic savings, credit creation of banks and net capital inflows, being absorbed either by rising asset prices, newly issued bonds or more money being held. Government expenditure financed by government bond purchases of commercial banks is shown to be an important channel of money creation in Japan’s post-bubble period. With the price level being assumed to be dependent on both goods with free market prices and good with prices controlled by the government we show that inflation in Japan has been kept low by mainly three factors directly or indirectly influenced by the Bank of Japan: increased money holding of households and enterprises, central bank-backed debt-financed price controls and net capital outflows.