Is the world economy turning Japanese?
We examine the vulnerability of economies such as the US, Europe and China to “Japanese disease” and discuss how authorities could potentially avoid deflation.
11 May 2016
For 25 years Japan has seen low growth, low or negative inflation and low bond yields. A link to the full document is provided below, but in summary, we find that China and Europe seem most likely to suffer from this “Japanese disease”.
The US appears to have enough differences compared to Japan to suggest that deflation is not going to become the default state.
What needs to happen?
If deflation is a threat, not yet a promise, what needs to happen to avoid it?
Probably not much. The labour market is flexible and banks are functional. Should the threat grow, government can consider using fiscal measures such as debt forgiveness (e.g. student loans).
Germany has a solid fiscal position and is underinvested in public infrastructure. Fiscal constraints are hampering Italian efforts to clean up and recapitalise their banks.
If fiscal policy is crimping demand and stopping structural reform then it is too tight. The question for Europe is whether the politics and institutional framework of the eurozone can allow for a reversal and accept an expansionary fiscal policy.
In some ways, China looks like Japan in the 1970s – coming off its investment boom, but a long way from a bubble and crisis. In other ways it looks as though it is succumbing to Japanese disease in terms of its declining growth and inflation.
China has overcapacity in some industries which is driving deflationary pressure. It needs to address this overcapacity. Given the deflationary pressure it probably also needs looser monetary policy.
That is difficult to do without also leading to a weaker currency, which is politically difficult. The overarching conclusion is that there are certainly things that can be done to alleviate deflationary pressure.
But many of them would be considered quite radical and necessitate some considerable political movement in both China and Germany.
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