The eurozone is showing the perturbing symptoms first diagnosed in Japan, but ever-looser monetary policy is not the answerby Paul Wallace / August 16, 2019 / Leave a comment
Two decades ago as Europe was preparing to launch the euro, something rather odd was starting to happen on the other side of the world. In the late 1990s, Japan began to experience deflation, a condition thought to be banished in the buoyant post-war era of global expansion. Both short-and long-term interest rates fell to historic lows, even turning negative in some parts of the money market. At the time the phenomenon appeared to be specific to Japan, reflecting a wrenching economic slowdown and a prolonged banking crisis. But now the exception is fast becoming the rule as “Japanification” spreads around the world, above all in the euro area.
Along with Donald Trump’s trade wars, Japanification explains much of what is happening in the global economy at the moment. Take the Federal Reserve’s decision to cut interest rates at the end of July, even though that month marked the longest ever economic expansion in America on records going back to the 1850s. One reason was that the US central bank felt compelled to protect American businesses from the backwash arising from Trump’s tariff follies. More fundamentally, however, the Fed was responding to the fact that its preferred measure of headline inflation is, at 1.4 per cent, uncomfortably below its 2 per cent target even though unemployment (currently just 3.7 per cent of the work force) is at its lowest in almost 50 years.
Even more so than America, the euro area is feeling the pain from Trump’s wrecking ball and a slowing Chinese economy. The 19-strong monetary bloc is much more exposed to trade headwinds than the US. The eurozone’s hub economy, Germany, is in trouble as its export-reliant manufacturing sector has gone into reverse. German GDP contracted by 0.1 per cent in the second quarter, curbing growth in the euro area to just 0.2 per cent, well below potential.
The setback is all the more worrying because Europe has a much more serious case of Japanification than America. The currency union, set up with such high hopes 20 years ago, is showing many of the gloomy symptoms once thought to apply only to Japan. Headline consumer-price inflation in July was a low 1.1 per cent according to Eurostat’s initial estimate. Core inflation, which strips out volatile components including…