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2008年11月 1日 (土)




>Four lessons from Japan : How to avoid getting trapped into deflation


>At the beginning of the 1990s, Japan was facing a similar situation. An asset price bubble had developed and the Japanese private sector had massively built up debt to finance this bubble.


After the Japanese central bank tightened monetary policy and had pricked the bubble, households were left with high debts and banks were facing bad loans in their portfolios.


In the process of driving down debt back to reasonable levels, Japan made several policy mistakes. Its economy rapidly fell into deflation and got trapped in a situation of continuing low growth for more than a decade.


Here are a number of lessons to learn for European policymakers from the Japanese debt deflation process.



>Make sure monetary policy wins the race against deflation. To drive down debt, the private sector starts to save more and to invest less. The slowdown in domestic demand drags down overall growth and creates overcapacity. Disinflation follows. If left uncontrolled and if interest rates are not cut in time to stabilise the economy and stop this trend, disinflation eventually turns into deflation. From that moment, the zero bound on nominal interest rates bites. Real interest rates start increasing again and monetary policy loses much, if not all of its power to stimulate the economy.


>Japan indeed got stuck in such a liquidity trap (see Figure 2). From 1992 onwards, the Japanese central bank did cut interest rates from what had been extremely high levels – 8% interest rate with inflation running at less than 4%. Meanwhile, however, inflation started falling as well. Two years later, nominal interest rates were still at 2%, while inflation had turned to zero and then negative. By reducing interest rates too slowly, Japanese monetary policy had missed out on the opportunity to stabilise the disinflation process in time. Against this background, negative real interest rates were no longer possible and the Japanese economy paid the price for this outcome in the form of continuing slow growth.


>Lesson No. 1:

The lesson to learn is to avoid inflation reaching zero before nominal interest rates can do so.

With the ongoing credit crunch triggering a standstill in the real economy, a strong disinflationary process can be expected. European central banks therefore need to engage in the race against disinflation and win this race by deciding deep and fast cuts in interest rates.



>Downward wage flexibility deepens and prolongs the deflationary trap. Depressed economic activity in itself weakens the bargaining position of workers and trade unions. In Japan, however, this weakening of workers’ bargaining position was exacerbated by the widespread existence of bonus systems at company level topping up regular or
conventional wages. Confronted with lacklustre demand for their products and services,
Japanese companies started to cut on workers’ bonuses. As a consequence, deflation got prolonged because both domestic demand and cost-push inflation were absent


>Lesson No. 2:
Today, many European economies are characterised by a downward wage rigidity from the moment at which wage growth reaches 2% (see Figure 3). This is actually a good thing: it provides a downward floor to the process of disinflation and thus contributes to maintaining price stability. European policymakers would therefore do well not to attack and dismantle those wage formation institutions delivering this downward rigidity in the form of minimum wages, sectoral collective agreements, legal extension of collective bargaining agreements and limitations at company-level opening clauses. If European policymakers decide otherwise and try to compensate for the lack of competitive devaluations of national currencies by engaging in competitive cuts of nominal wage levels, deflation processes would be made stronger



>Some structural reforms make matters worse. Japan also responded to the continuing
slowdown by degrading its tradition of permanent and highly secure jobs. New entrants in the labour market, mainly women, were forced to accept so-called part-time jobs. This type of jobs, however, needs to be understood in the Japanese context: in Japan, a part-time job means a full-time working schedule paid at a part-time rate


>This increase in precarious work also undermined the macroeconomic transmission channels. Any initial positive demand shock to the economy turned out to be weak and feeble since the benefits of the demand shock immediately went into profits and not into wages. Because of workers in precarious employment relationships having no bargaining power whatsoever, the multiplying effect of more jobs creating more purchasing power for workers and their households was no longer functioning.


>Lesson No. 3:
The Japanese experience regarding precarious work also holds an important lesson for Europe. Indeed, in Europe, the use of precarious work is spreading in many different ways: jobs paying poverty wages, series of fixed-term contracts, agency workers paid unequal wages for equal work, involuntary part-time employment and fake self-employed people. Moreover, ongoing reforms – such as a backward revision of the Working Time Directive and misguided flexicurity reforms using the six weeks ‘grace’ period in the draft Temporary Agency Work Directive to organise a ‘revolving door effect’ – may be abused to accelerate precarious work practice in Europe. If this were to happen, the depression would be prolonged and the process of disinflation/ deflation would be prolonged.


>Avoid pro-cylical fiscal policy tightening and allow the public sector to compensate for private sector de leveraging. An economy going through a process of driving down private sector debt needs to compensate this by accepting a certain increase in public debt. If it does not accept such compensation, economic activity will suffer substantially. In the absence of public investments supporting aggregate demand, private sector efforts to increase savings and cut investments will undermine overall growth. In turn, depressed growth and rising unemployment will push deficits upwards. Fiscal policy turns procyclical if it tries to cut these deficits, thereby prolonging and deepening the slowdown. Japan again provides a telling illustration such a process. To cut the deficit and to keep public debt within limits, Japan decided to hike TAV rates in 1998. The results were catastrophic: the economic recovery was lost, economic growth decelerated sharply again and the Asian financial crisis was triggered.


>Lesson No. 4:
In Europe, the Stability Pact lays the foundations for another potentially vicious circle.
Depression pushes deficits up, fiscal policy reacts and more depression follows. Therefore, utmost care must be made when applying the Stability Pact. Certainly, in the present situation in which governments have rightly saved the banking system from collapsing by injecting massive amounts of capital, there is a high risk for policymakers to resort to pro-cyclical fiscal tightening. Instead, the Stability Pact needs to be applied with a high dose of flexibility to avoid such fiscal tightening.







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