Does ‘Japanification’ loom for the sluggish Eurozone?

Confronted with slowing economic growth, uncertain politics and wobbly markets the European Central Bank reliably came to the rescue the week before with new stimulus measures and a postponement of the start to any normalisation of interest rates. Yet, despite the soothing tonic markets were initially disturbed. This was partially because of the sharpness of the ECB’s downgrade to this year’s growth forecast from 1.7 percent to 1.1 percent. But it was also a response to the downbeat rhetoric of ECB president Mario Draghi, who portrayed the Eurozone as being in “a period of continued weakness and pervasive uncertainty.” Therefore the school-of-thought gaining traction is that a low-growth, low-inflation situation in the Eurozone, along with a negative deposit rate and extensive central bank liquidity, emulates a conspicuous correlation to post-bubble Japan. Thus, is the Eurozone, heading for a simulacrum of Japanification?

Admittedly. Whilst the Eurozone economy has left behind its “normal” expansion path following the global financial crisis and has fallen into the Japanification territory that has characterised that country for the past quarter century. The continental Europeans has not been tormented with Japanese-style deflation. And whilst Japan’s gross public sector debt remains at close to 240 percent of the gross domestic product. Whilst Eurozone public debt is down to 86 percent from approximately 92 percent five years ago. Yet the demographic similarity is intriguing. Japan has the world’s oldest people. Its population dwindled by 1m between 2012 and 2017, a measure comparable to the populace of Stockholm, and is anticipated to diminish by 25 percent in the next 40 years. The Eurozone is now traveling in the same direction, with a working-age population that began to dwindle in 2009. Shrinkage is forecast to advance notwithstanding continuing immigration.

The controversy with the analogy, it implies is that the Eurozone is not a homogeneous bloc. Southern Europe, notably Italy and Greece, diverges from the north and has arguably performed much worse than Japan. In addition, impressions of Japanese stagnation have been warped by demography. Yet, perhaps the most conspicuous difference stems from Japan’s particular structural dilemma, whereby the society has depended on massive government deficits to negate the deflationary impetus of undue private sector savings so as to try to sustain domestic demand.

Because of fears about excessive government debt policymakers embark on periodic consumption tax grabs to correct the fiscal position. Another is expected later this year, which causes the economy’s growth trajectory to be bumpy.  Whilst, in the long run, this uneven movement of financial support is unpredictable. Yet perhaps the Eurozone has its own variant of this malady. The bloc runs a sizable current account surplus reflecting northern Europe’s propensity to save more than it invests. It also possesses a faulty monetary union that produces an over-competitive exchange rate to Germany and other northern Europeans. Their fiscal conservatism militates against any undertaking to tackle the North-South imbalance that derives from these ramshackle monetary provisions.

The consequences of this are that the Eurozone will continue to be over dependent on the rest of the world for demand stimulus, and thus this muted Japanification will become a more familiar word in the European vocabulary; whilst populism will similarly advance, and interest rates will remain lower for much longer than most people anticipate.