Europe...Japanisation?

A slowdown in Euro area growth momentum from an already anemic pace, combined with ongoing concerns about deflation risks, has pushed the question of whether the Euro area will follow in the footsteps of Japan's so-called "lost decades" to here. The question is a complicated one. For starters, what do we really mean by Japan's "lost decades?" In general, the phrase seems to refer to a prolonged period beginning in the early 1990s when Japan's economy was characterized by two features that are distinct but often muddled together : stagnation - which denotes low growth - and deflation - which denotes declining prices.

In one's interview, there have been two phases of the stagnation that characterized the "lost decades" with very different underlying problems : initially, deleveraging post the bursting asset bubble in the early 1990s, followed by a rapid decline in the working-age population over the recent decades.

The notion of "Japanese-style" deflation also often seems misunderstood. He clarifies that while Japan has experienced the more malign so-called "deflationary spiral" in which price declines lead to further prices declines and, ultimately, a vicious, demand destroying spiral. He believes that drivers of this deflation were related to - but not the same as - the drivers of stagnation, with wage flexibility playing a prominent role.

With all of that in mind, he emphasizes that Japan's underlying problems in recent decades are very different from the fundamental challenge facing the Euro area today - the lack of economic integration. So in some sense, the Japanese experience has little insight to offer to the Euro area. But the key lesson Europe can take from Japan is that focusing on fixing the underlying problems is the only path to recovery. In his view, framing Japanese and Euro area problems in terms of the monetary phenomenon of deflation rather than fundamental drivers gives the misguided impression that the problems can be solved by monetary policy. He does not hold out much hope that monetary policy can improve the outlook for the Euro area economy.

Another one is more optimistic about the ability of policy activism to lead to a stronger Euro area economic and asset market recovery than what Japan experienced. But she emphasizes that demand-boosting monetary and fiscal policies alone will not be a panacea for the Euro area.

And someone sees a near-to-medium term path for the Euro area that is not dissimilar to Japan's past experience - very low but still positive growth and potentially some bouts of benign, and more malign deflation, even though the causes of these developments are, in large part, different from those in Japan. He also maintains that - similar to the Japanese experience - the likelihood of a malign deflationary spiral akin to the Great Depression remains remote.

One professor is far more concerned about the outlook for the Euro area. He is perhaps the most optimistic that the combination of the right fiscal and monetary policies, namely, a rolling-back of austerity and full-blown sovereign QE, could jump-start Euro area growth. But he sees little scope for these policy shifts given the large political obstacles to both. In his view, the Euro area remains materially velnerable to a return of a liquidity crisis, a solvency crisis, and even political upheaval should the region continue on its current path.

Even barring this worst-case outcome, another one underscores that Euro stagnation could be more costly to the global economy than was Japan's earlier experience given the Euro area's larger economic weight and stronger financial linkages with the rest of the world.

Finally, one analyst zeroes in on equity market parallels between Japan and Europe. She concludes that despite worrying similarities between recent, lackluster profitability of European companies and Japanese corporates in the 1990s, more reasonable starting valuations suggest that European equity performance is unlikely to repeat Japanese equities' dismal experience in decades past.