The Eurozone’s 'Japanification'

The prospect of some kind of ‘Japanification’ of the eurozone supports our view that interest rates will remain lower for much longer.

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This week, the European Central Bank will again experience how difficult it is, once out in the open, to put the genie back in the bottle. While deflationary risks in the eurozone have disappeared, still muted inflationary pressures and concern that the economy may be in the middle of a protracted downswing have brought back speculation about new easing measures.

An end to the current unconventional monetary policy, i.e. the negative deposit rate and ample liquidity, is not in sight and the ECB is expected to do everything it can to avoid an unwarranted tightening of its monetary stance.

But a low growth, low inflation environment in the eurozone, coupled with still loose monetary policy, bears a striking resemblance to Japan, which raises questions about the central bank’s monetary toolkit and the options at its disposal.

The 'Japanese disease'

Since the 1990s, Japan has been struggling with an extremely high public debt ratio and very low and even negative inflation and growth rates. Only in 2016 did Japan’s nominal GDP return to levels seen in 1997. Last year, Japan’s debt-to-GDP ratio stood at 238%, and since 1994, headline inflation has been negative for almost half of the time. This trend has also emerged in the eurozone in recent years. In Greece, the sovereign debt ratio rose to 183% following the European financial crisis, Spain was in a deflationary environment between 2014 and 2016, and Italy had to contend with predominantly negative growth rates between 2008 and 2013.

When turning to the causes, both the so-called “Japanese disease” and the euro crisis show similarities. In the 1990s, unprofitable loans, bonds and corporate debt, and a relatively deregulated financial market led to a bubble in the market and subsequent financial crisis. A similar, albeit profound financial crisis hit Europe and the whole world in 2008, suggesting some comparability. These examples and anomalies raise the question of whether a ‘Japanification’ of the eurozone is, in fact, inevitable.

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