History Repeats Itself: The Deflation Story

banner-deflationEurope has an economic problem. Today on the news I heard that prices in Belgium are not likely to raise. A good thing, you might think, but a little bit of inflation (sustained increase of the general price level) is actually a feature of a healthy economy. In Germany and Spain as well consumer prices fell and provoked a fear of deflation (decrease in the general price level). At first lower prices may seem great for the consumer, but eventually people will delay their purchases because things keep getting cheaper. In the end, deflation causes poor economic growth. And worse, deflation may result in a deflationary spiral (decreases in prices -> lower production -> lower wages and demand -> further decreases in price)…

…which is actually the case in Japan since the latter half of the 1990s. This chronic deflation is presumably caused by a collapse in the stock and real estate market (“burst of the bubble economy”), unfavorable demographics, the inclination of Japanese people to save their money, import of cheap Chinese materials and a tight monetary policy. The Japanese economy stagnated and real GDP growth average only reached 0.8% between 1993 and 2012.

deflation-japan-USSince 2012, prime minister Abe Shinzō has been trying to put an end to this longstanding issue. The so-called “Abenomics” focuses on three arrows: fiscal stimulus, monetary easing and structural reforms. The Bank of Japan set a target of 2 percent inflation. By the end of 2013, the long period of deflation was declared over. The first two arrows have been put successfully in action, although many economists question the efforts in structural reforms, essential to turn the entire economic policy of Abenomics into a long-term solution.

The European Central Bank is now working on a quantitative easing program, more specifically buying bonds from the banks to increase flows of credit. This story is to be continued, for sure…

References and Further Reading

“Chronic Deflation in Japan”

“Japan Deflation to End” – Forbes

Abenomics: Preliminary Analysis and Outlook

Abenomics Structural Reform Problem – The Diplomat

– The eurozone needs an alternative solution to its economic woes – The Guardian

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