Skip to main content

How Europe is Turning into Japan

  • Author:
  • Updated:

Martin Wolf

in the FT has a very piece on how Europe is heading in the same direction as Japan did in the 1990's. Here's the crux of the argument:

The best explanation of this lies in the work of Richard Koo, Chief Economist of the Nomura Research Institute in his book, The Holy Grail of Macroeconomics (John Wiley, 2009). He updated the argument in a presentation he made at the April 2012 conference of the Institute for New Economic Thinking in Berlin.

In essence, Mr Koo argues that the experience of the US and UK looks like that of Japan because it is: all these countries are experiencing balance-sheet recessions.

During asset price bubbles and, in particular, property bubbles, credit and debt explode unsustainably. After these bubbles burst, businesses and households are left with what they now believe to be excessive debt. Moreover, the financial system is also damaged by the same process of deleveraging. In this environment, businesses and households seek to run down their debts by trying to ensure that they spend less than their incomes. The result is the threat of a huge contraction in aggregate demand.

If affected economies are to escape deep depressions, they need huge swings either towards current account surpluses or towards fiscal deficits, as vents for the excess desired savings of the private sector. If the government reacts to its deficit by trying to eliminate its deficits too quickly, domestic demand will collapse.

Japan experienced over a decade of economic stagnation and is clearly a country Europe doesn't want to emulate when attempting to reverse what is happening now. What does that mean? Not using austerity measures as Japan did.....

Enhanced by Zemanta