Deflation and Macroeconomic Policy: Japanese and European Perspectives

In the general discussion session, participants exchanged views on the states of the economies in Europe and Japan, i.e., how they assess the present state of the European economy in light of Japan's experiences during the 1990s, how they diagnose the state of deflation in Japan, and so forth. The main arguments made are as follows:

1. In his presentation, Senior Fellow Keiichiro Kobayashi showed that the Bank of Japan significantly increased the supply of base money in the 1990s. However, a more broadly-defined money supply, such as M2, showed only a limited increase. This seems to indicate that the Japanese financial system was impaired at the time, which caused the credit multiplier to decline and diminished the effect of easy-monetary policies. Vigilance is required as the EU could now be facing a similar situation.
2. It seems certain that rising imports from China are having a deflationary effect in Japan. In other words, the income redistribution function is working because of the easy availability of cheap daily commodities. The deflationary effect may be at least 1%.
3. With respect to the view that deflation is progressing as a result of improved efficiency in the distribution of goods and services made possible by IT technology, the causal relationship is not so clear. According to research on the actual state of trade and investment, the gravity model still fully applies, with distance controlling the size of trade and investment. Thus, it cannot be concluded that IT technology has rendered distance insignificant, or that IT has caused deflation.
4. The current economic conditions in Europe are very severe and as a matter of course give rise to pessimism about the future of the European economy. Reasons for this view can be described in the four factors below:
   1. A great deal of effort is required to adjust the global trade imbalance. A trade structure observed in the relationship between developing economies in Asia and developed countries in Europe and the Americas also exists between countries within Europe. That is, peripheral EU economies are increasing exports to developed EU countries, taking advantage of lower manufacturing costs. Because no exchange rates exist within the Euro zone, adjustments to correct intra-regional imbalance must be made through product prices. What we see here is an adjustment mechanism not by means of monetary policy but by changing the quantity of real goods. This imposes a large burden on companies. Although government debt has been offset (financed) by savings surplus in the corporate sector, it is highly doubtful that this can continue.
   2. Restraint on fiscal spending: If EU members abide by their agreement to halve government debt, the European economy will undoubtedly experience a double-dip recession. This could invite a situation in which economic recovery takes 20-30 years. Rather, it would be advisable for them to break this agreement because as long as inflation remains around the rate of 2%, substantial government spending should pose no problem.
   3. Banks are being subjected to stress tests. Their financial situation is the foremost concern.
   4. The Greek economy is in turmoil, going beyond the boundaries of economic discussion to become a full-blown political issue of who should pay and who should be helped. Although Germany bears a considerable burden in this regard, there is significant political uncertainty as to whether public understanding can be achieved if the crisis engulfs other countries.
5. The economic recovery of Japan during the 2000s was partly attributable to its foreign exchange policy, as Japan managed to differentiate itself from other countries by adopting the zero interest rate policy. Now that other countries have followed Japan's example, they are competing to drive down the value of their currencies, leading to policy ineffectiveness.
6. As the average maturity of government debt of 13.7 years in the United Kingdom is fairly long, measures such as a moratorium are unnecessary. However, countries like Spain and Italy may be forced to consider a moratorium on government debt. This gives the impression that governments not only face a rise in the interest burden like the Japan premium, but are also finding that raising funds is becoming increasingly difficult.