Mario Draghi has never been so explicit. The ECB will take action to safeguard price stability with respect to both inflationary and deflationary pressures. It will do so with conventional measures (interest rate cuts) but if necessary also "with a targeted longer-term refinancing operation, or through a securitized asset purchase programme", finally with the purchase of a "broad" spectrum of titles. He said this last Thursday in a speech in Amsterdam on the occasion of the XNUMXth anniversary of the Dutch central bank.
What worries the president of the ECB is the inflation rate in the euro area which remains at 0,5%, well below the medium-term objective of the Eurotower (2%). The specter of deflation has been hovering in Europe for some time now. More dangerous than inflation, falling prices are capable of triggering a deadly spiral: corporate revenues fall and indebted firms go bankrupt, investors and consumers tend to spend less in the expectation of being able to buy later at better prices (even if at first employees and retirees have an advantage and see their purchasing power increase), the economy freezes and in the long term the level of wages is crushed by a now depressed system.
The result is that everyone is poorer. The example always reported is that of Japan which in the XNUMXs, with the bursting of the stock market and real estate bubble, ended up in the deflationary trap floundering in two decades of anemic economy. Today Prime Minister Shinzo Abe, in an attempt to awaken the country from its torpor, took the field with a monetary and reform bazooka never implemented before (Abenomics) which the whole world is watching closely.
On more than one occasion Draghi wanted to reassure about the appropriate differences between the situation in the Eurozone and what occurred in Japan. “There are many reasons why the Eurozone is in a radically different situation from Japan”, he explained in the press conference on rates last December 2013. “The Eurozone is not facing the deflation encountered by Japan and “there are no risks at the moment”, he had repeated again at the beginning of April, albeit specifying that “this does not mean that the board should remain indifferent”. Because “You can think you have zero inflation when in reality you are already in deflation”.
Different situation, the Japanese one, but emblematic enough to be carefully studied and examined to draw important lessons for the Eurozone. The Bruegel think tank, based in Brussels and led by former ECB dominus Jean-Claude Trichet, has just published a book born from the research partnership launched in recent months between the European Union and Japan with the aim of deepening similarities and lessons valid for both countries starting from the assumption that "Japan and the EU are both open economies with significant trade and financial ties, both face similar challenges in many respects" .
The work, which is titled “Japan and the European Union in the global economy”, collects the contributions of various authors (from Peter Praet, member of the board of the ECB, to Guntram B.Wolff director of the same Bruegel, from Takuji Kinkyo, professor of Economics at Kobe University to Kiyohiko G.Nishimura of the University of Tokyo) ee is divided into four parts: 1) trade and financial links between Europe and Japan; 2) the real estate bubble, the government response and economic/corporate adjustments: can Europe learn from Japan; 3)financial and fiscal policies and the monetary system in Japan and Europe; 4) What lessons to draw?
The book also houses the thesis of Joachim Fels, chief global economist of Morgan Stanley, who for several months now has been talking about the "real risk of Japanification of the euro area", i.e. of Japanization, using the English term “Japanification” indicating the process or desire to become a part of Japanese society. The contribution of Kiyohiko G.Nishimura, head of the Faculty of Economics of the University of Tokyo instead outlines three practical tips for politicians: 1) avoid wishfull thinking and face reality; 2) be proactive, not reactive; 3) communicate effectively. Finally, for Peter Praet, member of the ECB board, the lesson for the Eurozone is clear: the restructuring of the financial system must be completed in its entirety, selective repairs will not be enough.
THE JAPANIFICATION OF THE EUROZONE
“Isn't that ironic?” he asks rock in his contribution (in part 2) which takes up a report of his already dated 30 October 2013: “just when Japan is about to emerge from deflation thanks to its aggressive monetary and fiscal policy, the euro area risks entering a similar deflationary trap to what Japan experienced between the 1997s and XNUMXs. Japan then experienced a protracted recession, a belated and overcautious monetary response, periodic sharp appreciation of the currency, a failure to implement rapid cleanup of bank balance sheets, premature fiscal tightening in XNUMX that pushed back the economy in recession and a general sclerosis of institutional reforms. “Sound familiar?” Fels teases. “Obviously – adds the economist – the euro area is not Japan and history does not repeat itself. But there are echoes. And given the many parallels, a Japanification of the euro area is a serious risk”.
But how Japanese is the euro area? In other words, how similar is the Eurozone to Japan? Fels draws up a list of similarities and parallels:
1) As in Japan, a cycle of boom, bubble and blowout has been at the root of the euro area's current problems.
2) However, much of the boom and bubble in the periphery was financed by lenders in the center, who quickly took out their capital when the bubble burst. Thus the bursting of the bubble and the banking problems turned into a payments crisis within the euro area which led to doubts about the feasibility of a single currency. In this sense, Fels points out, the European crisis was much worse than the Japanese one.
3) Furthermore, the markets soon realized that the Eurozone states weren't real states because they were indebted to a currency they couldn't print themselves. As a result, the markets refused to finance governments at a reasonable interest rate and the sovereign debt crisis was triggered. Consequentially, unlike Japan, the eurozone countries most affected by the crisis have lost the possibility of implementing counter-cyclical fiscal policies and instead they had to apply the tightening when the economy was down, thus aggravating the recession. Conversely, Japan has been able to mitigate the consequences of the recession in the private sector through an expansionary fiscal policy. And the government's decision to raise the consumption tax in 1997 after the economic recovery of 1995-96 turned out to be a mistake because it pushed the country back into recession.
4) Another important parallel with Japan then and the euro area today is the slow progress in cleaning up banks' balance sheets and recapitalizing financial institutions. As a consequence, both Japan and the euro area have experienced (and the latter is still experiencing) a contraction in credit volumes. The European Central Bank's plan is to achieve balance sheet cleanup and recapitalization on the road to banking union. If successful, this could be an important catalyst for fixing the credit mechanism. In any case, there is still much work to be done, and in the meantime, bank deleveraging with its deflationary effects will likely continue.
5) So far the ECB has managed to avoid deflation and keep inflationary expectations anchored to its definition of price stability (below but close to 2%). This, Fels says, was due to its rather timely and aggressive response since the eruption of the 2007-2008 crisis, when the ECB began engaging in various forms of unconventional easing. However, it should be noted that deflation set in Japan eight years later, so Fels believes it is too early to rejoice for the euro area. The risk of deflation in the Eurozone has recently increased. Why?
Credit continues to contract as bank deleveraging continues and indeed accelerates in 2014 ahead of the asset quality review and stress tests. Second, wages in several crisis countries like Spain are now starting to fall as a lagged consequence of high unemployment and past labor market reforms. Third, the euro strengthened further in response to the Fed's tapering decision. Meanwhile, current inflation is already significantly below target. But until now, notes Fels, the ECB has stubbornly refused to acknowledge the deflationary risks (the book was published on April 8, therefore before Draghi's latest statements, ed), in a very similar way to how the Bank of Japan did before of the onset of deflation in the country.
For the economist, the “Japanification” of the Eurozone can be avoided if European politicians pay attention to three lessons from Japan:
1)monetary policy must move early and aggressively before deflation sets in;
2) regulators must implement a cleanup of banks' balance sheets, including realistic assessment of bad assets and rapid recapitalizations where needed;
3) Governments should avoid excessively strict fiscal policies that risk pushing the economy back into recession. “I think there is a good chance that these lessons will be taken into account and the “Japanification” of the euro area can be avoided. But I'm nervous,” concludes Fels.
THE THREE ADVICE TO POLITICIANS
Of the many pieces of advice that can be drawn from the study of the Japanese and European experiences, Nishimura (University of Tokyo), chooses to focus on three aspects. The first concerns the need to avoid the attitude of wishful thinking, which has led us to develop estimates that have repeatedly proved to be too optimistic. “Wishful thinking in crises is particularly harmful – says Nishimura – since it leads to the behavior of “waiting for the old normal (the normality of the past ed.) that never returns. This causes a substantial delay in the implementation of the right policies”. Nishimura notes that there is ample evidence of how problems have been underestimated and then magnified to become worrisome. The scale of the impact of non-performing loans is the worst example of undervaluation and wishful thinking of this kind, which made the balance sheet problems in Japan in the XNUMXs and the Eurozone in the XNUMXs much more severe and persistent .
The second lesson is the ability to act proactively and not reactively. However, that clashes with the needs of policymakers. "Policymakers are increasingly under pressure to be accountable, which implies that their policies must be evidence-based," says Nishimura. And so they tend to avoid making decisions right away when available economic data show no change in economic conditions. “They are waiting for more data confirming the changes – adds Nishimura – Which may be wise in normal times but is not often the case in times of crisis. Unfortunately, the data is often sloppy and late." Nishimura takes the dynamics of Japanese GDP as an example, concluding that statistics on gross domestic product have not proved to be good guides for economic policies in times of difficulty. Above all, the tendency towards initial underestimation is problematic.
Finally, Nishimura recommends communicating effectively. “When the economy undergoes profound structural changes – he points out – the old way of thinking is no longer valid both in main street (the real economy of the people) and in the financial markets. Then communication policies become very important in explaining the problems we face and the policies we need”. Not only. Communication policies must not simply be based on announcing forecasts and intentions for action, but must include careful management of credibility.
