Deflation in Japan, Abenomics and lessons for the euro area

The article takes as its starting point the similarities between the current situation in the euro area and that prevailing in Japan for the last two decades, namely slow economic growth and low – or even negative – inflation. Owing to the fact that Japan’s deflation, although persistent, has remained moderate and the economy has not fallen into a deflationary spiral, it can actually be argued that the Japanese economy shifted to a new equilibrium situation between the early 1990s and the beginning of the 2000s. In this new equilibrium, the nominal interest rate is close to its zero lower bound and inflation negative, but, just like before, the real growth rate is around its potential level. Yet it seems that this new equilibrium is not without costs. A deflationary regime like Japan’s effectively reduces the central bank’s capacity to support economic activity in the event of an adverse shock and thus increases the risk of secular stagnation. Taking this into account, the so-called ‘Abenomics’ economic programme introduced in April 2013 is aimed precisely at putting an end to the long period of deflation that Japan has gone through and at stimulating the economy while ensuring the long-term sustainability of the country’s public debt. Three major lessons can be drawn from the Japanese experience over the last 25 years. First of all, prevention is better than cure when it comes to financial crises. Secondly, it is crucial to keep inflation expectations firmly anchored. Thirdly, it is important to react to a balance-sheet recession in a prompt and well-coordinated way, so as to maximise the impact of the measures adopted and to facilitate the adjustments that must be made. Moreover, all areas of macroeconomic policy should be brought into play to support both the supply and demand sides. Lastly, events in Japan show that the costs of deflation depend very much on the specific features of an economy, and more specifically on its nominal flexibility.