To: Maurice Winn who wrote (103604 ) 11/5/2013 10:49:42 PM From: elmatador Read Replies (1) | Respond to Prompt action required on eurozone deflationeurozone inflation rate has fallen progressively from 1.6 per cent in July to 0.7 per cent in last week’s flash estimate for October. That is well below the European Central Bank’s target of just under 2 per cent and does indeed raise the possibility of Japanese-style deflation. There are striking similarities to ponder.weakness of bank balance sheets after their respective financial crises. Worries about debt sustainability are another common feature. In both cases politicians have been slow to use the time afforded by loose monetary policy to embark on supply side reform. Decision-making in the face of their financial crises has likewise been extraordinarily dilatory.Germany looks nothing like Japan did at the start of its long period of economic stagnation from 1990. Alone among the big European economies the German economy has grown back up to its peak of 2007 and beyond. Unemployment is at its lowest level since unification, asset prices have been going up not down and the output gap has almost certainly been closed. The ECB seems likely to be delivering low real and nominal interest rates to the Germans for the foreseeable future, given the depressed state of much of the rest of the eurozone. That is giving rise to legitimate concern in the Bundesbank about potential house price bubbles in major cities. Nothing Japan-like about that.Periphery challenge The greater similarity is with the heavily depressed countries in the rest of the eurozone. Yet even there it is hard to see any parallel in labour market conditions. Over the past two decades Japanese unemployment has remained at low levels while eurozone unemployment outside northern European countries such as Germany and Austria has ballooned. Most importantly Japan over that period had exchange rate freedom which ensured that competitiveness was always a manageable problem.No flexibility The eurozone countries with the biggest competitiveness problems have no exchange rate flexibility. They will have to address their cost disadvantage through internal devaluation. That is where the latest eurozone inflation numbers become disturbing, because it is much easier to reduce real wages if there is inflation. With deflation workers would have to accept falls in nominal wages. In unionised countries such as Italy this is unlikely to happen without considerable strife, if it happens at all.
