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Friday, September 20, 2002


This piece from David Barker in the Financial Times draws attention to the fact that the country with the greatest immediate exposure to deflation Japan style may not, in fact be the US, but Germany. I couldn't agree with him more.

The bursting of the bubble in US equity prices, particularly for technology, media and telecommunications stocks, has led some commentators to draw parallels with the Japanese situation at the end of the 1980s. The US may suffer a decade of lost growth, just as Japan did during the 1990s, they argue. But when looking for a country most likely to be sucked into a deflationary trap, people should focus on Germany, not the US.Domestic final sales - gross domestic product excluding the contribution to growth from stockbuilding and net trade - are a good measure of the underlying ability of an economy to generate its own growth. German domestic final sales fell 1.9 per cent year on year in the second quarter of this year, worse even than the low point of the 1993 recession. In Japan, sales were 0.8 per cent down on a year earlier during the same period, after an even worse performance during the first quarter.

Both Japan and Germany have lost control over real short-term interest rates. For Japan, this is because nominal short rates have reached the lower limit of zero and inflation is stuck in negative territory. For Germany, the European Central Bank has to set interest rates to achieve price stability across all eurozone countries. Though the cause is different, the effect is the same: interest rates are too high for both Germany and Japan. One method for determining the right level for interest rates - the so-called Taylor rule - would imply that interest rates in Germany should be as much as 3 percentage points lower than in the rest of the eurozone.

Demographics show that Japan and Germany will suffer from a shrinking and ageing population during the next 40 years, although German demographics are not quite as bad as Japan's. Not only do ageing populations have an increased incentive to save, reducing consumption growth, but they also place increased strain on pension systems.
Source: Financial Times

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