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Tuesday, June 03, 2003

Euro Train Wreck?

To even things up, here's another view on deflation, one that's a bit nearer the mark. From Stephen Roach, who else?

The deflation debate is finally out in the open. As well it should be, in my view. But there is one key aspect of this argument that is still considered verboten -- the Japan precedent. The Japanese experience with deflation over the past seven years is widely viewed as a unique outgrowth of the world’s most dysfunctional major economy. As I travel the world in my role as a deflation provocateur, the most common refrain is “We’re not Japan -- so it can’t happen here.” I hear that these days in Germany and, of course, in the United States. It’s hard to argue with one aspect of that that assertion -- no two countries are alike. But does that mean we should ignore the lessons of the Japanese experience?

I would argue that the answer to that question is an emphatic “no.” First of all, Japan does not have a monopoly on the case for deflation. To the extent that deflation arises from policy blunders and/or from prolonged disparities between aggregate supply and demand, there’s more than one way to fall into this trap. Second, I would heed the warnings of America’s Federal Reserve. Sure, the public utterances of senior Fed officials about deflation all contain the codeword “remote” in assessing the likelihood of such an outcome. But they have no choice in their spin -- the authorities want to convince the public that the odds of deflation are extremely low. To do otherwise would strike fear into the hearts of the masses, reinforcing the very expectations they are trying to quash. My advice: Listen less to the rhetoric of a public relations campaign and pay more attention to the Fed’s role in providing legitimacy to the deflation debate. The Fed’s policy statement after its 6 May meeting dispels any lingering doubts -- it states explicitly that the risks are now skewed more to deflation than inflation. In that same vein, a research paper published nearly a year ago couldn’t be clearer -- the lessons of Japan are not to be taken lightly (see Alan Ahearne, et. al., “Preventing Deflation: Lessons From Japan's Experience in the 1990s,” Federal Reserve International Finance Discussion Paper 729, June 2002).
Source: Morgan Stanley Global Economic Forum

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