2002 November 07 Thursday
The Economist: Germany Greater Deflation Threat

For details of their comparison of Germany, the US and Japan see the chart "Testing for Nipponitis" on this page.

Our analysis suggests that Germany has more symptoms of the Japanese disease than America. America's bigger bubble infected its economy more severely; but its more flexible markets and institutions should now help it to adjust. For now, both countries remain in danger.

Policymakers dismiss the risk of deflationójust as in 1990 it would have seemed far-fetched to predict that Japan would enter a deflationary slump that would last for more than a decade. Yet as Marx reminds us: history repeats itself first as tragedy, then as farce.

The US scores highest on "Size of asset-price bubble", "Coporate overinvestement", and "Large private-sector debts" with a moderate score for "Risk of deflation". Whereas while Germany only scores highest on "Large private-sector debts" and "Shrinking/ageing population" it also has a longer list of moderate scores for "Size of asset-price bubble", "Risk of deflation", "Weak banking system", "Severe structural rigidities", and "Political/social paralysis".

Update: Also, see this article that argues Germany's problems are not as serious as Japan's.

'We're a long way from that sort of psychology in Germany,' said Mr David Walton, the chief European economist at Goldman, Sachs.

He noted that the benchmark short-term interest rate in the 12 nations using the euro currency stands at 3.25 per cent, leaving the European Central Bank some flexibility to lower rates, an option the Bank of Japan has exhausted.

Japanese banks are also a world apart from those in Germany.

Update II: This article lays out the opposing views about whether the US Federal Reserve still has additional unused power to stimulate the economy:

On the other side of the argument are economists such as Russell Sheldon of BMO Nesbitt Burns, who wrote a report for clients recently entitled "The Myth of Fed Impotence," in which he said "readers are about to be deluged with stories about Fed impotence, suggesting the final rate cuts won't matter." According to Mr. Sheldon, such stories "are perfectly normal for the end stage of any Fed easing process and can safely be ignored," because the benchmark Fed rate "is not as low as you think."

The BMO economist says while the Fed funds rate may be at a 40-year low, it isn't that low on a historical basis if you use the Federal Reserve's preferred inflation benchmark, which Mr. Sheldon describes as "smoothed core PCE." Using this measure, the Fed moved rates as low as negative 1 per cent in real terms after the 1990 recession, and has done so in previous downturns as well. On that scale, U.S. interest rates are still well above zero, and therefore there is still room for more cuts ahead.

The problem with the more complacent viewpoint is that if inflation drops then without the Fed even changing interest rates the real cost of money will rise. If inflation drops to zero then the Fed will no longer even be able to make real interest rates go negative.

Share |      By Randall Parker at 2002 November 07 12:19 PM  Economics Political


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