Deflation could give UK Japan-style ‘lost decade’
Bank of England economist says it’s deflation – not inflation – that is the big worry
Recent worries about inflation are overblown, according to a member of the Bank of England’s Monetary Policy Committee, who says we should be more worried about deflation and the possibility that the UK is at risk of producing a ‘remake’ of Japan’s so-called ‘lost decade’.
Adam Posen, an American economist and expert on the Japanese economy, said: "The UK worryingly combines a couple of financial parallels to Japan with far less room for fiscal action to compensate for them than Japan had."
In late 1980s Japan, low interest rates and high land values led to massive borrowing, much of the proceeds of which were invested in the shares. When the Ministry of Finance suddenly raised interest rates to bring the situation under control, the stock market crashed and there were mass debt defaults. For the whole of the 1990s, interest rates were reduced to nearly 0 per cent.
Unfortunately this made no difference because deflation meant that, in reality, interest rates were much higher.
The parallels with the UK today – with its high property prices and low interest rates - are worrying.
But Posen fears Britain cannot export its way out of the recession, as Japan did in the 1990s. Not only is the UK’s manufacturing sector significantly smaller, but Japan was able to sell its goods to booming foreign markets – a luxury we do not have today. Particularly worrying for the UK is the weak growth and sovereign debt crisis infecting the eurozone, its biggest trading partner.
The euro fell a cent yesterday against the pound to €1.167, which will not help British exporters. Posen’s own assessment of the outlook for the eurozone is not good: "Let us just say that the prospects for strong growth in most of the euro area are rather dim for the next several years," he said.
One obvious difference between the UK today and 1990s Japan is our current high rate of inflation, which in April hit 3.7 per cent – almost twice the target figure of 2 per cent. This, the ongoing euro crisis and a stock market fall in China has led some economists to fear we could be heading into another period of recession.
Posen acknowledges inflation is high, but sees it as a temporary problem: "We may not have [set interest rates] perfectly right - we are overshooting our target a bit - but I'd rather temporarily be missing the target by 1 per cent on the upside than be facing deflation.
"More active investors and greater openness in the UK than in Japan may be able to turn this around." ·
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