Why is Japan's growth rate negative

Chart of the Week | 01.03.2019

The ideal index value is in a corridor of around four to six, assuming a output gap of zero percent, target inflation of two percent, a short-term interest rate of two percent to four percent and a percentage change in the old-age ratio of zero. The lower the index value, the greater the risk of "Japanese Disease".


The index for Japan has been in the red, negative zone since 1992, as our chart of the week shows. It is noticeable that between 1992 and 2017 Japan had significantly worse values ​​in all four categories than the euro zone and Germany. The mean value of the output gap is -1.4% (Europe -0.4% and Germany -0.1%), the mean value of inflation is 0.3% (Europe 1.9% and Germany 1.7%) and the mean of the key interest rates at 0.5% (Europe 2.5% and Germany 2.5%). The mean value of the percentage change in the old-age ratio is 3.7% (Europe 1.6% and Germany 1.6%).


However, if one only considers the period of the last five years between 2013 and 2017, a different picture emerges, at least for Europe. The course of the graph clearly suggests a rapprochement between Japan and Europe. And since 2012, Europe's index values ​​have always been in negative territory. The mean values ​​of the four categories are sometimes only marginally apart. The average output gap is -1.9% in Japan and -1.6% in Europe. The mean inflation rate is 0.9% in Japan, 0.7% in Europe, and the average key interest rate is 0.03% in Japan and 0.15% in Europe. Only the change in the old-age ratio is much faster in Japan (3.5%) than in Europe (2%).


So has Europe been infected with the "Japanese Disease" and only shows slightly different symptoms?

The concise answer to this question is probably “yes and no”! Because even if there is undoubtedly a lot in common, the economic connections and the financial policy reactions must be clearly distinguished. Japan found itself in a deflationary spiral as the reaction to falling prices was too late and too hesitant. Because of the zero percent limit on nominal interest rates, deflation caused positive real interest rates in Japan, so there was no incentive to consume, which had a negative impact on inflation and economic growth and created the longevity of Japan's “lost two decades”. Europe does not have this problem at the moment. And even if the output gap in Europe has been larger in the last 10 years than in Japan in the 1990s, it is closing significantly faster and was even positive last year (0.3%).


Demographic and structural factors also have (so far) a significantly greater influence in Japan than in Europe. Japan's dependency ratio is increasing at a dramatic pace. Due to the shift in the age pyramid, people feel compelled to save more and consume less in order to be prepared for retirement provision. Rising inequality in income also leads to this behavior, which makes it more difficult to achieve the inflation target and potential production. Europe and Japan will continue to struggle with these problems in the future. The age pyramid will continue to move upwards and financial and social inequality will continue to increase in the future, according to forecasts by the European Union and OECD.


So Europe has not completely infected itself with the "Japanese disease": The European Central Bank took measures in good time to prevent it from sinking into a deflationary spiral. In addition, demographic change is not proceeding at the rate and extent that Japan is struggling with. Immigration is more pronounced in Europe than in Japan. Furthermore, the Eurozone as a monetary union and the European Union as a community of political values ​​cannot be compared in many areas with the characteristics of Japan (e.g. social cohesion, conservative voting behavior, identification). Even if there are currently many parallels between Japan's “lost two decades” and Europe's time after the financial crisis, one can at most speak of “Japanization light” in Europe.


And we want to state that a Japaneseization of Europe would not only have negative sides. Despite all the economic disaster figures, Japan is doing very well in many areas: According to the OECD Better Life Index, Japan is at the top in the areas of student performance, life expectancy and occupational safety and above average in the areas of employment, income and general safety. Inflation and growth should not be used as the only indicators for assessing the wellbeing of an economy, and we should be warned that fiscal and fiscal stimulus should never lead to bubble formation - after all, it is what Japan's “lost two decades” and Europe's last Ten years in common: The consequences of a (avoidable) financial crisis.