A European Lost Decade?

Europe's current economic predicament sounds a lot like Japan’s in the 1990s, which culminated in a “lost decade” of stagnant growth and deflation from which the country is still working to recover. How can Europe avoid a similar fate?

MUNICH – Europe is in a difficult predicament. Inflation has fallen to 0.4%, and economic growth has been anemic for years. Though the European Central Bank has kept interest rates close to zero, private credit growth is stalling and public debt continues to rise. This sounds a lot like Japan’s situation in the 1990s, which culminated in a “lost decade” of economic stagnation and deflation from which the country is still working to recover. Is Europe bound for a similar fate?

The parallels between the European and Japanese economies’ trajectories are undeniable. Both experienced a prolonged debt-fueled real-estate and asset-price boom, followed by a deep balance-sheet recession. As wealth was wiped out and wages contracted, consumption growth collapsed. More damaging, prices for real estate and financial assets plummeted, but the liabilities remained – a major shock for businesses and the financial sector.

Indeed, the combination of declining collateral and rising bad debt squeezed Japanese banks, which were too weakly capitalized to bear large losses. To avoid a surge of insolvencies, they rolled over corporate debt, bringing about a long and painful period of financial consolidation, low investment, and slow economic growth. To compensate for weak private demand, the government increased spending, more than doubling the stock of public debt, to more than 230% of GDP, in just 15 years.

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