Commentary Type

Yes, We Are Probably All Japanese Now


This paper argues that the euro area has in recent years shared the same unfortunate concurrent systemic economic/financial crisis and demographic turnaround to an outright declining working age population that Japan suffered in the early 1990s. This combination will continue to depress euro area inflation dynamics for the foreseeable future, making it imperative that new fiscal policy initiatives, including public climate related investments, complement the European Central Bank's (ECB) ongoing monetary policy stimulus.

Executive Summary

  • Inflation dynamics are today subdued throughout the advanced economies. In Japan, however, this situation is not new, but started 25 years ago in the mid-1990s, following the country's dramatic economic boom-and-bust in the late 1980s and early 1990s. From 1995 onwards, Japan in addition reached its long-term demographic turning point, as its working age population began to decline inexorably. The combined effect of these two developments exposed Japan to intense deflationary economic pressures.
  • The decade-long zero-interest-rate-policy and asset purchase policies and extraordinary fiscal stimulus pursued by the Bank of Japan and the Japanese government respectively since the mid-1990s have not managed to restore Japanese inflation levels to the targeted levels.
  • The euro area has in recent years suffered the same twin effects of a concurrent systemic economic crisis and its demographic turnaround and a declining working age population since 2009. This will subject the euro area to dramatic deflationary pressures for the foreseeable future.
  • Ageing and a demographic turnaround negatively affect all three component drivers of long-term economic growth: potential workforce, capital accumulation and productivity. Fewer potential workers reduce economic growth prospects. Lower growth depresses profitable investment opportunities, and ageing workers carrying more of the financial responsibility for their retirement themselves will save more. The retirement of increasingly well-educated generations leads to slower future educational attainment advances, lack of financial pressure on unproductive firms from low cost of capital, and an ageing related decline in entrepreneurship and business start-up rates are all effects likely in the long run to adversely affect productivity growth.
  • Japan's example of ineffective macroeconomic policies in the face of downward demographic pressure on inflation dynamics makes it clear that the euro area is unlikely to escape persistently subdued prices, unless a more integrated fiscal and monetary policy response is implemented. This could see euro area (and EU) governments commit fiscal resources, supported by the ECB, to an investment-led strategy to reach Europe's ambitious climate change goals.

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