Monday, 26 September 2011


Michael Burke: There is a widespread discussion in the US financial press and beyond on whether the economy is facing a prolonged period of economic stagnation including bouts of deflation. It has been dubbed ‘Japanisation’.

After the stock market and land price bubble burst in Japan in 1989 the economy went into a prolonged depression. In effect it has spent not one but two ‘lost decades’ since, recording miserably low levels of growth.

But it would be a misconception to believe that Japan has recorded no growth at all in the last 20 years. Over that time, real GDP as risen in 15 years and contracted in just 5 years. But the average annual growth over the entire period from 1989 has been just 0.7%. However, even this has been flattered by repeated bouts of deflation, that is, outright falls in prices. If prices fall faster than the fall in nominal growth, real growth will be recorded as positive.

It is not at all given that the US will experience Japanisation, most importantly because the starting-point for the level of debt in the corporate sector is not comparable to that of Japan at the end of the 1980s. As a result there is no financial compulsion to reduce private sector investment in the US, a key factor in the economic stagnation.

Irish Deflation

Why is this relevant to Ireland? Simply put, this economy is currently experiencing more severe deflation than Japan. In the table below we set out the pace of price changes (GDP price deflator) in Japan and Ireland and useful comparators.

Change In GDP Price Deflator (annual % change)

Source: World Bank

According to World Bank data deflation has been worse in Ireland than in Japan over the last 4years, prices falling by 6.8% versus 4.5% price declines in Japan. This is also very different to the experience of the OECD and the Euro Area as a whole, who have not experience deflation.

This is important in light of the recent GDP and GNP data for Q2, which have widely been described as a turning-point for the Irish economy and proof that ‘expansionary fiscal contraction’ is at work. In terms of GDP growth in the first half of this year, real GDP grew by 2.1% in H1 2011 compared to H2 2010. But nominal GDP rose by just 1.3%. This implies a GDP deflator of -0.8%, or -1.6% for the year as whole. This is not very different from the World Bank’s forecast for deflation in 2011 as a whole.

But the situation is even more pronounced in relation GNP. Given that the export sector is artificially inflated by (mainly) US MNCs booking profits in this jurisdiction to avail of low taxes, then GNP is decisive in terms of measuring the growth of the domestic economy and its ability to service government debts. In real terms GNP fell 4.7% in H1 from H2 2010, highlighting the extremely divergent paths of the domestic and export sectors. But nominal GNP fell by 6.5% over the same period, implying that the price deflator fell by 1.8% in the first 6 months of this year.

Price falls are not unequivocally bad news. For those fixed incomes, such as pensioners, real incomes rise. But if the majority of incomes also fall in the household, corporate and government sectors, then the effect is to increase the real burden of existing debts. Given that the economy is facing a debt crisis, as Japan did before it, deflation exacerbates the key problem facing the economy as a whole.

The latest data show that Ireland has not broken the deflationary cycle it entered in 2008. There can be no serious talk of turning-points unless it does.

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