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Secular Stagnation in the Euro Area

Most discussion about the possibility of secular stagnation has focused on US data, partly because most of the new secular stagnationists are American, partly because the data are easier to work with. But as Izabella Kaminska and James Mackintosh point out, the euro area seems closer to Japanification than the US. So are there structural changes in Europe that arguably will lead to persistently lower demand unless offset by policy?

Indeed there are. Start with demography: a falling rate of growth in the working-age population leads, other things equal, to lower investment as a share of GDP, because there is less need to equip workers with new factories, office buildings, houses, etc. And if we look at working-age population for the US, the euro area (EA), and Japan we see that Europe is now where Japan was around 1998, when I and other Japan worriers started talking in earnest about liquidity traps:

 

Add to this the end of ever-increasing leverage. In the US we focus on how ever-growing household debt was a major source of demand before 2008, which won’t come back; in Europe much the same was going on, but it also makes sense to focus on a different measure, large capital flows to peripheral countries, which won’t come back even if the woes of austerity abate. And these flows were a big part of overall European demand before the crisis:

So with a shrinking working-age population and without the boost to demand caused by the capital-flow bubble, Europe is extremely likely to have a significantly lower natural real rate of interest heading forward than it had in the past. This in turn suggests that it’s a really really bad idea to let inflation drift down, whether or not it turns into outright deflation.

 Source: The New York Times