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HomeeconomyDeflation wars? Economists fear Japan-style lost decade

Deflation wars? Economists fear Japan-style lost decade

Inflation data for the euro zone managed to meet expectations on Thursday, while figures in the U.S. are expected to show a moderate uptick later in the session. But despite this, a growing number of economists has warned that not dealing with weaker prices could cause a downward economic spiral.

Christine Lagarde, managing director of the International Monetary Fund, told an audience in Washington on Wednesday evening that "if inflation is the genie, then deflation is the ogre that must be fought decisively."

"Even for the advanced economies, however, the outlook is still subject to significant risks. With inflation running below many central banks' targets, we see rising risks of deflation which could prove disastrous for the recovery," she said at a National Press Club event.

(Read more: Europe needs a credible deflation strategy)

The euro zone's final reading for inflation in December came in at 0.8 percent, year-on-year, on Thursday. This met expectations, but marks a steady decline in price growth since it hit 3 percent in 2011.

Sha Ying | CNBC

Meanwhile, consumer prices in the U.S. look set to have risen by 1.5 percent on the year in December, after a 1.2 percent gain in November, although the number still remains below the U.S. Federal Reserve's target of 2 percent.

Albert Edwards, Societe Generale's uber-bearish strategist, said investors have increasingly recognized that both the U.S. and euro zone are sliding close to outright deflation, but have failed to price that threat into securities.

"However much U.S. and eurozone policymakers deny we are witnessing a repeat of what happened in Japan in the 1990s, it does indeed look just like Japan to me," he said in a note on Wednesday.

One result of deflation is to push down demand, as people hold off purchases in the hope of more price declines. It can also cause increased unemployment and even lead to economic depression.

Japan, for instance, suffered what has becomes known as a "lost decade" to deflation, when companies cut their prices to revive lackluster demand, which in turn hit businesses' revenue and had a knock-on effect on the economy.

(Read More: Germany's economic critics 'can't have it both ways': Ifo)

Edwards went on to argue that stagnant corporate profits and slowing productivity growth in the U.S. could cause a recession that would trigger outright deflation.

Economists Paul Krugman and Larry Summers have also both warned of "secular stagnation" in developed economies over recent weeks, with Krugman adding that he sees all the hallmarks of what happened in Japan in the 1990s.


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