The European Central Bank (ECB) surprised investors two weeks ago by cutting its benchmark refinancing rate to a record 0.25 percent. It acted after economic reports exposed the weakness of the recovery. Inflation last month was a scant 0.7 percent. That raised the risk of deflation — a prolonged drop in wages, prices and the value of assets like stocks and homes.
The rate cut “signals that the ECB is not prepared to accept the risk that the euro area falls into deflation,” Peterson Institute for International Economics senior fellow Jacob Kirkegaard said.
“Once prices begin to fall, you start to see consumers and businesses change their behavior,” Kirkegaard said. “Why should you buy a car today if the price of the car is going to fall tomorrow? Falling into the trap can be very difficult to get out of.”
Japan’s economic recovery has gained momentum since Japanese Prime Minister Shinzo Abe took office late last year.
Under “Abenomics,” the government and central bank have injected money into the economy through stimulus spending and rate cutting. The economy grew at a robust 3.8 percent annual rate from April through June.
However, economists worry about whether the recovery can be sustained and whether Japan can grow enough to make up in tax revenue what it is spending on stimulus.
Doshisha University professor Noriko Hama contends in Kyoto that only higher wages and rates will give people the income and confidence they need to spend more and restore the economy’s health.
Like the Fed, the Bank of Japan could struggle with how to time and carry out a reversal of its easy money policy once the economy improves or if inflation or asset bubbles emerge as a threat.
“They have placed themselves in a very difficult situation indeed,” Hama said. “It’s a double-edged sword.”
China’s economy grew at a two-decade low of 7.5 percent in the three months that ended in June compared with a year earlier. That is still a vigorous pace compared with the developed economies of Europe, the US and Japan.
However, for China, it marked a slowdown, and Beijing launched a mini-stimulus program, spending on railway construction and other public works.
It worked: Growth edged up to 7.8 percent from July through September from a year earlier.
Yet some economists doubt the gains in China will last.
“I can’t see the rebound lasting for very much longer, because it has been driven by government projects,” Capital Economics’ Mark Williams said.
In the latest quarter, more than half the reported growth was due to investment, not trade or consumption.
Many economists say China’s continued reliance on government-led investment is dangerous. It threatens to produce factories that make goods no one wants and unneeded real-estate developments that cannot repay loans.
China responded to the 2008 global crisis by ordering its banks to open their lending spigots. The recovery has been underpinned by a surge in borrowing, which is up 20 percent this year.
China’s central bank has warned that the aggressive lending is unsustainable and could cause bad loans to pile up dangerously.
“I think we’re going to see policymakers try to crack down on credit in the next few months,” Williams said.