Japanese-style stagnation could affect UK, warns MPC member

Deflation cannot be ruled out as a threat stalking the British economy, a member of the Bank of England's Monetary Policy Committee warned an audience at the London School of Economics last night.

Just days after the Bank sent its seventh letter to the Chancellor explaining why inflation is running too high, the MPC's Adam Posen said that the persistent stagnation that bedevilled the Japanese economy from 1992 to 2002 is still a danger facing the UK.

In a speech using Akira Kurasawa films Ran, Rashomon and the Seven Samurai to illustrate Japan's recent economic history, Mr Posen said: "The UK worryingly combines a couple of financial parallels to Japan with far less room for fiscal action to compensate for them." But he also noted that the UK's openness and more active investors may offset the dangers.

Mr Posen argued that Japan's problems were not the unavoidable outcome of the asset bubbles of the previous decades, but rather stemmed from a series of macroeconomic mistakes. "It takes more than a bubble to become Japan," he said.

But there are lessons for the developed economies now struggling to return to growth – not least regarding the longer term costs of recession as job losses turn to unemployment and financial disruption turns to under-investment and capital misallocation.

"It is impossible to completely offset such negative structural effects," Mr Posen said. "I believe that there is reason to think they will be larger and more immediate in the UK today than they were in Japan in the 1990s."

The UK lacks some of the advantages that the Japanese economy had in the mid-1990s. British savers and investors are more likely to move their money abroad; labour and capital need to be re-allocated to different sectors of the economy to offset the contraction in financial services; and export markets are ever more competitive. Worse still, the UK's main export market is the eurozone, which has "dim" prospects for strong growth.

The good news is that the Japanese experience demonstrates a lot of textbook macroeconomics. It is therefore "amenable both to comprehension and, within limits, avoidance, or at least amelioration", Mr Posen said.