Unstable Economy: Reflections On The Effects and Consequences in The Event of Deflation (The Case of Italy)

Int. j. econ. manag. soc. sci., Vol(4), No (10), October, 2015. pp.
457-468
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Unstable Economy: Reflections on the Effects and Consequences in the

Event of Deflation (The Case of Italy)
Giovanni Antonio Cossiga *
Presidente sindaci Policlinico Umberto I, Universit degli Studi La Sapienza Roma.
*Corresponding author: g.cossiga@alice.it
Keywords
Abstract
Unstable economy
Deflation
Structural inflation
Tendency to stability
Double cycle
The essay aims to explore the possible effects that excessive public indebtedness may cause on the
efficiency of economic systems. To do so we draw to your attention the suggestion that, beyond a given
threshold of debt, the economy system suffers from a loss on development capacity and is showing a
characteristic tendency to deflation, which is pushing nominal prices toward zero or even to real deflation.
This particular form of instability due to excessive indebtedness would result in a sort of latent financial
crisis, which though not fully resulting in a clear crisis nevertheless is somehow suffering from the effects of
the financial crisis. That is why, we will examine the intimate and correlated behavior of economic cycle and
inflation cycle (i.e. deflation), to search all the factors producing a sharp potentialities fall and causing the
tendency to implosion of the price system.
1.
Introduction
This essay aims to investigate some aspects of an economy, which became unstable. In particular, the survey would like to give a general answer
to some questions. Why an economic system becomes unstable, in spite of the general trend to stability? Which are the effects and consequences
that the instability state produces on the running of the economy and which are the changes suffered by the economic system?
To look out for an answer, as far as possible, to these problematic issues, first it is required to define whats an unstable condition, after
considering the changes occurred to the economy, when compared with its stable state. We may answer with the simple observation that
inflation or deflation are both symptoms of an instability in the systems. Then, are becoming unstable those systems, which are struggling with
the monetary diseases of inflation and deflation. This statement, only apparently trivial, however implies the theory that inflation or deflation are
usual aspects of the unstable environment. As a result, inflation would not be an unavoidable byproduct of the economic systems growth, but
instead is a specific symptom of the instability condition.
If we consider the hypothesis that inflation is a symptom of the unstable condition, then it is coming to evidence a more specific question. Which
are the profound forces producing the progressive loss of the stable economic condition and therefore pushing toward the crossing of the
instability threshold? In general, we could state that the instability of an economic system is caused by the attempt to live beyond our resources,
then persisting in this dangerous behavior. E.g. in the seventies, the terrible increase of the oil price pushed many countries to release, with the
deficit on public spending, the consequences of the higher cost of energy on the production system and on families. If persistent, this shift of
increasing charges from private to public can become a cause of instability.1
In the same way, in the case of a financial crisis due to speculative excesses, the virtual liquidity created by the speculative excesses can be
equivalent to trying to live beyond actual resources. The return to stability is therefore consisting in the recovery of the collective consciousness
of the actual potentialities of the economic system, and then consequently should start the adoption of appropriate measures.
Therefore, is appearing as concrete the hypothesis that the economy instability is a condition affecting the nominal price system, so creating
inflation or deflation. According to this approach, inflation and deflation can be considered as tools becoming active within unstable economies,
as a corrective response arising from the presumable natural vocation to the stability, typical of the economic systems. Therefore, we may
deduce that the longtime stable systems, in absence of shock, can be immune from pressures of monetary nature (inflation or deflation).
Within an unstable system, the control actions of the monetary authorities can cooperate for the return of inflation (or deflation) prices to their
natural profile. In any case, we have to recognize that the economic system under inflation (or deflation) does not lose a substantial quality:
inflation (or deflation) does not modify in depth the running of the economic system. In other words, the alteration of nominal prices caused by
inflation or deflation does not perturb, at least within certain limits, the economic system functionality.
The reasonable predictability of the inflation (or deflation) profile in the near future is essential for the formation of future prices. As far as this
essential requirement is guaranteed (within reasonable errors), the system though troubled by monetary changes does maintain an acceptable
functionality. Consequently, the movement of nominal prices caused by inflation is not accidental (stochastic), but is following instead a regular
motion (deterministic), at least in the absence of any intervention or with limited intervention.
Therefore, the passage of an economic system from the unstable condition, with persistent inflation or deflation phenomena, to a normal
monetary condition should be verifiable through the detection of the presence of "structural breaks" 2, which are marking the changing passage
from and toward normality. In this way, we could try to understand what happens in an unstable system struggling with a long running choice to
live beyond resources, with debt accumulated on excess. In particular, we can try to define, on experimental basis, the public debt limit to be
considered excessive, i.e. such that the system can become unstable when this limit is exceeded. This condition seems to generate a latent
financial crisis, during which are coming out events similar to those of a full and clear financial crisis, with a tendency to economic depression
and deflation.
In the specific case of a severe financial crisis, e.g. during nineties in Japan, experience is showing that fiscal policy does not seem to have
played a key role for the removal of the post-crisis prolonged deflation. On the other hand, we can suppose that the insistence of supportive
policies in the Land of the Rising Sun, through generous amounts of additional deficit public spending, could have worsened the instability
condition. In the specific case of Japan, the events that followed the crisis of the nineties seem to show that the instability arising from a past of
1
In the specific case of the seventies, many countries were already at the threshold of instability in the attempt to maintain the growth rates experienced in the fifties. The oil shock during
mid-seventies pushed these weakened economies beyond the instability limits.
2
The structural breaks can occur in the economy for various reasons, e.g. changes in economic policy, changes in the economy structure. The structural breaks can be highlighted by a
sharp change of the regression coefficients at a specific date or by a gradual evolution of the coefficients along the time.
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International Journal of Economy, Management and Social Sciences Vol(4), No (10), October, 2015.
exuberant growth and uncontrolled, has not been adequately treated, when the big speculative bubble has opened the way to a strong financial
crisis.
In this context, with a history of accelerated growth, which became weak and fragile after the deep crisis, Japan may have suffered from a
structural break on its development potential: we can verify this breakage with a mathematical method.
Therefore, we could suppose that chronic increase in public debt was not only an inappropriate way to get out of deflation, but also a potential
cause of the extended tendency of the economy to depression. A trend particularly present in Japan and, with a different emphasis, in Italy as
well. The problem on which we have focused our attention concerns:
- The magnitudes of the public debt, beyond which we could assume that the economic system is becoming unstable, therefore suffering from a
latent financial crisis;
- How is carried out by these magnitudes the complex action, defining the instability threshold of the economic systems, which interferes on the
potential of the economy and how far these magnitudes are affecting the efficiency of the economic system;
- And, finally, which measures the economic system, dealing with instability, is able to activate as an automatic way to restore the economy,
with the assumption that there is a natural tendency of economic systems toward economic stability.
Moreover, it seems reasonable the hypothesis that economic systems must comply with and must be subject to a natural tendency, which
essentially provides the most harmonious and sustainable way to economic development. In the frequent case that human error would push the
economy toward the instability parallel universe, we should also admit that this natural tendency might be able to bring the deviated system on
the road for normality and balanced growth. Therefore, a parallel universe only transitory, from which the itinerary for the return would be
obliged (though tortuous).
2.
Stability and instability of economic systems
The stability of an economic system can be defined as the natural state during which the economy potential is maximized: no tensions in the
price system and the profile of the economy development is following a growing trend. In the same way, we can define the instability as the
unnatural state of an economic system that undermines the development potential, produces tensions in the price system and finally imposes a
cyclical character to the economy, with the progressive coming out of an economic depression if the instability is persistent. The stability is the
norm of economic systems, although the unstable state is prevailing because of the unavoidable tendency of individuals and communities to live
beyond their resources.
The unstable state of the economy does appear evident with tensions rising as an automatic reaction of the economic system, in an attempt to
reply against the anti-market behaviors causing instability. According to this approach, inflation or deflation are mere monetary anomalies that
we could perceive as expedients activated within economic systems -without a specific direction-to counteract the instability and then to
converge toward a virtuous course to reduce economic instability. So arguing, we cannot consider inflation and deflation the cause to be
contrasted, because they are equivalent to the antibodies activated by the sick system to recover the healthy normal state. Nevertheless, fighting
against antibodies does not resolve the disease, while the real enemy is the instability, which should be reduced by accepting the necessary
sacrifices.
In other words, we can consider inflation and deflation as two aspects of the same natural mechanism designed to preserve the general stability
of the economic system. According to this point of view, it would make no sense wishing to fight deflation with the use of inflation. Similarly, it
seems impossible for an economic system in deflation to induce a corrective inflation. Therefore, it seems thoughtful to promote the natural
correction for the return to stability. Of course, the natural way for a return to the economic stability is arduous and tortuous, but if not contrasted
this way somehow can turn off inflation or mitigate the grip of deflation.
Inside an unstable system, we can believe that the natural mechanism controlling the gradual recovery of the economy stability over the time is
the same involved in the process influencing, by changing its route, the natural linear trend of an economy on the course of a well-balanced
development. In fact, we know that when the system is taking the instability route, the linear trend of the economic development tends to change
into a cyclical model.
Following this approach, the economy cycle, as defined by J. Schumpeter, would not be an unavoidable course of an economic system on the
way of its improvement; the development natural way is essentially linear. The cyclical trend of the economy would be rather a temporary
parenthesis, with respect to the compatible development course, auto-imposed by a system in crisis to start the correction of alteration
(instability) penalizing the economy. The economy, which develops through cyclical phases, should be considered therefore as a natural model
for the instability correction. This model, introducing the cycle on the development course, must be structurally able to restore the development
natural model. In other words, then it must be able to reduce over the time the system state of instability, so that it may gradually return to the
natural course of a linear and sustainable development.
The natural mechanism activating the development through the business cycle operates as a correction factor on the unstable economy, through
an events sequence following the dynamics described by the common experience. A specific dynamic that modify itself in direct correlation to
the severity of the system instability. In the case of low inflation (<25-30%), the cycle is following the usual model, with alternating phases of
recovery followed by brief recessions. With a persistent instability and high inflation, the economic cycle is modifying its profile, by gradually
accentuating the recessions frequency and duration. At the same time, the cycle is compacting the recovery phase, up to suppress it when the
hyperinflation stage is reached. 3
This behavior of the economy cycle is (almost) in synchronism with the inflation profile, which also has a cyclical character, strictly dependent
on the economy conjuncture. In other words, the so-called cyclical inflation is positive and accumulates structural inflation, during the phase of
the economic recovery, while during the recession phase it becomes negative and is pushing down the structural inflation. Therefore, during the
recession (extended, in case of high inflation), the cyclical inflation remains negative and it is operating as a de-multiplier for structural inflation.
4 I must note that during a system instability phase, structural inflation is assuming an ascending trajectory, according to the uniformly
accelerated movement of inflation. Similarly, during the correction of a system instability, the structural inflation is tending to become
descending.
3 The American economist P. Cagan argues that we should talk about hyperinflation when the price growth rate is exceeding the 50 per cent on a monthly basis.
4 For structural inflation or basic inflation, we mean the nominal price variations, accumulating inside an economic system now unstable. The cyclical inflation created by the parallel
economy cycle is accumulating during the positive phase of the business cycle. The overall inflation, so accumulated in the system, will integrate the structural inflation. Therefore, the
structural inflation grows with a rate depending on the economy instability degree. Experience shows that, when the mature stage is reached, the inflation adjustment is taking an
accelerated trend, which gradually becomes independent from the unstable economic environment. Since the run of inflation is directly related to the instability degree of the economic
system, then a growing trouble within the economy is opening the way to hyperinflation. On the contrary, the correction of the unstable condition, while reducing the economy trouble, it
is reflected also on the inflation run, firstly slowing the price impulse and then deflecting the inflation rate.
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Unstable Economy: Reflections on the Effects and Consequences in the Event of Deflation (The Case of Italy)
Therefore, the mechanism of the double cycle is connecting concurrently in parallel, the conjuncture and the inflation rate modulated by the
conjuncture itself. This mechanism should be configured tout court as an automatic natural tool for the correction of an economic system
unstable condition. Generally planned to protect the economy from instability dangers, this natural tool is activated also when the altered system
is taking the way of deflation.
About the issue of the behavior of the natural system to correct the instability, in case of a deflation trend, let now examine the hypothesis of an
economy struggling with a severe financial crisis. Following the parallel trend of the evolution experienced in the inflation case, the context of
an extended recession is promoting a concomitant cyclical inflation movement, so resulting negative. As negative inflation works with a
subtraction mode on the price level, over the time it is accumulating gradually within the economic system in the form of structural deflation.
Please note that nominal prices, during the speculative bubble explosion, are appearing with an apparent state of stability or lowering inflation,
because prices are subject to the deflationary tension imposed by the instability. When the explosion detonates causing the financial crisis origin,
a deep recession in conjunction with the cyclical inflation (negative) both are pushing prices downward. Therefore, the structural deflation is
consolidating more or less abruptly, rapidly eliminating the modest inflation remains still present before the bubble burst.
With the deflation achievement, a substantial influence is taken by the intimate and concomitant relationship between the recession intensity and
duration (economy down-cycle) and the negative inflation accumulation (caused by the cyclical inflation decline). The deepness and persistence
of the GDP fall are in fact the first cause of the deflation intensity on the price system. For this reason, any intervention wishing to be successful
in lessening the deflation grip should focus on the conjuncture withstanding.
The improvement of the economic condition, or rather the beginning of a recovery process, can affect directly the parallel cycle of inflation
driven by the economic situation, which consequently reduces or even cancels the creation of negative inflation. When the production of
negative inflation is interrupted according to the improving economy, then is diminishing or ceasing the price deflation. However, only with a
secure economy recovery, the gradual return of nominal prices to their pre-crisis value will be possible.
The traditional monetary policy seems to have only an indirect effect on the downward trend of the price system. The creation of new current
assets and credit support are showing to have a substantial impact to mitigate the sudden fall and the implosion of income. The stop to the cycle
of falling income and a potential economic recovery, however, must rely mostly on Keynesian spending policies, which -in this specific
condition- can really help to alleviate the depressed scenario.
As the economy is revitalized, or at least with the resolution of the recession implosion, the intimate link between the economy and the price
system could help to stop or even to reverse the declining trend of prices. In other words, the cooperation of the monetary and economic policy
in promoting the economic situation improvement appears able to stimulate a parallel improvement in the price system, which is revived against
deflation. This strategy, which is moving according to the Keynesian model to support investment and consumption, of course is facing some
limitations according to the size of the public debt and to the effects that the increase of public indebtedness beyond certain limits may have on
the economic growth.
Therefore, the scenario of economy instability seems to be dominated by the combined procedures of the economy situation cycle and inflation
linked to the economic cycle, in both cases potential: the instability is renewing the price inflation in the economy or it is slowing down the price
system toward deflation.
In a scenario of an economy after a significant shock (e.g. in the seventies the oil price increased four times), the following depression was
buffered in most countries with large doses of public spending. The resulting rebound of the economy cycle has fueled the inflation acceleration,
which was already evident by the end of the previous decade (late sixties). At that time, in Western countries and in Southeast Asia, before the
oil shock the usual economic cycle according to Schumpeter model (with recovery phases and short declines) accelerated structural inflation
through cyclical inflation produced by the distorted recovery.
Differently, in the case of recent financial crisis the economy is particularly fragile after the extended speculative boom. Because of the strong
contraction, the economy enters a tunnel of gradual deflation, which gradually cuts any step of inflation (usually low) present at the outbreak of
the financial crisis. During the instability, it is created a close link between the economy situation and the price level. With the outbreak of the
crisis, the deep recession is generating a negative economic inflation that operates in subtraction face to structural inflation. In these
circumstances, we start from a limit already close to zero on the price level. Therefore, the formation of cyclic inflation (negative) creates a
structural deflation that will accumulate inside the system.
It seems reasonable to say that, truly approximately, the discriminating factor for which the natural mechanism of the double cycle (economy
and inflation) moves toward increasing nominal prices (inflation), or vice versa in gradual decline (deflation) could be identified with that
dynamic force inside the economy, when the system is crossing the instability threshold. In the seventies, the strong growth of the economies
from North America to Europe, from Japan to Southeast Asia, was hit by the unexpected multiplication of the oil price. In those years of strong
dynamism, the anti-market error has been paid with the transition to the inflation condition.
For countries with a relatively weak dynamism, the attempt to force the development run through anti-market actions can activate an insane
speculative acceleration that makes the unstable system to fall in a structural deflation, difficult to control. The recent financial crisis extended at
a continental level, when a huge speculative bubble in real estate exploded, seems to have followed this last model. An implosion of the
economy development -recalling the early years of the '29 crisis- has forced to a strong deflation the most exposed economies in America and
Europe. Some exceptional and unconventional measures taken by major Central Banks, as well as Keynesian widespread policies have contained
the potential damages of a so devastating financial crisis.
There are then two roads, distinct and specific, which may take an unstable economy. Despite this asymmetry, we can see that the natural
mechanisms for the instability correction in the two different symptomatologies, are acting through contiguous procedures. These natural
mechanisms seem to consist in both cases (inflation or deflation) in an evolution of the contiguity relationship between the economy cycle and
the so-called cyclic inflation. Because of the mutual relationship between the two cycles, the instability intensification is due to an inflation
acceleration or, vice versa, to the deflation worsening. On the contrary, the resolution of the instability is promising the gradual mitigation of
inflation and deflation.
It seems reasonable to say, however, that the instability takes possession of the economic system through its natural mechanisms (economic
situation cycles), only when the anti-market attitude is persistent and the consequences are significant, as in the case of an abnormal growth of
public debt. In other words, the economic system is showing to possess a kind of elasticity on staying healthy, before the falling into the subworld of instability. Therefore, only after exceeding a defined threshold, the correction mechanisms, which are characteristic of the instability
state, begin to be active within the economic system.
Note that the direction taken by the correction natural process (inflation or deflation) is directed mainly to correct the economic system on the
financial side. Let say that we may largely attribute the economy instability to the concurrence of various financial factors (too much debt). The
instability would be essentially a mere financial trouble. This is the reason that could help us to explain why the corrective natural reaction is
involving always anomalous phenomena affecting the currency. In the second post-world war, the inflation or deflation phenomena often have
been linked to latent financial crisis, activated by excessive debt, or to financial crisis supplied by financial excesses, incompatible with the
economy state.
460
In summary, then, it would be the stressed state of the economy, to require a specific natural correction. The extended recession -a long declining
wave inside the economic cycle- seems to be the tool usually selected by the economic system in order to reduce the financial excesses, in case
of inflation or deflation. This approach can be considered as a consequence of the economic systems natural tendency to stability. It follows that
any action you would take to mitigate the consequences of the financial crisis, you should consider the parallel and intimate relationship existing
between economic cycle and the inflation/deflation. We are talking, in other words, about the relation between the recession and the ongoing
correction of the altered system.
For this reason, contrasting the natural procedure for the instability reduction with inappropriate maneuvers can bring to unexpected
consequences. With reference to some simplified cases, it may be recalled that, in the case of high inflation, the use of large doses of new public
expenditure to contain the recession, could promote an inflation acceleration and an instability increase. Differently, during deflation caused by
the financial crisis, the use of new public debt to moderate the recession implosion can be successful, because the rising economy will mitigate
the deflation grip. In the first case, in fact, the attempt to alleviate the economy destiny will collide hardly against the corrective action of an
extended depression. In the second case, instead, the economic situation improvement deriving from public support can attract also a deflation
alleviation, if public indebtedness should remain under control.
3.
Inflation series: is it stochastic or stationary?
The series of inflation in the long term has a stochastic trend. A trend, unplanned and uncertain, which seems to contradict the basic
characteristic of inflation that follows a predictable profile (when all intervention is absent) and is against the observed (relative) neutrality face
to the functioning of the economy under inflation.The common experience is confirming that, in an economic environment with alternating
periods of relative stability and inflationary pressures, the profile of inflation in the long run is irregular. The experience helps to confirm that
the inflation series is maintaining a random trend in the long run. However, the approach will be different if we split the whole period from the
end of Second World War to today, being careful to distinguish the stability periods from those affected by inflation pressures. With this
arrangement, the results can be quite different. In fact, the series of nominal prices during stability periods can be recognized as stationary.
Instead, we can identify the series of nominal prices related to periods of extended inflation with large approximation as a stationary series with
deterministic trend.
Given that a deterministic trend is a non-random function of time, we submit to analysis the hypothesis that the price profile, during prolonged
periods of inflation, is showing a growth tendency over the long term.
To verify the hypothesis that the nominal prices in the case of a long-term inflation would configure a stationary series with a deterministic
trend, we begin by observing the nominal price trend within the major Western and Asian countries. Let us have a look at the period from 1960
to the early 1980s, during which occurred worldwide inflationary pressures culminating in the seventies with the first and second oil shock.
Subsequently, the pressures on prices gradually were run out.
To the series of data on the inflation evolution during the period 1960-1980 for the major countries, we apply the Dickey-Fuller test, enhanced
(ADF) at the regression (1), as hereunder specified, to determine the series characteristics. The test results can be varying between two
alternatives: - in the case of a null hypothesis, (i.e. the trend is stochastic) the series has a unit source; - in the alternative, instead, the series has
a deterministic trend.
Yt =0 + + Y t-1 + 1Yt-1 + 2Yt-2 + 3Y t-3 + 4Yt-4 + 5Yt-5 +ut
(1)
We point out that:

-
Yt-1Yt-5 they are self-regressors with five delays of inflation

1. 5 they are unknown coefficients to be calculated
= ( 1-1) so 1 is <1 or 0 if Yt is stationary with deterministic trend
number of observations
coefficient to be estimated
Once applied the procedure of the ADF test to many countries of Western and Asian area, we obtained (among others) the following results:
Table 1. Result of the ADF test for the detection of the presence of a deterministic trend in the inflation time series
Countries
Test (ADF)
Australia
0,229
Japan
-0,982
New Zealand
0,136
Italy
0,941
Germany
-1,443
U.K.
1,079
Unites States
-1,764
Elaboration on IMF data from International Financial Statistics
For all countries under review, the table no.1 shows that the ADF statistic is always greater than the critical value. 5 Thus, it can be argued that
at the 5% level it is not rejected the hypothesis that the nominal price shapes in the period 1962-1980 is containing a deterministic trend,
according to the several cases examined.
Once supported the hypothesis that the nominal price movements are following a deterministic trend during periods of extended inflation, we
can focus on the inflation trend throughout the whole period between 1960 and 2000. In most Western and South-East Asia countries, within
the long period under observation we can recognize a turning point, quite evident, between the increase conclusion and the start of the gradual
decline in the nominal price trends. Well, this clear break imposed by the reversal of nominal price directions, could it be interpreted as a
structural break in time series of the long-term inflation?
Trying to answer to the above question, first we examine the profile of inflation within the countries listed in Table n.1, selected to check the
ADF test. Graph n.1 is giving a clear picture of the inflation motion rising during the sixties and seventies, and then descending during the
following eighties, with reference to five countries of Western Europe, with the addition of Japan and Australia.
We may see that the turning point is occurring during the first part of the eighties, after the second oil shock. In the eighties, in fact, there is a
reversal on the nominal price trends, which more or less gradually are gliding in the early nineties toward a low inflation (> 5%).
This trend, noticeably divergent, with a dividing line marked from the early eighties, seems favourable to the hypothesis that the inflation trend
in Western Europe and in the Far East under observation has suffered from a structural fracture. The abrupt curve change during the reporting
period can cause some forecasts distortion and therefore -if detected we should carefully consider the fracture in the estimation of the socalled out-of-sample pseudo-forecasts.
5 The critical value of the ADF test at 5% significance level is -3.41.
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30
USA
U.K.
Germany
France
Italy
Japan
Australia
25
20
15
10
5
2010
2008
2006
2004
2002
2000
1998
1996
1994
1992
1990
1988
1986
1984
1982
1980
1978
1976
1974
1972
1970
1968
1966
1964
1962
1960
0
-5
Graph 1. Inflation trend in key countries during the period 1960-2000
In the light of the evidence provided by the graph n.1, we would like to confirm - with an econometric mathematical model - the possible
presence of a structural break in the inflation trend for the period 1960-2000. Examination through the modified Chow test (QLR) and the
research results are reported in the following chapter 5. We have extended the research to the G7 countries, along with Australia and New
Zealand.
Once verified the presence of a structural break in the inflation trend, the Chow test can provide a substantial support to the thesis concerning
the inflation nature. For all the above exposed, in general we can define inflation as an episodic process (although frequent) intended as a
temporary alteration of the stability natural condition of an economic system. In other words, the breakage in the inflation trend affecting the
whole economy on a continental level can be considered as the way, though impervious, to the progressive return to the natural state: a gradual
process of returning to the stable state, seconded by the tendency to stability of the economic systems. The concept of inflation, with episodic
and transitory nature, seems to support the hypothesis that there would be a clear discontinuity, not only conceptual, between a stable system
and a system subject to inflation, so that the first one could never appear in the other system.
The stable condition requires by definition that the system is not subject to structural inflation and, therefore, it is following a course of linear
development. A compatible natural growth condition of the economy, therefore, could not suffer from the typical alterations developed in an
unstable system. Therefore, a condition unfamiliar and unusual for the healthy economy is the inflation state, which instead is subject to the
sinuous motion of the economy cycle and to the emergence of a parallel inflation cycle.
Consequently, it is somehow reasonable to say that a real structural failure can occur when an economic system after prolonged inflation,
gradually eliminates all the residual inflation remains to return to an almost stable condition. The passage toward stability generally is requiring
a long time and it is a sort of precarious position, which will end if during this period of transition there would not be any fall into the errors,
which are responsible for the economic instability suffered. In this transition period, the economic system continues to be subject to the
irregularities typical of an inflation condition. In other words, it continues to suffer from the cyclical movements of the economy and inflation.
These phenomena will dissolve only with the establishment of the stable condition.
4.
The recession and deflation under the blows of a financial crisis
After a period of widespread inflation during the years 1960-1980, the following eighties saw a decade of gradual disinflation and the nineties a
decade of relative stability. The world economy context becomes more complex in the new decade. Incubated in the United States but later
extended to the whole West and Japan, speculative waves were developed in sequence, starting with the crisis of the so-called new economy,
continuing with the cost of oil and raw materials rising until the recent real estate explosion and subsequent severe financial crisis.
In conjunction with this series of speculative finance episodes, the price movements within the major countries has shown a creeping tendency
to deflation. Following this trend, the tendency in nominal prices demonstrated an unusual insensitivity facing the relentless raw materials price
trend in the Western area. With the outbreak of the financial crisis in 2008 then, after the implosion in the real estate sector, the weak trend of
prices has changed significantly in evident deflation, in conjunction with the severe recession that hit the world economy.
In the first decade of the new century, therefore, it is reasonable to argue that there has been a deflationary trend. An unperceived and
underestimated trend, because ambiguously it seemed to imitate an environment somehow similar to the stable condition of the economy (low
inflation). Nevertheless, this underestimation was also due to the persistent memory of the inflationary growth long wave. In practice, then, the
real deflation was partly masked within Western countries by the economic situation, supported by succeeding speculative waves. During
which, the impact of the increase in oil and commodity price levels was undeniably low. With this economic environment surreptitiously
overheated by the speculative pressure, the Western area countries and Japan were with a very low inflation (between 4 and 1%) on the eve of
the outbreak of the real estate speculative bubble. All that, even though the speculation had pushed the oil and raw materials price to very high
levels.
462
9
8
USA
U.K.
Germany
France
Italy
Japan
Australia
7
6
5
4
3
2
1
2010
2009
2008
2007
2006
2005
2004
2003
2002
2001
2000
1999
1998
1997
1996
1995
1994
1993
1992
1991
-1
1990
-2
Graph 2. Inflation trend in USA, UK, Germany, France, Italy, Japan and Australia during the twenty years 1990-2009
In spite of appearance (almost stability in prices and weak economic situation), this ambiguous economic environment linked to the speculative
evolution, seems to be the result of an extended instability and the prelude to a deflation that was just waiting. At the 2008 outbreak of the
financial crisis, the real economy situation became clear, so bringing the collapse of the frail house of cards (toxic assets created by the
speculative finance in real estate sector), which somehow had nourished speculation. In other words, the recent crisis of 2008-2009 has imposed
a clarification and simplification of the economic environment that dissolved and nullified the false values created by the speculative bubble.
This realism effort on the economy state has seen the work of the natural combination Depression-Deflation, which as a main concern is tending
to remove all financial excesses created by the economic system instability.
The recurring sequence of speculative bubbles and financial crises have serious effects on the economic environment evolution. Even more
devastating are the social consequences resulted from protracted instability, which occurred all along the last decade, mainly because they
exacerbate inequality in the distribution of prosperity, so damaging the less protected social classes, as they are more exposed to the risks of job
loss.
The phenomenon related to the recurrence of speculative waves, is suggesting that the economy at a continental level has suffered from a
prolonged instability. It is still unclear whether the 2008-2009 severe financial crisis, which hit the world economy, could have represented the
extension of an adjustment process for a gradual return to stable condition. Instead, if we can still expect some future speculative events,
because the recovery process of the instability in the economy is not yet completed.
As already mentioned, the instability is a temporary condition and then precarious, since the economic systems are subject to a hypothetical
permanent attraction toward stability. On the other hand, there are no doubts about the validity of the hypothesis that economic systems are
tending to stability, which can be defined as the necessary condition that over the centuries has ensured the human civilization development.
Because of this attraction toward stability, a sort of economic body DNA, we can assume that inside an unstable system it is necessary to
activate a recovery mechanism that over the time should be able to restore the natural condition for a compatible development. A compatible
economy evolution, regardless of human recurring errors, has been realized through the centuries on the fundamental assumption that the
economic system is protected by a natural mechanism, able to reduce the errors effects and, therefore, to facilitate the return of the economic
system to the normal stability condition.
If we consider the abovementioned, it seems reasonable to assume that, in the case of protracted instability, the restoration of the condition for
the compatible development is requiring an adaptation of the very own mechanism of economic systems development. A transitional adjustment
that involves a new cyclical dimension of the economy, to bring the correction factors of instability to play a part. Therefore, a specific
condition, which includes a cycle of economic activity and, in parallel, a cycle of inflation (or deflation) linked to the rhythm -even cyclicalrelated to economic development.
Recent experience seems to confirm the theory of the cyclical dimension involving the unstable economy into a prolonged recession. Recession
that, in turn, is imposing a so-called cyclic deflation, which accumulates inside the system creating a structural deflation. The phenomenon of
the cyclic deflation creation, and then the accumulation of structural deflation, is persisting concurrently to the intensity and duration of the
recession. Because of the intimate relationship developed between the economic cycle and the deflation cycle, deflationary fall in prices
becomes lighter and gradually dissolves when the economy cycle is renewed and the recovery is resumed. In any case, the removal of the
deflation tendency from the system requires the real restoration of stability in the economy. The return to stability then is corresponding to the
gradual dissolution of the cyclical dimension of the economy.
This intimate relationship between the economy in recession and the deflation, within a post-boom context, could offer therefore the
opportunity to operate active fiscal policy choices, in order to control the depression intensity and to limit the deflation impact. In fact, we
should remind that the impulse produced by the impact of a new deficit public spending seems neutral on the destiny of deflation, which
actually is a traumatic effect of a deep recession. The link between economy and inflation (or between recession and deflation) is excluding a
triangular relationship that would include also, in addition to the binomial economy-inflation, the public indebtedness variable. There is anyway
an important exception for those systems, which have accumulated an excessive public debt: for these systems, a triangular connection with the
three variables is verifiable. 6
The issue of a triangular connection with the three variables (conjuncture, deflation and public debt) will be analyzed later.
463
Therefore, if strong injections of public spending could help to curb successfully the economy fall and along the time to assist the recovery, the
link between the economic cycle and the inflation (or deflation) cycle should induce - as a result of the economic resurgence- a proportional
reduction of the cyclical deflation.
After these short premises, in the following pages we can explore as much as possible, the phenomena related to the instability and caused by
extended financial excesses in the public sector. Essentially, an economic system seems to become unstable also when the indebtedness is
becoming too high and unsustainable for the economy dimension. In a system long living beyond own resources, the dependence on increasing
debt becomes chronic, so producing a weakening of the development potential. Because of this addiction to debt, it is reasonable to assume that
the growing instability is dragging the economy into a crisis that, in practice, acquires the role of correction and removal of the "virtual"
economy portion created by the debt excess.
The phenomenon of excessive public debt may cause events similar to those created by the speculative excesses, finally resulting in a financial
crisis. The recent experience after 2008-2009 financial crisis, demonstrates that an excessive public debt (i.e. higher than a certain limit in
relation to GDP), does not degenerate into those events typical of a post-speculative crisis. However, there will be an almost speculative
precondition with some affinity elements with the financial crisis following a large speculative bubble.
The case of Italy is somehow emblematic. In the nineties, in view of the entrance into the Euro, the Beautiful Country has implemented
policies for the gradual reduction of public debt. However, the public debt very slow descent profile has hampered the ascent dynamics, but
didnt allow to compress it below the threshold of potential instability. It remained then at a worrying level above the 100% in relation to GDP
in 2000, the starting date of the European single currency. Just a few years later, the public debt resumed its ascendant course until to touch
quota 114% in relation to GDP, on the eve of the 2008-2009 great crisis. Being entangled in a severe double recession, the Italian economy has
increased the debt volume related to GDP (over 130% at the end of 2012), mainly due to the retreat suffered by the national income under the
blows of the prolonged depression.
It is interesting to note that in the nineties, when the public debt exceeded the threshold of the 90-100% of GDP, Italy has registered a drastic
downsizing of potential growth, previously very high during the post-war years and until the eighties.
On the issue of the possible relationship between economic performance and public debt trends, the Italian case has some similarities with the
problems affecting Japan. The Land of the Rising Sun has a prodigious acceleration history of the economic development during the post-war
period, which abruptly ended after the severe financial crisis started in the early 1990s, with the bust cycle in the construction sector and the
stock market decline. The shadow of this crisis lasted for more than two decades, leaving the legacy of the economy strong deflationary trend.
During the first decade of the millennium, deflation has pushed down the price system (in 2002: -0.9%); contraction that government has tried
to alleviate through a massive increase in public spending, so that at the end of 2010 the Japanese public debt was exceeding the 220% in
relation to GDP.
This story is not equivalent to the story of Italy, nevertheless has some affinities for the co-presence in both countries of a high public debt and
low economic growth for more than ten years.
We note that the equation more public debt to support the economy has not been successful in Japan, nor for economic revitalization nor to
overcome the deflation tendency. Therefore, we can theorize that the Japanese financial crisis of the nineties has not been resolved yet, because
the correction (recession) of the altered system has been hampered. Its worth to mention that after the bust of the speculative bubble in the
early nineties, the Japanese economy didnt enter into recession. The growth slowed sharply becoming anaemic but a significant retreat occurs
only in 1998 (-2.5%), due to the financial crisis involving the Southeast Asia tigers.
Subsequent efforts in Japan to overcome the anemic state of growth, with injections of public expenditure and exuberant public debt, may have
played an additional role contrasting the economic stability restoration. Therefore, we may argue that the Rising Sun economy has lived for a
long time together with a latent financial crisis.
5.
The theory of structural breaks in the growth trend and possible outcomes of excessive public debt
Now, let us ask the following question. In the case of latent financial crisis, how do move the economic cycle and consequently the parallel
inflation cycle? To get some indication, let us in the meantime verify whether in the history of the countries with a period of high public debt
there would be a point, a time limit marking the start of the suffering state, and then of the economy unstable state.
The economy seems to enclose a natural resistance to abandon the stable condition so shifting in the sub-world of the unstable state. It seems
therefore reasonable to assume that, only when the threshold of financial compatibility is exceeded, the economy reaches the instability level.
Rebus sic stantibus, the transition point between stability and instability should be measurable in terms of time, for the changes in terms of
efficiency and economic growth. These changes should be not only genuine and measurable but also relevant for the variation of the potential,
expressed in periods of normality and economic stability.
With sudden and persistent changes to the efficiency of an economic system, some real structural breaks could occur in the development
profiles: so these breaks can be detected through a joint examination of the time series for the key economic variables. To verify this theory, it
seems appropriate to compare the GDP performance, the related inflation change and the progression sustained by the public deficit and the
cumulated debt.
Following this approach, we plan to verify the theoretical supposition about structural breaks in the development profile for various countries of
the Western area and Asia. We underline that the estimate of a possible structural break in the economic trend of a country, is examined in order
to verify a possible connection to some kind of public debt, chronic and excessive, which could have pushed the economic system beyond the
instability threshold. In fact, the economic system instability, when dependent on public debt in excess, is assumed as a possible cause of
extensive decline in the potential and economic efficiency.
The presence of structural breaks in the economic growth profile could help us to identify the year when the breakage occurred, namely when
the efficiency loss of the system has become significant. Obviously, for a proper comparison, we will verify the countries that have forced the
public debt dimension to support the economy as well as those countries that have dosed with sobriety the public indebtedness. In so doing, we
should discover structural breaks in the countries unstable for a high volume of public debt, differently from the sober countries for which the
structural breaks theory is probably rejected.
After these premises, we can go hereunder to the procedure followed for the estimation of structural breaks that we suppose may depend on an
exuberant and chronic public debt. To verify this theory we used a function of the following type:
GDPt = 0 + 1GDPt-1 + 2 GDPt-2 + 3 GDPt-3 + 1Inf t-1 + 2Inft-2 + 3 Inft-3 + 1 Debpt-1+ 2 Debpt-2 + 3 Debpt-3 + 0Dt () +
1 [D t () GDPt-1] + 2 [Dt () GDPt-2] + 3 [Dt () GDPt-3] + 4 [Dt () Inft-1] + 5 [Dt () Inft-2] + 6 [Dt () Inft-3] + ut
(3)
464
We note that:
-
GDPt-1GDPt-3 are self-regressors with three delays in the annual variation of the GDP at constant prices
Inf t-1. Inft-3, Debp t-1. Debp t-3 are regressors with three delays of two predictors: respectively, the inflation and the public deficit
1 3, 1. 3, 1 3, 0. 6 are unknown coefficients to be calculated
D() is a binary variable equal to zero before the structural break and equal to one after the structural break
is the year in which the theorized structural break occurred
The assessment focused on the main countries in America and Europe: United States, Germany, France, Italy and Great Britain. For the Asian
continent, the research included Japan and Thailand. In addition, Australia. For all, the survey covers the period 1969-2010, a period
characterized by a wide variety of conditions in terms of inflation, potential of the economy, public debt developments.
For the countries concerned, the post-war high growth during the seventies has suffered from the effects of oil price shocks, which have
stimulated and widespread the inflation. During the eighties, with a dissimilar determination, the countries under review did start on monetary
policies to control inflation, which gradually settled down at an all-time low during the nineties. Since the nineties Japan and then from the
following decade many European countries have suffered from a decline in potential and a creeping tendency to deflation. The Land of the
Rising Sun, in particular, has experienced a deflation tendency for over ten years; its still unclear if, after a further weakening of monetary
policy and a striking public spending program sponsored by the Abe government, the country could finally escape from the deflation grip.
Regarding the United States, in the nineties the profile of the USA economy has diverged from Europe and Japan, with strong gains in
performance and productivity as well as reduction of the public indebtedness. This energy of the USA system, however, has encouraged
speculative bubbles in the last decade.
Defined in this way though really in brief- the economic situation of the examined countries, we propose to determine the following
objectives:
The chronic accumulation of public debt large doses may be responsible for a strong decline in economic potential.
The economy unstable condition, linked to the excess of public indebtedness, may have encouraged the deflationary tendency, which is
entering strongly in the global scenario?
The check on the major economies trend seems to show that the supposed structural break, in countries with high public debt, could have taken
place during the eighties: a decade marking the turning point for policies real change. The accommodative monetary policy of the previous
decade is inhibited during the eighties, due to a growing unwillingness toward inflation. The greater monetary rigidity, however, was balanced
with fiscal policies to support the economy. In this way would be created the conditions for the strain of the economies under the heaviness of a
growing public spending, which could have opened the access to a progressive instability of economic systems.
As already said before, the search for the eventual presence of structural breaks in the trend relies on the modified Chow test (QLR), assuming
that it is unknown the year when the structural break occurred. The test is utilizing the largest F statistic resulting from the processing of the
function (3) with the use of the data series for the period 1969-2009. Although the date of the supposed break on the growth trend profile is
unknown, it seems reasonable to argue that the eventual break should have occurred in the period 1986-2000, with particular reference to the
growth trend profile for the economy in Italy and Japan during the last fifty years. The endnote i shows the GDP graph in Japan and Italy during
the period 1955-2009.
The results of the modified Chow test (QLR) are exposed in Table n.3, reported below. For more evidence of the outcomes exposed in this
table, the graph n.3 is showing the F-statistic performance for the years 1986-2000 with reference to Italy and Japan, the two countries for
which the test seems to confirm the theory of structural breaks.
Table 3. Results of the modified Chow test (QLR) to verify structural breaks in the economy growth trend in some countries
Paesi
Test QLR
Italy *
1994
Germany
-
U.K.
-
United States
-
France
-
Japan
1995
Australia *
-
* The inflation series is differentiated in order to make deterministic the trend used in the equation (3)
F Statistic for the years 1985 - 2000 in Italy and Japan

14
12
10
8
6
4
2
0
86
87
88
89
90
Italy
91
92
93
Japan
94
95
96
97
98
99 2000
Critical value
Graph 3. F statistic to verify structural breaks of the performance in Italy and Japan
Elaboration on IMF data - Along the axis of abscissae there are the values of the F statistic
New Zealand
-
465
As mentioned above, the investigation about the possible presence of structural breaks in the GDP series -with the help of the related predictors
included in the equation (3) - aims to confirm the theory that excessive debt converted into chronic leads to exceed the instability threshold for
the economy. Through the equation (3), it has been possible to identify -with relation to Italy and Japan- the date of the presumable structural
break, marking the beginning of the system potential instability. This date seems to certify that in the two countries under review there has been
an economy variation toward a performance constant decline. At the same time, we can notice a creeping tendency to deflation -connected to
the system weakness- in these countries so subject to structural break, and which are showing the scars of a latent financial crisis due to
excessive public indebtedness.
In summary, the functional and structural weakening of an economic system can be settled up over the time by the tendency to live beyond own
resources? The survey seems to give strength to the theory that, in the configuration of chronic (public) indebtedness, the system enters into a
sort of latent crisis limbo, with similar phenomena, though weaker, to those experienced with severe instability and post-boom financial crisis
(cyclical trend of the economy and tendency to deflation).
About the calculation methods, it seems appropriate to specify that the results of the Chow test (QLR), shown in table n.3, are verifying the
breakage eventualities of the GDP profile in a period between 1975 and 2003. Therefore, the upper and lower ends of the observation period are
excluded, as they are subject to truncation to ensure the outcome efficiency. 7 As earlier mentioned, the data monitored by the equation (3) are
including a period of fifty years, from 1969 to 2009. The critical values of the QLR statistic -with a truncation at 15% and a number of
restrictions q (equal to the number of coefficients or delays, including the intercept, which may be subject to breakage)- are taken from Andrews
(1993). In the case of the equation 3 (q= 4 at the 5%), the critical value is 4.09.
From the graph n. 3, we can observe the F-statistic profile for the two countries, Italy and Japan: these profiles are showing visually the concrete
possibility of structural break on the GDP line, anyhow much deeper for the Country of the Rising Sun. The observation period exposed in
the graph n.3 goes from 1986 to 2000, during which the phenomenon reaches its greatest incidence.
Both countries, Italy and Japan, would have suffered from a structural break, due to a sharp decline in their performances of 1994 and 1995
respectively. During our analyzed period, Germany, USA, England, France, Australia and New Zealand, nevertheless, would not suffer from
structural crisis. For the six countries above listed, the F statistic during the examined years always remains below the critical value (4.09),
again presuming a truncation of the 15%.
It should be noted that, in the formulation of the equation (3), we have accepted the thesis outlined above, that the GDP trend and the cyclical
inflation (which, by the way, is included in the structural inflation trend) have a trend positively correlated (the increase or decrease of one is
inducing a parallel and correlated movement of the other). On this basis, the equation (3) comprises both the two variables among the
intermediation factors. It is assumed that, in the case of the economic system unstable condition, the coordination occurring in the evolution of
the two series (GDP and inflation) should provide some additional information for the outcome validity.
In other words, we can assume that inflation is an additional factor that, directly or indirectly, could influence the change (break) suffered by the
performance of the primary variable (i.e. GDP). In this relationship -defined intimate- between GDP and inflation, the unexpected third party is
the stress imposed by a great public debt over an economic system; moreover, this stress appears to influence both the growth factor and the
price dynamics.
On this basis of potential relations between the two variables GDP-Inflation, the second part of equation (3) -representing the intermediation
factors- contains the changes affecting both the GDP and the Inflation, as indicated here below:
< 0Dt () + 1 [Dt () GDPt-1] + + 3 [Dt () GDPt-3] + 4 [Dt () Inft-1] ++ 6 [Dt () Inft-3] >
We have used for the intersections with the binary variables only those variables considered suspicious, namely those somehow contributing to
the breaking situation of the GDP line. Please note that in order to assess the impact on the result of the binary variable [Dt () Inf] with three
delays, we tested the theory of a zero value for coefficients 4, 5 and 6 or, alternatively, of their consistency. 8
With this background, let us return to the graph n.3 that, as already said, is showing the performance profile of the F statistic derived from
equation (3) for Japan and Italy, for the period 1986-2000. According to the test, the break for the two countries in the GDP profile occurred in
1994 for Italy and in 1995 for Japan. From the date of the breaking, the performance of both countries has been sharply reduced and this
condition is still unchanged since then, while the public debt volume is increasing substantially in Japan, more gradually in Italy. In fact, the
public debt to GDP ratio increases from 92% in 1995 to 218% in 2009 for Japan, as it passes from 121% in 1994 to around 120% in 2010 for
Italy. During the period 1995-2010, the annual average of gross domestic product reached the 0.8% for Japan and less than 1% for Italy.
For the other countries under review, however, we can exclude the hypothesis of the performances structural break during the eighties and
nineties period. In fact, the comparison, specifically in terms of public spending policy, is showing some differences. In particular, France and
England have experienced in the seventies and early eighties a high inflation, similar to that of Italy and Japan at that time. However, the public
debt of the two countries remained well below the structural break edge. At the end of the nineties, in fact, reached the 40% in England and the
58% in relation to GDP in France, to raise up, respectively, to 51% and 67% on the eve of the great financial crisis. Similar considerations may
On the issue of truncation, it should be noted that for a good accuracy about the large samples of the QLR statistic distribution, the ends of the sub-sample, between 0 and 1, could not
be too close to the ends of the sample (i.e. 1969-2009). For this reason, the QLR statistic is calculated on a truncated interval, subset of the sample. With a truncation at 15%, then fixing
at 0,15T = 0 and 1 = 0.85% T, the F statistic is calculated at 70% as the central sample.
8
Equation (3) includes, inter alia, the interaction of the binary variable Dt () inf with three delays. The hypothesis is that the variable "Inf" is suspicious, namely that in some way
this interaction contributes to the determination of structural break. An eventual positive result can confirm for certain countries the hypothesis of a structural break in the "GDP" data
profile, linked to inflation trend. To do this, it is necessary to verify the combined hypotheses that the coefficients 4, 5 , 6 of the delays of the binary variable Dt () Inf are at a zero
value, against the alternative that they are consistent. So we can express these hypotheses as follows:
H1 : 4 = 0, 5 = 0 e 6 = 0 against H2 = 4 0, 5 0 e 6 0
Given that the combined hypotheses are imposing three restrictions, we use the Bonferroni test* for the control of the critical values of each t-statistic regarding Italy and Japan. In the
table n.4, we report the test results with reference to the year of GDP profile breaking (1994 for Italy and 1995 for Japan).
t-statistic Italy
1 = 1,91
2 = -2,76
3 = 3,03
t-statistic Japan
1 = -0,70
2 = 3,93
3 = 0,57
Table 4
critical value of Bonferroni test at the 5% level with 3 restrictions
2,394
(in absolute value)
* The Bonferroni test rejects the null hypothesis, supporting instead the alternative both for Italy and for Japan. The results are confirming that the coefficients of the interaction of the
binary variable Dt () inf with three delays are consistent. In particular for Japan, only one of the coefficients of the t-statistic related to interaction is greater than the critical value of
the Bonferroni test (see also endnote ii).
466
apply to the United States, which at the end of the nineties had a public debt equal to 61% of nominal GDP, gradually rising during the
following decade. Definitely more virtuous at this regard the other two countries under review, namely Australia and New Zealand. 9
The foregoing considerations are all based on the assumption that the supposed dependence of the structural break, found in the GDP profile for
only two countries of those under investigation, could come from the excessive public debt.
In support of this thesis, we verified whether the presence of the "public debt" predictor with three delays in the equation (3) is providing or not
a valid contribution to define the results, as exposed in Table n.3. To assess the weight of the "public debt" predictor in the equation (3), its
necessary to ascertain whether the coefficients 1, 2, 3 of the three delays of the "public debt" series in relation to nominal GDP, are null,
and consequently with a zero contribution to the result. Otherwise, it could be valid the alternative where the coefficients are from zero.
As well explained in the endnote ii, the null hypothesis is confirmed if the test involves the complete sequence for the data of the entire period
from 1969 to 2009. Otherwise, it is rejected in favour of the alternative ( 0) but only for Japan and Italy, if we restrict the survey period from
1992 to 2009 for Italy and from 1995 to 2009 for Japan. A result anything but unexpected, because is justified by the fact that during the
nineties, both in Italy and in Japan there has been an increasing of the public debt run, so overcoming the 90-100% in relation to GDP. The
public debt trend was slowed down then in the case of Italy since 1996, in view of the entrance in the common European currency, while
remaining beyond the above-mentioned limit. The public debt instead raised up rapidly in Japan, as already mentioned.
Therefore, according to this approach redefining the temporal limits of the survey, the "public debt" predictors with three delays have given a
concrete contribution to the result of the equation (3). At least, regarding those countries where the public debt has reached the 90-100% limit in
relation to GDP, beyond which is reasonable to believe that the economic system would become unstable.
Therefore, the behaviour of the "public debt" variable in its relations with the major macro-variables seems to change as consequence of the
public debt volume. When the debt extent is exceeding the threshold conducting to instability, inside the economy there will come out some
adverse effects penalizing the system efficiency. Under normal conditions and anyway below the above mentioned threshold, instead, the use of
public debt to support the economy, basically could be qualified as neutral, because it doesnt interfere directly and immediately on the
economy destiny and on the nominal price trends.
Within an economic situation of inflation or deflation, this public debt neutral configuration in relation to other variables, meaningfully, does
validate a close and almost exclusive relationship between the economic trends and the inflation profile. Moreover, in this specific sub-world of
instability we can verify the existence of another relationship, additional and transitory, occurring when the "Public Debt" variable exceeds the
threshold of 90-100% in relation to GDP. Actually, we can witness a crucial change in the mutual relations between the studied variables (GDP
and Inflation). In particular, we will observe the progressive interference produced by excessive public indebtedness on the efficiency and on
the development potential of the economy, as well as on the inflation speed.
In this case, a mutual relations triangle is configured with the three variables: economy, inflation (or deflation) and public debt. In fact, the
presence of a negative third party (the public debt above the threshold), becomes responsible for the economic performance deterioration and
for the emergence of a creeping inflation. However, the above considerations are allowing only a short explanation about the consequences of
the mutual play between a high "Public Debt" over the threshold and a tendency to "Deflation", which in combination seem to contribute to
weaken the economic growth capacity.
6.
Final remarks
The long-term configuration of public debt in Japan and Italy, in comparison with the other G7 countries, is suggesting that in these two
countries the excessive public debt persistence has been the source of anomalies in the behaviour of other variables. Such a configuration would
be responsible for the observed structural break in the correlated series of GDP and Inflation. The structural breaks presence on the system
efficiency side, then is making reasonable to assume that when the debt threshold (>90-00% relating to nominal GDP) is violated, a negative
interference would alter the economic growth and the inflation profiles.
As already mentioned, the pressure on the economy of an excessive public debt would cause the phenomenon of the potential weakening, also
accompanied by a creeping tendency to deflation, which concurs to depress the system efficiency. At this regard, we recall that during the great
financial crisis in 2008-2009, the majority of affected countries suffered from a sharp deflation imposed by the deep recession, which followed
the boom collapse in real estate sector. We note also that during the long period of insane speculation, the tendency to deflation was anticipated
by a remarkable phenomenon. During the boom, the countries later hit by a severe financial crisis showed a misleading (almost)-stability of
their economic systems, with inflation declining and generally low.
A similar phenomenon, with a gradual erosion of the inflation rate, is also evident in countries with a persistent public debt over the threshold.
When the economic system is in this long period configuration, there is not only a change in the economic cycle with a structural weakening of
the recovery phase: also the nominal prices are slowing in parallel with anorexic growth, as a direct consequence of the link between the
economic cycle and the so-called cyclical inflation, when a system is unstable.
In short, in a configuration estranged by a persistent public debt, we can observe that the unstable economy remains subject to opposing forces
on the price side. The liquidity injected into the system by the progressive growth of public spending may lead to a slight upward pressure on
nominal prices. However, the unstable condition of the system, due to the current financial crisis, is activating a tendency to price deflation. The
combination of the two conflicting marks, the slight upward pressure on prices and the tendency to deflation, is witnessing this last prevailing
over the medium term, due to the weak strength of the economy. Therefore, in this unstable condition the inflation inside the system is tending
to decrease.
According to the analysis summarized in the previous pages, in the period 1995-2009 the persistent deflation in Japan -in parallel with the GDP
low profile- could be due, at least in part, to the public debt exuberant growth. Financial instability inherited from the after-effects of the
enormous speculative bubble in the early nineties, its presumed that not only would not have been treated properly but also would have taken
strength for the uncontrolled public debt.
The Italian syndrome, somehow similar, would be less acute thanks to the weak attempts to contain the accumulation of public debt on the eve
of euro coming and during the euro early years. In any case, the Italian public debt remained for almost 20 years (1992-2009) over the threshold
of the system instability.
In the context emerging after the severe financial crisis of 2008-2009, its outlined a probable division of the world's economies into two main
areas, the Euro-American together with Japan on one hand, and the Asian together with Australia on the other hand. The two major areas are
subdivided in relation to their performance and inflation. The first area is close to or already exceeded the instability threshold, due to the sharp
increase in public indebtedness incurred to mitigate the effects of post-crisis depression-deflation. Therefore, in the area there is a condition of
relative instability appearing responsible for the pale economic situation and for the economy deflation tendency. The second area -thanks to
The public debt of the two countries, Australia and New Zealand, at the end of 2010 was respectively of 32% and 20.5% in terms of GDP.
467
the impetuous growth of the economy in the large continental nations, China and India- has been able to keep under control the public debt and
does not seem to suffer from performance fatigue and deflation tendency.
In particular regarding China, it is worthy of attention its economy growth still quite strong, driven by the boom in investments. According to
the considerations above summarized, an indication about the economic situation outlook and the development potential in China could come
from the profile of nominal price tendencies in the near future. In theory, we could suppose that the inexhaustible strength of the Chinese
economy growth would drag a limited rise in nominal prices. In this case, the growth profile will continue to be connected to the worlds
economy trend. However, if in the near future a deflationary trend would tend to prevail, with a gradual decline in nominal prices, we can
suppose that China will be struggling with a boom that could lead to a possible financial crisis.
Acknowledgements
Acknowledgements section is optional and it can be placed before references section.
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Endnotes
i
Trend of Economy growth in Japan and Italy

20
15
10
5
-5
1955
1957
1959
1961
1963
1965
1967
1969
1971
1973
1975
1977
1979
1981
1983
1985
1987
1989
1991
1993
1995
1997
1999
2001
2003
2005
2007
2009
0
Italy
Japan
-10
Graph n.1a GDP Trend in Japan and Italy from 1955 to 2009
468
ii
Equation (3) includes the predictor "public debt" with three delays. The question relates to any additional information that the regressor "public
debt" is providing, so contributing or not to the result. An eventual positive result can confirm for certain countries the hypothesis of a structural
break in the "GDP" data profile, connected to excessive indebtedness. To this end, its necessary to check the joint hypotheses that the
coefficients 1, 2 , 3 related to delays in the "public debt" regressor, are null against the alternative that they are consistent. So we can express
these hypotheses as follows:
H 1 : 1= 0, 2 = 0 e 3 = 0 against H2 = 1 0, 2 0 e 3 0
Considering that the joint hypotheses are imposing three restrictions, we use the Bonferroni test * for the control of the individual t-statistics
critical values, regarding Italy and Japan. In the table n.1a, we report the test results with reference to the entire review period from 1969 to
2009. The results do not confirm that the "debt" regressor coefficients are consistent, with the exception of only one coefficient in the case of
Japan.
t-statistic Italy
1 = -1,47
2 = 0,102
3 = 0,85
t-statistic Japan
1 = 0,15
2 = -2,47
3 = 3,17
Table n.1a
Bonferroni test critical value at the 5% level with 3 restrictions
2,394
(in absolute value)
Therefore, we have limited the investigation to the period 1991-2009 for Italy and 1995-2009 for Japan, in order to ascertain the Bonferroni test
behavior over a period of time during which the public debt in the two countries has exceeded the 90-100% threshold. In particular, Italy's public
debt followed a controlled progression while in Japan touched the doubling at the end of 2009. The results are shown in Table 2a.
t-statistic Italy
1 = 4,65
2 = -0,94
3 = -2,74
t-statistic Japan
1 = 3,19
2 = -4,03
3 = -1,26
Table n.2a
Bonferroni test critical value at the 5% level with 3 restrictions
2,394
(in absolute value)
With the limitation of the period under observation, the Bonferroni test is rejecting the null hypothesis in favour of the alternative for both Italy
and Japan. Thus, it is confirmed that for both countries the "public debt" regressor values are contributing to the result formation of equation (3),
during the exceedance period.
-------------------------------------* The Bonferroni test for the joint null hypotheses 1 = 1,0 and 2 = 2,0 based on the critical value c> 0 follows this rule: "does accept the null
hypothesis if t1 c and if t2 c; otherwise does reject it". Please note that:
- t1 and t2 are the t-statistics to verify the restrictions on 1 and 2 ;
- The critical values c of the individual t-statistics in a Bonferroni test of joint hypotheses, are distinguished according to the number of
restrictions and to the level of significance.

Unstable Economy: Reflections On The Effects and Consequences in The Event of Deflation (The Case of Italy)

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Unstable Economy: Reflections On The Effects and Consequences in The Event of Deflation (The Case of Italy)

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Int. j. econ. manag. soc. sci., Vol(4), No (10), October, 2015. pp.

International Journal of Economy, Management and Social Sciences

Copyright 2015. All rights reserved for TI Journals.

Unstable Economy: Reflections on the Effects and Consequences in the

Giovanni Antonio Cossiga *

Stability and instability of economic systems

Giovanni Antonio Cossiga *

Inflation series: is it stochastic or stationary?

We point out that:

Yt-1Yt-5 they are self-regressors with five delays of inflation

Elaboration on IMF data from International Financial Statistics

The recession and deflation under the blows of a financial crisis

Giovanni Antonio Cossiga *

Giovanni Antonio Cossiga *

F Statistic for the years 1985 - 2000 in Italy and Japan

Giovanni Antonio Cossiga *

Trend of Economy growth in Japan and Italy

Giovanni Antonio Cossiga *

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