Europe might be confronting a “long dip”, rather than a “double dip”. The weakness of the euro area economy during 2002 and the concomitant persistence of inflation can be easily explained if one starts from one key fact: productivity growth has slowed down to a snail’s pace. The deterioration of productivity growth can explain both weakness of domestic demand (consumers and investors will spend less if the future looks bleak) and inflation (at given wage increases lower productivity means higher prices). As it is unlikely that productivity growth will recover quickly Europe might have to face not a “double dip”, i.e. a second temporary shock to demand, but the prospect of lower growth for some time to come (long dip). Monetary policy will not be able to change this. The ECB should acknowledge that adverse productivity makes it even more difficult to force inflation below its self-imposed ceiling of 2 %. Overview There has been much comment recently on the fact that productivity growth in the U
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