The lobby of the ECB's Frankfurt headquarters is decorated by a large round mural of the euro currency half bathed in sunshine and half submerged under water. This strange installation symbolises the risks facing Europe, and hence the world economy. If the euro emerges too quickly into the sunshine, it could sink Europe' s economies, because the overall economic effect of a stronger euro is similar to a tightening of monetary policy. Indeed the ECBs rate cuts this year have barely offset the rise in the euro. a further drop in the dollar and appreciation in the euro, particularly a sharp one, would soon far outweigh any monetary loosening from the ECB ighter macroeconomic conditions would not only deter growth in demand but would also make much-needed structural reforms politically more difficult In short, a fast-rising euro, which could take some of the pressure off America's current account deficit, could harm Europe's economies and hence any hope that a second engine for the global economy might get started If Europe's macroeconomic policies have made a difficult situation worse, then Japan's hav broad script-necessary structural change put off and then made harder by macroeconom he turned a structural problem into a slow-motion disaster. Although the details are different, the ineptness-is exactly the same. Will the sun ever rise? Japan's main problem is its inability to restructure the financial system that collapsed after the 1980s bubble economy burst. Too many bust banks remain open, keeping too many unproductive firms alive and locking resources into weak areas of the economy. The prescription is simple: Japan's banking system needs an overhaul to create a more effective system of credit intermediation which, in turn, would force much-needed corporate restructuring. Yet for a decade the government has failed to come to grips with the problem This has caused the economy to stagnate and get caught in a deflationary cycle. With prices falling, the real value of the debt held by Japan's bankrupt banks and firms has risen. deepening the financial quagmire. Conventional wisdom argues that Japan tried and used up, all the traditional fiscal and monetary tools. Though government debt doubled and short-term interest rates fell to zero, the economy stayed in a rut. Keynes seems to have failed The reality is more subtle. As the IIE's Mr Posen and Kenneth Kuttner of the Federal reserve Bank of New York have persuasively argued Japan ' s fiscal policy has on balance been tight Despite intermittent huge public-spending programmes, they point out, over 80% of the increase in Japan's public debt has been due to lower tax revenues from a shrinking economy. On the monetary side the Bank of Japan did too little too late. It was slow to cut interest rates after the bubble burst in 1990 and refused to reflate the economy by printing yen to buy overnment bonds or other assets. Though there have been tentative efforts in that direction during the past year, they did not pack enough of a punch once deflationary expectations had set in. Instead, Japan's most tive macroeconomic policy has been massive intervention the currency markets to stop the yen appreciating against the dollar and cutting off the relatively small but vibrant export sector. So far this year the Japanese government has spent around $80 billion buying dollar assets. In other words, Japan's only policy has been to stave off the dollar devaluation that would help to rebalance the world economy.The lobby of the ECB's Frankfurt headquarters is decorated by a large round mural of the euro currency, half bathed in sunshine and half submerged under water. This strange installation symbolises the risks facing Europe, and hence the world economy. If the euro emerges too quickly into the sunshine, it could sink Europe's economies, because the overall economic effect of a stronger euro is similar to a tightening of monetary policy. Indeed, the ECB's rate cuts this year have barely offset the rise in the euro. A further drop in the dollar and appreciation in the euro, particularly a sharp one, would soon far outweigh any monetary loosening from the ECB. Tighter macroeconomic conditions would not only deter growth in demand, but would also make much-needed structural reforms politically more difficult. In short, a fast-rising euro, which could take some of the pressure off America's current￾account deficit, could harm Europe's economies, and hence any hope that a second engine for the global economy might get started. If Europe's macroeconomic policies have made a difficult situation worse, then Japan's have turned a structural problem into a slow-motion disaster. Although the details are different, the broad script—necessary structural change put off and then made harder by macroeconomic ineptness—is exactly the same. Will the sun ever rise? Japan's main problem is its inability to restructure the financial system that collapsed after the 1980s bubble economy burst. Too many bust banks remain open, keeping too many unproductive firms alive and locking resources into weak areas of the economy. The prescription is simple: Japan's banking system needs an overhaul to create a more effective system of credit intermediation which, in turn, would force much-needed corporate restructuring. Yet for a decade the government has failed to come to grips with the problem. This has caused the economy to stagnate and get caught in a deflationary cycle. With prices falling, the real value of the debt held by Japan's bankrupt banks and firms has risen, deepening the financial quagmire. Conventional wisdom argues that Japan tried, and used up, all the traditional fiscal and monetary tools. Though government debt doubled and short-term interest rates fell to zero, the economy stayed in a rut. Keynes seems to have failed. The reality is more subtle. As the IIE's Mr Posen, and Kenneth Kuttner, of the Federal Reserve Bank of New York, have persuasively argued, Japan's fiscal policy has on balance been tight. Despite intermittent huge public-spending programmes, they point out, over 80% of the increase in Japan's public debt has been due to lower tax revenues from a shrinking economy. On the monetary side, the Bank of Japan did too little, too late. It was slow to cut interest rates after the bubble burst in 1990 and refused to reflate the economy by printing yen to buy government bonds or other assets. Though there have been tentative efforts in that direction during the past year, they did not pack enough of a punch once deflationary expectations had set in. Instead, Japan's most proactive macroeconomic policy has been massive intervention in the currency markets to stop the yen appreciating against the dollar and cutting off the relatively small but vibrant export sector. So far this year the Japanese government has spent around $80 billion buying dollar assets. In other words, Japan's only policy has been to stave off the dollar devaluation that would help to rebalance the world economy