Following a huge credit bubble and financial crisis, the Japanese were slow to react, Drayson says, and the country suffered more than a decade of deflation and economic stagnation from which it has only recently recovered.

Some are worried the rapid fall in house prices and other assets may lead to a deflationary environment in the West, which will amplify the effects of bad debt and hurt productivity and employment for many years to come.

However, Drayson says lessons have been learned from the Japanese experience, and believes rapid action by governments in the US, UK and Europe may stop an economic nightmare.

Interest rate setting is a key issue in the coming months, according to Drayson, and he believes the Fed has taken the right decision by rapidly cutting interest rates.

“We are confident the Fed has the ability to avoid a repeat of Japan’s experience – even though a period of weak US economic growth now seems inevitable,” he says.

LGIM expects the Bank of England to follow the Fed’s example as the threat of inflation has waned by rapid falls in the price of oil and food.

Drayson says the Bank is likely to cut its base rate aggressively over the next year. He believes rates could come down to around 2% by the end of 2009 to prevent mass defaults as fixed rate mortgages expire and ensure an orderly correction in the housing market.

He adds growth in the Western world will be sluggish for some time, and Asian countries such as China and India may well emerge as the world’s economic powerhouses. However, the threat of deflation has been reduced by decisive policy action which should prevent a prolonged and damaging downturn.