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Page added on January 26, 2015

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Should the euro zone really fear deflation?

Public Policy

* Euro zone inflation negative in Dec for first time in 5 years

* Debt deflation, raised real interest rates key concerns

* “Good” and “bad” deflationary periods

* QE’s impact on euro leads to higher import prices

 

If the multi-billion dollar consumer electronics industry can function fine with constantly falling prices, why is deflation in the broader economy such a threat?

Falling prices may really be more a symptom of malaise rather than a cause for further grief.

European Central Bank policymakers have repeatedly warned of the risk of being drawn into a prolonged downward price spiral, a danger that has led them to an unprecedented government bond-buying programme that will pump hundreds of billions of new euros into the sagging euro zone economy.

Inflation turned negative in the currency bloc for the first time in five years in December. But this is not yet the sustained deflation policymakers fear, and even ECB board members accept weaker oil prices should increase spending power – recognising that falling prices do not necessarily stifle consumer demand.

A prime evil of deflation, some in the ECB warn, is that consumers and companies would delay purchases and investment because they anticipate lower prices in the future.

Sure enough, Italians are cutting back on basic purchases in an environment of falling prices. But is there a causal link? Would you defer buying a car or a sofa simply because you expected it to be 1-2 percent cheaper next year?

Also, with interest rates so low, what is the incentive to save?

“Personally I think that the issue of consumption deferral is not the case, at least in the euro zone,” said Guntram Wolff, director of the Bruegel think-tank in Brussels.

However, Wolff and other economists say there are reasons for concern.

First, negative inflation means real interest rates are always positive, given lenders do not offer loans at rates below zero. This dampens investment.

Second, falling prices increase the real burden of debt, hampering, for example, Italy’s efforts to stabilise a debt-to-GDP ratio of around 130 percent.

“It’s a vicious circle that sees the real weight of debt increasing and the state cutting spending to service it. That’s the main worry of the ECB,” said ING’s chief euro zone economist, Peter Vanden Houte.

This was the debt-deflation theory of American economist Irving Fisher on the Great Depression that reckoned that any increased spending by creditors would not match spending cuts forced on debtors.

A further issue is that the euro zone needs varying levels of inflation – low in the euro zone periphery to restore competitiveness and high in countries such as Germany to let the chasing pack catch up.

Prices have fallen year-on-year for multiple months in Greece and Spain and for three of the past five months in Italy, according to Eurostat data, but German harmonised inflation is now also just 0.1 percent.

“GOOD” AND “BAD” DEFLATION

The Bank of International Settlements (BIS), in its last annual report, differentiates between “good” deflation and “bad” deflation.

In the period before World War One, deflations were generally “good”, as real GDP mostly continued to expand when prices declined.

Between the wars, the number of “bad” deflations increased, although at most times output still rose, albeit more slowly.

For the 1990-2013 period, deflation episodes were on average more like the earlier “good” kind, BIS said.

Furthermore, it said that only the Great Depression could really be referred to as a deflation spiral.

Commerzbank Chief Economist Joerg Kraemer confesses he does not see deflation as a grave problem.

“Deflation is one of the most abused terms in economic policy discussion,” he said.

Corporations can overcome mild deflation with increases in productivity, he said. For governments with debt, deflation poses a challenge, but one that is manageable with savings.

He also points to Switzerland as a country that has logically chosen deflation, by unpegging the franc from the euro and so allowing it to jump. Its central bank had previously been intervening aggressively in currency markets, boosting its liquidity and driving up real estate prices.

“They will have a longer period of negative inflation but they are ready to take the risk to avoid the longer-term risk of a real estate bubble,” Kraemer said.

Commerzbank says the euro zone’s problem is not deflation, but “zombification”, particularly ECB policy that reduces pressure on governments to carry out overdue reforms.

Demon or not, will the ECB’s quantitative easing boost prices? The euro has dropped sharply, making imported goods more expensive, and stock markets have risen. But the aggressively increasing money supply needs to enhance overall sentiment if consumer prices, not just asset prices, are to rise.

“If there’s no final demand, you can’t raise prices and there’s no inflation. The financial side is important, but the real economy has to follow to get prices rising again,” said ING’s Vanden Houte.

 

reuters



23 Comments on "Should the euro zone really fear deflation?"

  1. Davy on Mon, 26th Jan 2015 8:15 am 

    The entire global system must fear deflation and the likely policy reactions from central banks which will surely just make the descent worse. Deflation means the vast amount of debt cannot be repaid. The central banks are currently in a catch 22 of limits to these policies and diminishing returns and the need to do something to show control. The whole financial system is destabilizing. Our current complex global interconnected system has a narrow rpm range to operate in and still keep the global ship running properly. We are now experiencing low power with fluctuating rpms in a steady downward trend. It is as if the engine is being starved or flooded of vital fuel. The global system cannot operate long out of its narrow range of operation or vitals to the global engine will be destroyed.

    We see this most notably now with POD and ETP of oil combining with financial descent. This is a vicious cycle down of demand and supply destruction. The only way the system can be held together now is wealth transfer and social cannibalism in a hyperthermia of descent. This will lead to failed states and social unrest in TBTF systematic global nodes. Time frame is the big question especially from us time conscious humans. Will this play out over 10-15 years or 3-5 years? That is very important for our time value comfort level.

    Since this is descent this descent will increasingly become random, dysfunctional, with economic and social abandonment. We will see irrational policy responses along with irrational social responses. Much is going to depend on how, when, where this cascade of failures begins. It has already begun but the policies of wealth transfer and financial repression benefiting the global plutocracy of politicians and industrialists can drag on with a triage of locals and regionals. The simple and plain truth is deflation will eventually lead to hyperinflation as confidence is lost and all that huge amount of digital wealth that has no reality to the physical violently shifts around destroying vital survival infrastructure of an overpopulated complex global system.

  2. bobinget on Mon, 26th Jan 2015 10:17 am 

    Deflation fears will encourage yet another EU
    stimulus, this time including Germany.
    In the US:
    Deflation is a cinch to counter. Just put middle classes back to work at something better then existing minimum wages. Instead of giving free money to banks to lend, drop bags of the stuff on city halls. They will rehire police, teachers, firefighters, street repairers.

    Deflation co/exists with low wages, under employment.

    Fucking banks lend to each other, creating wealth for a tiny few already rich folks.

  3. Davy on Mon, 26th Jan 2015 10:27 am 

    Bobby, even if that would fly it won’t fly per limits of growth. Why don’t you just jump on the bumpy descent band wagon and forget the BAU corn porn addictions. You seem to be coming around to the dangers of geopolitical collapses through conflict. Yet, you are still a corn on economics.

  4. Plantagenet on Mon, 26th Jan 2015 11:02 am 

    Once the EU chucks out Greece, the economic statistics for the whole EU are going to improve.

    Lets see an economic analysis of the EU without Greece. I bet the deflation issue will go away and GDP growth will look a heck of a lot better.

  5. Davy on Mon, 26th Jan 2015 11:32 am 

    Dream on Planter, more like the whole edifice will start crumbling. If Greece leaves Portugal, Spain, and Italy are likely to follow at some point as the ship takes on water. This may happen not only for financial reasons but social pressures. The populous is getting sick and tired of the rampant corruption spewing forth from Brussels. Unlike the US the European Union is a recent event. National tensions simmer very close to the surface in Europe especially among the sheeples who haven’t a clue what is really going on. The sheeples just want to blame someone for the shit bag they are being handed by the plutocrats. This is especially true of the young and educated with no future.

  6. Plantagenet on Mon, 26th Jan 2015 11:55 am 

    Most Europeans like living in the EU. Even the Greeks like having the Euro.

    Once Greece gets thrown out, its economy will collapse. This won’t encourage others to exit—it will encourage Spain and Portugal to buckle down and cut even more to stay within the EU.

  7. Davy on Mon, 26th Jan 2015 12:31 pm 

    Planter, how would either of us know what’s going to happen with a Greek exit? Is this another one of your “glut” bones? I can assure you this the young in Europe are getting angry. Regions are getting angry when they subsidize the central authorities corruption. The economic situation in the EU is in a fog with no real direction with no historical precedence. There is no way to predict an outcome. I see all EU outcome as negative. I see no positives anywhere globally, none!

  8. Plantagenet on Mon, 26th Jan 2015 12:50 pm 

    Hi Daver:

    The Eu may be mysterious to you, but I spend a lot of time in Europe. I was in Greece a couple of years ago, France last year, and Spain this year. Its pretty darn obvious that if Greece defaults and is forced out of the EU, it will go into an even deeper depression. Greece is living on EU loans—take those away and there isn’t much of an economy there.

    On the bright side, if Greece exits the EU and goes back to the drachma, it will be a grand time to visit the Greek Isles because their currency will soon become virtually worthless.

    Γειά σας

  9. Davy on Mon, 26th Jan 2015 1:02 pm 

    Planter, my daughter is Spanish and lives in Madrid currently. My fiancée is Italian and we visit her home yearly. I lived and worked in Germany for a year in the 80’s. Lived in Spain and Southern France with my 1st wife in early 90’s. I don’t think you are any more of an expert on Europe Planter. You just looking for another glut to obsess on. I think you know Europe like Palin knows Russia, you know, you all can look out your windows and see Russia which makes your guys Russian experts. I guess your few tours of Europe has made you a European expert. All the power to you Planter. You should put that knowledge to work and play the markets or something.

  10. Plantagenet on Mon, 26th Jan 2015 1:14 pm 

    Daver

    I was just in madrid two weeks ago at the end of my trip through southern Spain—a very pleasant city to visit. I also spent thee months in Spain last year. I’ve also lived in northern Europe full time and also have many additional connections to Europe. Your snarky fantasy about Sarah Palin notwithstanding, in reality we both have some personal connections and personal knowledge about the EU.

    Given that reality, I have simply expressed my opinion that Greece’s economy will suffer if they leave the EU. You apparently disagree. However, please note I’m not alone in having this opinion—-this is pretty much the standard view outside the hothouse of leftist ideology that is Syriza.

    Cheers!

  11. Davy on Mon, 26th Jan 2015 1:35 pm 

    Nope planter, Greece will suffer plenty. It’s downhill for Europe all together. Glad you liked the Palin Snark. Yea seems we both have an appreciation or Europe Planter. I guess that makes us Euro lovers. My point planter is Europe probably has the highest living standards in the world in reality. The people live well and have a higher culture than most other places which points to a big fall ahead. The same is true of the U.S. with all our consumption and all our stuff. We got a big step down coming.

  12. Northwest Resident on Mon, 26th Jan 2015 1:54 pm 

    What are the big industries in Greece? Answer: Tourism and shipping. As the world goes down the financial crapper, what industries tend to suffer the most? Answer: While not a complete list, tourism and shipping are certainly among those most severely hit in hard economic times.

    And this, from Wikipedia:

    “In early 2010, it was revealed that through the assistance of Goldman Sachs, JPMorgan Chase and numerous other banks, financial products were developed which enabled the governments of Greece, Italy and many other European countries to hide their borrowing.[95][96] Dozens of similar agreements were concluded across Europe whereby banks supplied cash in advance in exchange for future payments by the governments involved; in turn, the liabilities of the involved countries were “kept off the books”.[96][97][98][99][100][101]”

    Corrupt politicians aided and abetted by oligarchs and international banking drove Greece into debt, but kept it secret. Now the idiots are coming out of the woodwork to accuse the Greeks of living beyond their means — AS IF there is any other European (or other) country that is not doing the same.

    From my point of view, Greece is just the canary in the coal mine. As we watch what happens in Greece, try not to laugh and pontificate too loudly because we may all be “Greeks” in the near future as this financial freak show called the global economy begins to unravel in earnest.

  13. GregT on Mon, 26th Jan 2015 1:59 pm 

    Plant said:

    “Most Europeans like living in the EU. Even the Greeks like having the Euro.
    Once Greece gets thrown out, its economy will collapse. This won’t encourage others to exit—it will encourage Spain and Portugal to buckle down and cut even more to stay within the EU.”

    You are entitled to your opinion Plant, just like anybody else. What you wrote above is your opinion, not the facts.

    Here are other’s opinions for balance.

    “If Greece were, however, to leave the euro, the general consensus is that the Euro zone might survive – just. According to JP Morgan, a Greek exit would see the euro fall to 1.05 against the dollar, resulting in significant costs and volatility in trade with the US and China.”

    “Greece might also be able to recover from a European exit since the government runs a primary surplus – if the debt was wiped (which would happen in the event of Grexit) the country would immediately be better off because the government collects more than it spends.”

    “If Greece was seen to be doing well after a couple of years, its currency cheap and its exports (and holiday resorts) booming, it’s possible that Italy or Spain (where the rise of leftist parties such as Podemos has been a threat) would attempt the same.”

    http://blogs.spectator.co.uk/coffeehouse/2015/01/greece-lightening-what-you-need-to-know-about-syrizas-victory/

    My opinion?

    Allowing the ECB, IMF, central banksters to gain control of the Eurozone was a very bad idea. One that will ultimately end badly for all involved.

  14. Plantagenet on Mon, 26th Jan 2015 2:21 pm 

    @GregT

    You don’t even understand your own posts. I said a Greek exit from the EU would result in the a greatly devalued drachma. I said it would be a great time to visit Greece. The bit you quote says the exact same thing I said. The precise words in your own post are ” Greece ,,,, its currency cheap….(holiday resorts) booming”

    If you would try to understand what the words say in the things you are quoting you’d much be better off. What I posted is just common sense—thats why the bit you quoted agrees with me.

    Get it now?

    Cheers!

  15. Plantagenet on Mon, 26th Jan 2015 2:24 pm 

    Hi daver:

    I agree 100%. Folks in the EU have the highest living standards in the world. Anyone with any sense has to admire the way the people in the EU have created a very pleasant place to live.

    What was the argument about again? I don’t see it now……

    CHEERS!

  16. Rita on Mon, 26th Jan 2015 2:48 pm 

    The greeks have little english knowledge and they have no clue of peak oil. The greens are part of Syriza, and peak oil is in the New Green Deal, so I suppose Syriza knows better what is happening. Perhaps their understanding of peak oil makes them want out of the EU (it will happen any way due to peak oil).

  17. Northwest Resident on Mon, 26th Jan 2015 3:10 pm 

    Here’s another interesting and perhaps worthwhile view on why the Greeks are in such dire financial straits:

    Lazy Greeks At Fault? These Two Charts Suggest Otherwise

    (hint: The Euro and the EU gave distinct advantages to some countries and distinct disadvantages to others, Greece for example)

    http://www.zerohedge.com/news/2015-01-26/lazy-greeks-fault-these-two-charts-suggest-otherwise

  18. GregT on Mon, 26th Jan 2015 3:12 pm 

    Plant said:

    @GregT
    I said a Greek exit from the EU would result in the a greatly devalued drachma.

    You said:

    “Once Greece gets thrown out, its economy will collapse. This won’t encourage others to exit —it will encourage Spain and Portugal to buckle down and cut even more to stay within the EU.”

    Which is in complete disagreement with what I quoted:

    “If Greece were, however, to leave the euro, the general consensus is that the Euro zone might survive – just. According to JP Morgan, a Greek exit would see the euro fall to 1.05 against the dollar, resulting in significant costs and volatility in trade with the US and China.”

    “Greece might also be able to recover from a European exit since the government runs a primary surplus – if the debt was wiped (which would happen in the event of Grexit) the country would immediately be better off because the government collects more than it spends.”

    “If Greece was seen to be doing well after a couple of years, its currency cheap and its exports (and holiday resorts) booming, it’s possible that Italy or Spain (where the rise of leftist parties such as Podemos has been a threat) would attempt the same.”

  19. Plantagenet on Mon, 26th Jan 2015 3:38 pm 

    @GregT

    You are living in a fantasy world if you think Greece is going to export into the EU.. And If Greece drops the Euro and leaves the EU then who will it export to?

    Right now Greece is part of the EU common market, but if they leave the EU they will no longer be able to export to the EU. They would have to negotiate entirely new treaties with the EU, where every potential Greek export to the EU would come under scrutiny from unfriendly EU bureaucrats……and do you think the Germans, French, Spainish and other EU countries that bailed out Greece are going to welcome Greeks bearing exports?

    Think it through, dude. IF Greece drops the Euro and leaves the EU then it is no longer part of the EU.

    Get it now? Cheers!

  20. GregT on Mon, 26th Jan 2015 4:02 pm 

    Not my opinion Plant.

    If you read what I wrote, the opinion is from JPMorgan and CapX.

  21. GregT on Mon, 26th Jan 2015 4:05 pm 

    Also Plant,

    From above:

    “My opinion?
    Allowing the ECB, IMF, central banksters to gain control of the Eurozone was a very bad idea. One that will ultimately end badly for all involved.”

  22. Davy on Mon, 26th Jan 2015 4:06 pm 

    Simplistic Planter and BTW who died and made you chief Euro Expert? I know, you spent a few months in Southern Europe just like you can look out your window and see Russia.

    Europe can’t aford a failed state on its southern border. There will likely be an involved ad hoc separation that just may give Greece plenty of EU aid. This could be a similar situation as with the Ukraine. Both countries are too important to Europe for failure.

  23. Grego on Wed, 28th Jan 2015 5:43 pm 

    Infinite growth with finite resources. Do we really think this story has a happy ending? The peak oil analysts who new there stuff always predicted that the first warning flag would be falling oil prices not hyper inflation as most suggested. The original posts are still out there (eg. ourfiniteworld) This is demand and debt contraction not over supply. Greece, Germany Italy, whatever. It doesn’t matter. We are already in the first stages of total meltdown. Playing around with paper money or economic policies won’t change the outcome.

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