Deflation in the Eurozone
Ruining everything
A shocking number of American commentators and an even larger number of European policymakers continue to be worried about the specter of possible future inflation even as the opposite is happening right before our eyes:
The eurozone’s annual rate of inflation turned negative in June for the first time since the single currency was introduced in 1999. Prices in the 16-nation zone fell 0.1% in the past year, Eurostat said. The inflation rate had been 0% in May. Inflation in the eurozone has been dragged down by lower energy and food prices, and by falling demand for goods from companies and households.
This is, simply put, a disaster. In particular, the devastated economies of Spain and Ireland are never going to recover with this sort of thing going on. And that, in turn, is only going to make things worse for Germany and the rest of them. From the get-go the European response to the recession has been very misguided. And to a striking extent, the American debate continues not to recognize that the European Union has surpassed the United States of America in terms of the scale of its economy. Jean-Claude Trichet is the most important central banker in the world, and it’s extremely difficult for anything Barack Obama and Ben Bernanke try to do to work if the Europeans make poor choices.
42 Responses to “Deflation in the Eurozone”
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June 30th, 2009 at 11:33 am
Might a 50% drop in the price of oil have just a little bit to do with the very slight deflation? It doesn’t seem like it’s much of a systemic problem if it’s largely linked to a huge decline in energy prices.
June 30th, 2009 at 11:35 am
It’s a disaster when the price of energy and fuel drop? I hope we can avoid a plunge in the price of health care and college tuition, too.
June 30th, 2009 at 11:39 am
Although it would be better for everyone to have the right policies in place (whatever those are), I admit that just from an experimental perspective I’m interested to see two different policies being pursued. In five years we can see whether Europe has sunk itself with its tight money policies (vindicating Keynes) or whether the US has suffered lots of inflation and dollar devaluation (vindicating the inflation hawks). Or both, suggesting that we are only choosing among disadvantages…
June 30th, 2009 at 11:41 am
Jean-Claude Trichet is the most important central banker in the world, and it’s extremely difficult for anything Barack Obama and Ben Bernanke try to do to work if the Europeans make poor choices.
You sure about that? I’d argue he’s very important. But Ben Bernanke remains the central banker of the dollar, which is still the world’s reserve currency.
June 30th, 2009 at 11:41 am
Boy, I don’t know where your confidence comes from to describe the two slightly different policy responses to the depression as “good” and “bad”. I also don’t know what qualifies you to make such a judgment.
We’ll see if transferring the risk of $13 Trillion from the private sector to the public sector via guarantees and the transfer of toxic bets will do the trick. We will also see if the direct transfer of another $2 to $3 Trillion to the private sector (including the 3 stimulus measures going to the “little guy”) and huge $2 Trillion deficits for the foreseeable future is the way to go.
In fact, the U.S. has only kicked the can down the road and it’s public and private debt (as a % of GDP) has only increased since the crisis has began. I would not be crowing about success just yet.
Indeed, you’re setting yourself up to look pretty silly with your smug conviction. More debt and more liquidity sure doesn’t look like the right solution.
The rest of the World is not going to double down on American-style capitalism as quickly as you would like. The Washington Consensus looks to be extremely flawed and American progressives better start re-evaluating everything they thought they knew about finance and the economy. And that means you Matt.
June 30th, 2009 at 11:46 am
Jean-Claude Trichet is the most important central banker in the world, and it’s extremely difficult for anything Barack Obama and Ben Bernanke try to do to work if the Europeans make poor choices.
Maybe we should invade.
June 30th, 2009 at 11:56 am
[T]he American debate continues not to recognize that the European Union has surpassed the United States of America in terms of the scale of its economy.
True, but let’s not get carried away: it is not like the EU economy is an entire order of magnitude larger than the U.S. economy.
Jean-Claude Trichet is the most important central banker in the world, and it’s extremely difficult for anything Barack Obama and Ben Bernanke try to do to work if the Europeans make poor choices.
And this would be getting carried away a bit. Poor choices in Europe will likely slow down the U.S. recovery a bit, but they are unlikely to completely halt or reverse the U.S. recovery. I believe exports had peaked at around 12% of U.S. GDP right before the recession, and I think about 25% of U.S. exports go to Europe. So a deeper and/or more prolonged recession in Europe would affect the U.S., but it would still only directly affect something like 3% of U.S. GDP (and we could well get some partial offsetting effect from buying European products more cheaply).
June 30th, 2009 at 12:03 pm
BBC:
“But European Central Bank officials have played down the threat of deflation, saying that any fall in prices is likely to be temporary and linked to the drop in oil price.”
Also to stick of the Europeans a little, they believe inflation leads to hyperinflation leads to people pushing around wheelbarrows full of cash leads to Nazis leads to the levelling of Europe.
Also European labor laws are more fair and better and hence can more easily lead to a wage-price spiral.
But yeah the global economy isn’t out of the woods yet.
June 30th, 2009 at 12:10 pm
No more green shoots?!?!? I’m shocked!! Shocked, I tell you!!
June 30th, 2009 at 12:13 pm
The Washington Consensus looks to be extremely flawed and American progressives better start re-evaluating everything they thought they knew about finance and the economy. And that means you Matt.
Don’t lump all American Progressives together. You cant blame all of us just because a few Progressives think Megan McArdle knows anything of what she talks about(besides her love of Ayn Rand). Anyway, I haven’t heard Republicans come up with anything better. Be that as it may, Obama seems more interested in listening to Wall Street, sadly.
June 30th, 2009 at 12:23 pm
It’s a disaster when the price of energy and fuel drop? I hope we can avoid a plunge in the price of health care and college tuition, too.
The “disaster”, namely a deflationary spiral, can occur when deflation is caused by “falling demand for goods from companies and households.” In turn that is what is tricky about energy prices: if energy prices are down for supply-side reasons (or sustainable energy-specific demand-side reasons), that is fine. But if energy prices are down because of the anticipation of falling demand for goods and services in general, that can be a leading indicator of a possible deflationary spiral.
June 30th, 2009 at 12:28 pm
In five years we can see whether Europe has sunk itself with its tight money policies (vindicating Keynes) or whether the US has suffered lots of inflation and dollar devaluation (vindicating the inflation hawks).
Not really. For all the talk about European countries refusing to pass large stimuli, it turns out deficits in France and Germany will be above 7% of GDP for both 2009 and 2010. It seems Krugman (and therefore Matt) forgot how strong those automatic stabilizers can be.
June 30th, 2009 at 12:34 pm
Also, Ben Bernanke can make some super-secret deals with banks and flood with the economy with trillions of dollars without much control or oversight. By contrast, the ECB monetary policy is much more open and collegial, with Trichet only primus inter pares.
June 30th, 2009 at 12:39 pm
The theory is that adapting to deflation is much more costly than adapting to inflation. Let them deflate a little and test the theory.
June 30th, 2009 at 12:47 pm
deficits in France and Germany will be above 7% of GDP for both 2009 and 2010
Correction for Germany: deficit expected to reach 3.9 percent of GDP in 2009 and 5.9 percent in 2010.
“The European Commission forecasts that 13 out of the 16 countries sharing the common currency will breach the 3 percent rule in 2009 and 2010.”
So they’re monetarists in rhetoric and Keynesians in actual action.
June 30th, 2009 at 12:54 pm
“But if energy prices are down because of the anticipation of falling demand for goods and services in general, that can be a leading indicator of a possible deflationary spiral.”
True, but we’re talking about a time when energy and food have undergone huge runups in prices. It would be odd if the prices of those commodities didn’t come down. As with house prices, a recovery almost depends on a return to lower prices.
June 30th, 2009 at 1:13 pm
I don’t think anyone’s had in mind the possibility the Europeans (chiefly the Dutch-Germans) are playing the long game here. The euro could emerge at the end of this he only credible currency. That could be a huge boon for the eurozone, as that automatically means lower interest rates than in the dollar-zone.
June 30th, 2009 at 1:24 pm
True, but we’re talking about a time when energy and food have undergone huge runups in prices. It would be odd if the prices of those commodities didn’t come down.
Well, that somewhat depends on why those commodity prices ran up in the first place. But in any event, please note that I agree that not all decreases in commodity prices (or, more specifically, energy prices) are indicators of an upcoming deflationary spiral. It really depends on why that is happening, and what is worrisome in this case is that we have other indications of falling demand.
As with house prices, a recovery almost depends on a return to lower prices.
I don’t think what we want to see with respect to house prices is very comparable. With houses, we have a supply excess, and we need to clear that excess before we can eventually get people back to work building houses. Unfortunately, house prices tend to be sticky, so we are indeed stuck waiting for some further capitulation on prices before all of that excess inventory is likely to clear out.
Now with energy prices, it is possible there was a speculative bubble in energy prices, and to that extent it would be good if that has gone away. On the other hand, it is very unlikely that we currently have a true excess in energy supply, which brings us back to the worry that any ongoing fall in energy prices is indicative of the anticipation of falling general demand. In that sense, what we really want to see at this point is stable energy prices, the exact level mattering less than the stability itself (at least within a certain range–obviously it would not be great if oil stabilized at $150/barrel).
June 30th, 2009 at 1:56 pm
I don’t think anyone’s had in mind the possibility the Europeans (chiefly the Dutch-Germans) are playing the long game here. The euro could emerge at the end of this he only credible currency. That could be a huge boon for the eurozone, as that automatically means lower interest rates than in the dollar-zone.
June 30th, 2009 at 1:58 pm
@19 quote
People have been saying that for years and I’ll believe it when I see it.
It’s curious that those who obssess over budget deficits and inflation have exactly no interest or concern about deflation. At all.
June 30th, 2009 at 2:06 pm
I think you’re off base here Matt. In the US, we’ve had core deflation, the EU hasn’t.
If you look at the numbers, the EU uses about 5.5 billion barrels of oil per year. With the price dropping from $128 to $68 in a 12 month period, that’s about $330 bllion dollars. Dividing that by EU GDP ($16 trillion) should give a rough approximation (a lower limit) of the effect of oil on inflation/deflation. That yields .02, or deflation due to the oil price drop of about 2%. That means EU inflation barring oil is at least 2%.
They don’t have a deflation problem. We do.
June 30th, 2009 at 2:10 pm
In the United States, the core rate of inflation is almost perfect – 1.8% over the last 12 months. The variablity of the energy index is important for what consumers actually are dealing with, but is largely irrelevant for purposes of determining future problems.
In the US, we are currently in the sweet spot for inflation – neither too high nor too low. Bernanke’s doing a great job. It isn’t clear what the core rate is in Europe, but a rate that is overwhelmed by the energy outlier is just not that important.
June 30th, 2009 at 2:17 pm
For all the talk about European countries refusing to pass large stimuli, it turns out deficits in France and Germany will be above 7% of GDP for both 2009 and 2010.
Good point. There’s been too much focus on the particular plans promulgated in various countries with the label “stimulus” and not enough attention paid to plain old public sector deficits-as-percentage-of-GDP. In addition to those mentioned above, Britain is borrowing nearly as much as the US. I would imagine Spain is running rather massive deficits, too.
June 30th, 2009 at 2:29 pm
Do you know what a 1-bedroom apartment in inner London costs?
I’m all for falling prices…
June 30th, 2009 at 2:29 pm
By the way, I agree with the points people are making about “automatic stabilizers” and budget deficits in Europe. So personally, I’m not terribly concerned about fiscal policy in Europe–I’m just a little concerned about monetary policy.
June 30th, 2009 at 2:34 pm
Jason:
In what Bizzaroworld does Washington Consensus = Keynesianism?
As for the larger issue about Europe, it’s good that Europe’s social welfare state is acting as a good counter-cyclical force – it would be even better if that wasn’t being blunted by a pro-cyclical monetary policy.
June 30th, 2009 at 2:57 pm
it would be even better if that wasn’t being blunted by a pro-cyclical monetary policy.
To be fair, the ECB benchmark interest rate is only 1%. They could go a bit lower, but it is not like they are engaging in Volcker-like tactics. The main difference is this:
Nobody knows exactly what Bernanke is doing, so we can only hope it will work.
June 30th, 2009 at 4:14 pm
So here’s an interesting thing. At the start Bush’s presidency, Europe’s economy was smaller than ours. During Bush’s term, Europe’s growth rate was smaller than ours. Yet now Europe’s economy is bigger than ours. How does that happen? Well, we measure growth relative a market’s own currency, and the Euro has outperformed the dollar. Maybe it’s time we measure this stuff relative to a basket of currencies to filter out the currency effects. And if we do that, is Europe’s economy really deflationary? Naturally, if we did this, Bush’s entire term would look like a Depression, but maybe that’s an accurate assessment.
June 30th, 2009 at 5:56 pm
People have been saying that for years and I’ll believe it when I see it.
The catch is, of course, they don’t have to do it conscientiously. In fact, this sort of thing is impossible to do conscientiously.
What guides them is a a sort of very gut understanding that hard currency = good, soft currency = bad. And if at the end of this thing the US dollar degenerates into some sort of a soft currency, like the pound sterling for most of the postwar period, or the franc for quite a while, or the lira, the rest of the world will have no choice but to follow the euro.
And one huge advantage of the euro being in the top spot is lower interest rates, which are automatic, and thus lower borrowing and financing costs, which are also automatic, and thus a better business climate, which is also automatic, and thus a comparative advantage vis-a-vis the US, which is also automatic.
If you look at Treasury yields today and compare it against Bund yields, it makes absolutely no sense rationally. The only thing holding the yields down is the reserve currency status and the automatic cash infusion. Imagine if that were switched; we could see potentially something like 100, 150 basis point spreads between Treasuries and Bunds.
This isn’t a conscientious game; this is how things could simply turn out due to reality. The Europeans (mainly the German-Dutch again) don’t need as serious monetary policy as the U.S., and because of their hewn-in-stone faith in anti-inflationary inclination, they don’t have to face populist pressure for it.
June 30th, 2009 at 5:56 pm
so the euro-zone has deflation of -.1% eh? just goes to show that you can make numbers say whatever you want them to say. in the meantime obama fiddle’s with the greatest economy ever in his quest to control everything. don’t pay attention to what he says, pay attention to what he does.its about over for us, i know it, now you do too.
June 30th, 2009 at 6:02 pm
What people don’t seem to realize here, of course, is that this time it is really different. If the United States seriously does something very injurious to the value of the dollar (default by inflation and devaluation), the world has an alternative, unlike the entire post-war era.
This isn’t 1972, when there is no credible reserve currency candidate to replace the U.S. dollar. The Deutschmark, which wasn’t even in the same weight class, gained even then a great amount of credibility vis-a-vis the U.S. dollar, and in fact became the dominant currency in the European area.
This time around, there is another fellow in the same weight class, and with a lot better discipline and innoculation against populist fervour. He is called the Euro.
June 30th, 2009 at 6:53 pm
“This time around, there is another fellow in the same weight class, and with a lot better discipline and innoculation against populist fervour. He is called the Euro.”
This is exactly why we should create an alternate reserve currency based on all currencies. At least our dollar can pull some weight there. If we don’t do it, the euro will become the reserve currency and we’ll have no say. Our choice is whether we want to have half a say or no say at all.
June 30th, 2009 at 7:19 pm
Re: euro could emerge at the end of this he only credible currency.
The Euro will become a credible currency (a la the US dollar) if and only if Europe undergoes a significantly greater degree of political integration than even the EU’s most enthusiastic boosters think possible. For the foreseeable future there simply is no alternative to dollar: the Euro has no ballast, the Yen and the Pound both have more problems than the dollar, The Canadian and Australian dollars are both very sound but their underlying economies are too small, and no one in his right mind would suggest the ruble, rupee, or any other lesser curerncy.
June 30th, 2009 at 7:45 pm
Deflation a disaster? Not for those of us who save our money (in other words, average Joes)! Our purchasing power will increase while the rich fat cats get lower investment returns and have to sell their Gulfstream Jets and Ski Cottages. Boo-hoo!
I want to see DOUBLE DIGIT deflation for essential services. Education, healthcare, housing, transportation. If deflation is a disaster, then bring on the MF’ing apocalypse!
June 30th, 2009 at 9:20 pm
This inordinate fear of deflation is baseless. Mr. Yglesias needs to learn the Austrian Business Cycle Theory and some history. Consider the 1920-1922 depression. Between the second quarter of 1920 to the third quarter of 1921, wholesale prices fell 44%. Factory employment and industrial production fell 30%. The Fed raised the discount rate from 4% to 7% and then back to 4%. The Harding government did basically nothing in the way of so called Keynesian stimulus. Harding specifically and intentionally did nothing to interfere with falling wages and prices. Further, Federal spending declined from $6.3 billion in 1920 to $5 billion in 1921 and $3.3 billion in 1922. Tax rates, meanwhile, were slashed—for every income group. And over the course of the 1920s, the national debt was reduced by one third. The crisis was over quickly. Thomas Woods has an interesting article on this.
There is no evidentiary, historical or logical basis to either fear deflation or to expect Keynesian “stimulus” to produce anything other than misery, poverty and economic dislocation.
Check the historical tax rates here:
Note how the rates rise to ridiculous levels starting in 1932 under Hoover and keep going up. No wonder the depression lasted until FDR died and Congress slashed spending by 2/3 after WW II.
June 30th, 2009 at 11:12 pm
This is exactly why we should create an alternate reserve currency based on all currencies.
I agree with you in spirit, but not all currencies. Certainly none of the African currencies, which have a habit of frightening hyperinflation, except for the South African Rand; nor any of the South American currencies. If anything, it should just be a basket of North American and European currencies, plus China, the rouble, and the Australian/NZ dollars.
The Canadian and Australian dollars are both very sound but their underlying economies are too small, and no one in his right mind would suggest the ruble, rupee, or any other lesser curerncy.
Exactly the rationale for people like me who think that there should be a common currency zone within the Commonwealth Five (UK, Canada, Australia, New Zealand, South Africa) and the associated Caribbean states. It would essentially monopolize the entire mining finance sector.
July 1st, 2009 at 1:09 am
Bob Roddis nailed it.
Austrian economics is the only praxeology that has a cohesive, logical explanation for why business cycles occur, and, in this instance, why capital was so grossly misplaced to the housing sector.
Yes, rich fatcats are greedy, but they are also fearful. They are afraid that they will make mistake, and that those mistakes will cause them to lose money.
But the government took away that fear. The government said, ‘Don’t worry, we’ll protect you. We’ll bail you out. We’ll keep you from failing.’ Which is exactly what happened. The housing misallocation didn’t happen because of greed–there has always been greed!–the meltdown happened because of a lack of fear. And that lack of fear was caused by government intervention.
July 1st, 2009 at 3:07 am
Yes, Austrian economics possesses tremendous explanatory power, the likes of which no other economic theory has ever possessed.
Take the mystery of why AIG went bust, for example. Mainstream economics can’t possibly explain it. But Austrian economics can — AIG shares went from $70 to $1 because the government made AIG shareholders unafraid of losing all their money. They said, “don’t worry, we’ll protect you, we’ll bail you out.” As a natural consequence, AIG shares lost 99% of their value. See how much damage the government caused?
Wait, this made a lot more sense in my head. Oh well.
July 1st, 2009 at 4:25 am
This isn’t a conscientious game; this is how things could simply turn out due to reality. The Europeans (mainly the German-Dutch again) don’t need as serious monetary policy as the U.S., and because of their hewn-in-stone faith in anti-inflationary inclination, they don’t have to face populist pressure for it.
Why would you think that the UCB won’t face populist pressure? Say unemployment in Spain reaches 20% or higher, and they elect a government that runs on withdrawing from the eurozone so they can run their own monetary ad fiscal policy to encourage things like more government spending and increased exports. The whole European Union faces collapse in a situation like that, and that is why the Euro will not replace the Dollar as the default reserve currency. There is simply not enough political stability, even if there is monetary stability.
July 1st, 2009 at 5:20 am
no one has stated the obvious; the euro-zone and nafta have destroyed national economies. the dollar will continue to fall, the euro will also.two currencies that won’t be worth the paper they are printed on. spain has 14% un-employment and other euro countries have astonishingly high rates. the US is at close to 10% and rising.if the governments would get out of the way these things would improve, but it is to their benefit to keep large segments of the population dependent on them.soon,within a year or two,governments will start to fail, and revolutions will begin. look for changes in spain,ireland,the UK, and shifts in congress in the states. hyper-inflation will begin by the end of this year and will not end until governments get out of the way of the free market.
July 1st, 2009 at 8:15 am
Deflation a disaster? Not for those of us who save our money (in other words, average Joes)! Our purchasing power will increase while the rich fat cats get lower investment returns and have to sell their Gulfstream Jets and Ski Cottages. Boo-hoo!
This, of course, has things exactly backward. “Average Joes” are net borrowers, and it is the “rich fat cats” who are net lenders.
There is no evidentiary, historical or logical basis to [] fear deflation . . . .
Ah yes, the history-began-in-1913 theory. In fact, the U.S. economy experienced a series of terrible deflationary recessions in the 19th Century and early 20th Century, of which the Great Depression was only the last and worst (see, e.g., the Panic of 1857, the Panic of 1873, Panic of 1893, and Panic of 1907).
And to forestall the usual Austrian response, no, GDP is not a proper measure of the effects of those recessions. The United States was industrializing in this period, so it is true U.S. GDP was rapidly increasing. But during those recessions, large numbers of people became unemployed, homes and life savings were lost, communities were destroyed, and so on.
No wonder the depression lasted until FDR died and Congress slashed spending by 2/3 after WW II.
Ah, another fun piece of historical revisionism. By any relevant measure the Great Depression ended DURING the war, not after. And when the war ended, there was a brief but sharp recession in 1945.
Which brings us back to the post-WWI recession. Like the recession of 1945, it was caused by the sudden drop in government wartime spending and influx of labor from returning troops, and it was indeed relatively quickly corrected as the factories were retooled and the troops were put back to work. But those post-war recessions are obviously unique in those ways.
So, yes, it is a good idea to look to history. But it is a bad idea to listen to people who cherry-pick their recessions and their statistics when looking at history.
July 1st, 2009 at 10:28 am
The example of the 1920 depression completely obliterates the Keynesian model. That’s why Keynesians must sweep it under the rug. Budget and tax rate slashing with little or no help from the Fed should cause the world to stop according to the Keynesians. The Keynesians also predicted another round of depression following demobilization after WWII. It didn’t happen then either. I submit that a change-over from a war economy to a peace-time economy should be much more traumatic than solving a simple little business cycle recession. BUT NO! For the Keynesians, this change-over was just a simple matter following WWI. Let’s just forget the budget and tax rate slashing, the lack of unemployment insurance and the total lack government programs and regulation.
But the issue here is whether deflation is something to fear. I’ve seen no argument here for that. There was a great deflation in 1920-1921 and we popped right out of it. If prices of goods and services have been artificially bid up and distorted by mindless Keynesian central bank monetary dilution, it is essential to learn ASAP what the actual value of the those goods and services really is. Keynesian monetary dilution makes people think that they are richer than they are and causes all sorts of investment mistakes. That $500,000 house might only be worth that if some new buyer can borrow $500,000 of new money created out of thin air by the Fed. Once that process invariably hits the wall, people in the market might only be willing to pay $200,000 for it upon realizing how much poorer they really are. The economy needs to get to that point (where people are paying actual value) ASAP to eliminate the mistakes induced by the Fed. Deflation is caused by the necessary correction to the preceding noodle-brained immoral Keynesian monetary dilution. It is not some hobgoblin like a Martian invasion that has to be fought. Just let it go (like in 1921).
Robert P. Murphy in his book eviscerating the New Deal, also eviscerates the idea that deflation caused the Great Depression.
Further, the idea that WWII cured the Great Depression and brought back prosperity is preposterous. We all know that there was no prosperity during WWII. Ridiculous. Read Robert Higg’s great article on why prosperity only returned after FDR died.
Finally, the Austrians generally never ignore the pre-1913 era of fractional reserve banking. Tom Woods in his great book “Meltdown” explains the distortions inherent in pre-1913 fractional reserve banking.
The suggestion that Austrians purposefully ignore the pre-1913 era is intentionally false and defamatory.