The Beauty of Deflation
Deflation Paranoia
The euro zone’s consumer price inflation rate declined below 1% in early 2014, getting closer to zero during 2014, nowhere near the ambitious 2% benchmark set by central banks. A further small downward adjustment in the inflation rate has put it into negative territory, so harmonized euro area consumer prices are now declining. Western monetary authorities and economists appear genuinely fearful of deflation. Headlines in leading papers reflect this fear very strongly, describing deflation as “the world’s biggest economic problem”, or a “nightmare that stalks Europe” that could lead to its “demise and collapse”.
The real question is though, why do our governments fear deflation? Why do they perceive it as a chronic disease that could infect the economy and why do they go to such great lengths to avoid this “taboo” event? The mainstream argument is that we should avoid deflation because it causes a drop in overall demand and hence lowers economic growth (Germany and other European countries have experienced a slowdown recently which has resulted in a downgrade of 2014 and 2015 growth expectations). Also, deflation implies lower corporate earnings and asset prices, particularly real estate prices.
The euro area’s harmonized index of consumer prices has recently dipped slightly into negative territory, which is excellent news for European consumers – click to enlarge.
But the greatest concern to governments is not deflation itself; the real concern is the impact of deflation on the already over-indebted governments of Europe. Seven euro zone countries are projected to have public debt to GDP ratios of over 100% next year! The worry is quite legitimate from the perspective of indebted governments. With deflation, the burden of debt increases, making defaults more likely. So what are policymakers doing to tackle this problem?
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