Eurozone: Subdued inflation can lead to more recession

Eurostat table: Euro area annual inflation and its main components (%). Harmonised indices of consumer prices (HICP)

Eurostat table: Euro area annual inflation and its main components (%).
Harmonised indices of consumer prices (HICP)

Inflation in Eurozone remained subdued during last January at 0.8%, stable as in December 2013 but way below the January 2013 quote at 2%. According to Eurostat, compared with December 2013, annual inflation fell in seventeen member states, remained stable in seven and rose only in four. In January 2014, negative annual rates were observed in Cyprus (-1.6%) and Greece (-1.4%). On a monthly base euro area inflation was negative at -1.1% in January compared to December.

Eurostat found that “The largest upward impacts to euro area annual inflation came from tobacco (+0.08 percentage points), electricity and milk, cheese & eggs (+0.05 each), while fuels for transport (-0.19), telecommunications (-0.13) and heating oil (-0.05) had the biggest downward impacts”. On many occasions this newspaper has insisted that subdued inflation pressure is an infallible witness that the applied austerity economic policy mix doesn’t offer a sure way out of stagnation and may even lead to a new recession period.

With the growth rate oscillating between zero and the three decimal points above naught since the second quarter of 2013, nobody can argue, using basic logic, that the euro area economy is now growing again. Not to forget that until the second quarter of 2013, Eurozone was receding for at least twelve quarters in a row. The European Central Bank, the only Eurozone institution which incorporates in its analysis and programs the inflation rate for the entire Eurozone, has extended the time horizon of its prediction of persistently low inflation. In this way, the ECB points out, albeit indirectly, that nothing is right in the Eurozone. On the other side of the fence Germany obviously doesn’t mind about the devastating deflation (negative inflation) in Greece and Cyprus.

The role of ECB

Mario Draghi, despite the fact that he repels the assertion about deflation in the hole of Eurozone, keeps repeating with astonishing insistence that the inflation target is set by the ECB at “below but close to 2%”. Understandably, 0.8% is not close to 2% so the ECB should have taken action but it doesn’t. Unfortunately, the ECB, bound by its mandate, cannot take action and actively support economic growth by a more relaxed monetary policy, as every other major central bank would have done. The two Germans, participating in its Governing Council block any relaxation of monetary policy. They oppose all measures which could help the positive effects of the the monetary policy to be felt in all member states and help growth. Probably the President of ECB wants to denounce this reality, when speaking about the inflation target being set “below but close to 2%”.

Eurostat graph: Weights of the main components of the euro area harmonised indices of consumer prices (HICP)

Eurostat graph: Weights of the main components of the euro area harmonised indices of consumer prices (HICP)

During the last monthly Press conference which Draghi regularly holds after the meeting of the Governing Council, he left it to be understood that the ECB has extended the time horizon of its predictions for subdued inflation. Until recently the ECB predicted that inflation will continue to be at much lower levels below the 2% target, all along this and the next year. Now it seems that the model the ECB uses shows that inflation will continue to oscillate around 1% even well into 2016. This is tantamount of predicting that growth in Eurozone will not exit stagnation in the foreseeable future.

This is like condemning the south of Eurozone to the longest and deepest recession after WWII, of course without hope for a betterment in the labour market. This means that the unseen before unemployment levels in Greece, Spain, Italy and Portugal will not recede and more than 60% of the youths will continue, for the years to come, to be without a job.

Subdued inflation means recession

The forecast that inflation in Eurozone will continue to be subdued in the long run, is backed by the analysis of its components. Eurostat notes that “Looking at the main components of the euro area inflation, ‘Food, alcohol & tobacco’ (1.7%, compared to 1.8% in December) had the highest annual rate in December, followed by ‘Services’ (1.2%, compared to 1% in December), ‘Non-energy industrial goods‘ (0.2%, compared to 0.3% in December), and ‘Energy‘ (-1.2%, compared to 0.0% in December)”.

The heart of every economy beats in the sector of the non-energy goods. This sector represents the deep structures of the entire productive machine and determines the long term prospects of any developed economy. With the price developments in this sector being stuck around zero, Eurozone has no chance of exiting stagnation, without a generous change of economic policy. The currently applied austerity, imposed mainly by Germany, cannot bring about a new growth period and it may even lead to deflation, thus endangering all values in the economy, even in Germany.

Unfortunately, France and President Francois Hollande seem to have changed course and now follow the ‘German way’, having introduced a new austere program of spending cuts to the tune of €50 billion. If this goes ahead, Eurozone may soon even return to recession, just after a brief period out of it.

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