Eurozone closer to a deflation – stagnation trap

Olli Rehn, Vice-President of the EC in charge of Economic and Monetary Affairs and the Euro, gave a press conference on economic forecasts for Eurozone. (EC Audiovisual Services).

Olli Rehn, Vice-President of the EC in charge of Economic and Monetary Affairs and the Euro, gave a press conference on economic forecasts for Eurozone. (EC Audiovisual Services).

In a six line and few words Press release, Eurostat, the EU statistical service, announced its flash estimate for March Eurozone inflation at 0.5% further down from 0.7% in February, setting wide open the deflation (negative inflation rates) trap for the 18 countries euro area. This fast disinflation (falling inflation rates) course started last October, when inflation took a clear downwards turn to 0.7%.

Deflation is a major threat to all developed economies leading to exponential reductions of all nominal prices and chronic stagnation of real economy. The Japanese economy has suffered from deflation for ten years and still is not certain if it has exited from this trap, despite the hundreds of trillions of yen of extra government spending and borrowing.

International economic analysts and institutions like the International Monetary Fund have warned about the disinflation or even deflation dangers that threaten Eurozone. Still, the German government and the country’s central bank, the Bundesbank, pretend that nothing is happening and actually demand a rise of interest rates.

Away from targets

ECB’s President Mario Draghi has repeatedly stated that inflation is bound to remain at very low levels for a long time, far away from central bank’s target, set at below but close to 2%. This persistent tendency of disinflation in the Eurozone has attracted heavy criticism on the grounds that Eurozone doesn’t do enough to support internal demand and thus lead its own economy out of recession and the world to a higher level of growth. The IMF and the US have been warning Europe about that for a long time.

In any case, the new Eurostat announcement makes things crystal clear. Eurostat says “Euro area annual inflation is expected to be 0.5% in March 2014, down from 0.7% in February, according to a flash estimate. Looking at the main components of euro area inflation, services is expected to have the highest annual rate in March (1.1%, compared with 1.3% in February), followed by food, alcohol & tobacco (1.0%, compared with 1.5% in February), non-energy industrial goods (0.3%, compared with 0.4% in February) and energy (-2.1%, compared with -2.3% in February)”.

Given that energy prices are considered as an exogenous variable, all the other sectorial inflation indices keep falling from month to month. Incidentally, the inflation index of the key sector ‘non-energy industrial goods’ is dangerously close to zero. This sector is considered as the heart of every developed economy. In the case of Eurozone, the pricing of the sector’s product signals a persistent stagnation of demand.

The ECB to decide

Despite the fact all those negative data are confirming that Eurozone is very close to a deflation trap and may soon return to its four year long recession period, Germany insists that there is no need for monetary measures to help the economy exit from this dreadful region. Berlin repels measures like negative interest rates on commercial banks’ deposit accounts with the ECB or a further reduction of central bank’s basic interest rate from presently at 0.25% to, why not 0%. Obviously, Germany prefers to gain some billions in interests on its huge reserves, while totally ignoring the needs of all the other Eurozone member states. Everybody else except Germany need low interest rate financing in order to exit the state of stagnation or even recession many countries are in.

The ball is now in Draghi’s court. Next Thursday the Governing Council of the ECB is due to meet and decide on the basics of Eurozone’s monetary policy. The Council cannot remain indifferent in view of the imminent deflation and recession dangers that Eurozone is threatened by. The ECB has to listen to the needs of the vast majority of Eurozone citizens. It cannot cater exclusively for the Teutons.

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