Is deflation a real danger for Eurozone?

Siim Kallas, Vice-President of the European Commission in charge of Transport and Economic and Monetary Affairs and the Euro (pro term), gave a press conference on the 2014 spring economic forecast... Inflation was expected to remain low, both in the EU (1.0% in 2014, 1.5% in 2015) and in the euro area (0.8% and 1.2%). (EC Audiovisual Services 05/05/2014).

Siim Kallas, Vice-President of the European Commission in charge of Transport and Economic and Monetary Affairs and the Euro (pro term), gave a press conference on the 2014 spring economic forecast… Inflation was expected to remain low, both in the EU (1.0% in 2014, 1.5% in 2015) and in the euro area (0.8% and 1.2%). (EC Audiovisual Services 05/05/2014).

There are rare times in the economic chronicle, and here they are now, when the merry going economies like Austria and Luxembourg have decent inflation rates around 1.5%, while the unlucky and miserable ones like Greece, Bulgaria and Portugal are being haunted by negative inflation records of up to -2.1%. Let’s get the full and rather alarming picture of Eurozone’s inflation. Not to forget that the European Central Bank has been warring about it for some months now and on Thursday 5 June it adopted extraordinary monetary measures in order to fight disinflation (falling inflation) and support euro area economic activities.

Coming to the core of the problem, Eurostat, the EU statistical service confirmed yesterday that the consumer price index for the entire euro area increased in May by only 0.5%, against an institutional target set by the ECB at below but close to 2%. The problem is not only that. According to the same source, on a monthly base, Eurozone inflation turned negative in May with an alarming reading of -0.1%. As all first year students of economics know, even the slightest negative inflation rate can trigger a crisis, by inducing sellers to further cut down their offered prices in order to remain in the market.

Eurostat found it negative

Eurostat’s Press release states clearly that, “Euro area annual inflation was 0.5% in May 2014, down from 0.7% in April. A year earlier the rate was 1.4%. Monthly inflation was -0.1% in May 2014. European Union (EU 28) annual inflation was 0.6% in May 2014, down from 0.8% in April. A year earlier the rate was 1.6%. Monthly inflation in the EU was -0.1% in May 2014”. This is the second estimate by the EU statistical service for the May inflation. Two weeks ago it had accurately predicted this variable; at the end of last month it had released its flash estimate for May 2014 also at 0.5%.

This is not the only frightening finding of Eurostat. Yesterday’s Press release came across the inflation rate for ‘Non-energy industrial goods’ for May at a straight 0.0%. This newspaper has repeatedly observed that this category of consumer products constitute the heart of any developed economy. Those products embody the core developments of costs and pricing and set the pace for the entire system.

European Sting had noticed it

In 1 October last year the European Sting writer Elias Lacon remarked that “Unfortunately, the sector is clearly in a state or close to disinflation. According to Eurostat, price changes of non-energy industrial goods during September 2013, was restricted to only 0.3%. Subdue price changes have been haunting the sector for quite some time. All along this year the relevant inflation sub index falls steadily from slightly below the unit to a mere 0.3% in September. The reasons for this development might be a weak demand or production overcapacity or both. Whatever the causes, the fact is that this core sector of Eurozone’s economy is heading or already has entered in a disinflationary spiral”.

There is no doubt that Eurozone is heading towards the deflation area (negative inflation), given that the current tendency towards disinflation (falling but still positive inflation rate) seems to have a lot more way to go. If one doesn’t believe what Elias Lacon stated many months ago, one has better give a thought to what happened in the last meeting of ECB’s Governing Council on 5 June. On that day, Mario Draghi, the ECB President, repeatedly confirmed that the central bank governors decision (while adopting the extraordinary monetary measures to support the Eurozone economy) was in unanimity.

Why unanimity?

This means the two German central bankers participating in this Council, Sabine Lautenschläger Member of the Executive Board of the ECB and Jens Weidmann President of Deutsche Bundesbank, both voted yes. It would have been unthinkable for the two German bankers to accept those unprecedented measures, if they didn’t possess strong evidence provided by Eurostat and the ECB, proving that Eurozone could be heading to deflation or it is to be haunted by very low inflation for a very long period. Of course stagnation would accompany Eurozone all along this dangerous path.

At the same time, the German Minister of Finance and architect of his country’s overall economic strategy in Eurozone, Wolfgang Schäuble, had openly demanded an increase of interest rates, despite the reduction the ECB had just decided. If the two German bankers didn’t possess strong evidence to contradict Schäuble’s argument over monetary policy, they would have denied the measures. Instead, the reduction of the interest rates and the extraordinary monetary actions were adopted unanimously by the central bank’s Governing Council, including the two German votes.

All this above analysis proves beyond reasonable doubt the existence of evidence that Eurozone is heading towards a very long period of close to zero inflation or even deflation. Hopefully, the extraordinary instruments just adopted by the ECB and probably more of the same kind being ready in the pipeline, will change all that. The much-needed resumption of economic activities however should be substantive and start bringing down the dreadful unemployment rates which presently plague more than half Eurozone. Otherwise, the entire single money edifice may start declining soon, even in the political level.

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