Europe’s deflation threat
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The European Central Bank has done something new and surprising: this is the first time in the bank’s 15-year history, the FT’s Tony Barber writes, that it is so directly taking on the threat of deflation, proving it’s more than “just an old-style inflation-fighting central bank”. Specifically, the ECB cut interest rates today to a record low. The details of the cut are here.
A little more than a week ago, European inflation came in at just .7% in October, far below the ECB’s target of 2%, and the lowest level since November 2009. (Paul Krugman called the numbers “disastrous.”) That kind of very low inflation has a habit of turning into deflation or, as Jack Ewing put it, “a decline in prices and wages that can become a vicious circle of economic atrophy.” In a statement, ECB president Mario Draghi denied that Europe is suffering from the D word, but said: “we may experience a prolonged period of low inflation, to be followed by a gradual upward movement towards inflation rates below, but close to, 2%.”
Neil Irwin sees the ECB’s move as proof that Super Mario “isn’t going to be passive if the trend toward deflation continues.” Izabella Kaminska has the analyst reaction: HSBC argues this is in large part about the euro, which had been on the upswing since July and threatened Europe’s export-dependent economy. “Massaging” the euro lower is the “ECB’s most potent economic tool to help growth and fight the deflation,” HSBC says. Matt Klein finds the ECB’s move underwhelming: he suggests the ECB should move to either a UK-style funding-for-lending program or just start snatching up government debt.
Europe’s disinflation problem (read: slowing inflation) is starting to look like a global problem. The Economist notes that “the average inflation rate in the mostly rich-world OECD is 1.5%, down from 2.2% in 2012 and well below central banks’ official targets (typically 2% or just under).” This dynamic can have crushing consequences:
Ultra-low inflation has costly side-effects. It tends to go with a weaker economy and higher-than-necessary joblessness…It also means that nominal incomes grow more slowly than they would if prices were rising faster. This makes both government and household debts harder to pay off. And low inflation makes it tougher for uncompetitive countries within a single currency to adjust their relative wages. With Germany’s inflation rate at 1.3%, Italian or Spanish firms need outright wage cuts to compete with German factories.
Even if the ECB isn’t done intervening, Draghi may have to start using the D word. Greece and Spain are already dangerously close to official deflation, according to Credit Suisse. — Ryan McCarthy
On to today’s links:
Twitter leaves more than $1 billion on the table in its IPO – Dan Primack
“Don’t invest in individual stocks. Especially don’t invest in tech IPOs” – Farhad Manjoo
The hidden technology that makes Twitter huge – Paul Ford