On Wednesday last week, an official report showed that consumer prices in the eurozone fell 0.2 percent last month from a year earlier, the first time they had dropped since the dark days of the global financial crisis in 2009.
It is an outcome that economists have been predicting for more than a year and a trend that has long been complicating Europe’s recovery.
Now, the latest data are adding concerns that Europe is headed for a new financial and economic crisis. Unemployment remains persistently high. The euro has been particularly weak, and the political upheaval in Greece is prompting talk about the stability of the 19-country eurozone.
Illustration: Yusha
With the outlook deteriorating, pressure is mounting for the European Central Bank (ECB) to take more aggressive action to avoid a downward price spiral that could undermine the economy for years to come, and officals have been signaling that they could announce a major bond-buying program later this month.
However, the question that many economists have raised is whether the bank has waited too long to act, and whether its arsenal is powerful enough to address the eurozone’s fundamental problem — a lack of demand from businesses and consumers for goods and services. European Central Bank President Mario Draghi has said that the central bank alone cannot shoulder the burden of restarting growth.
“The eurozone is suffering from a profound malaise,” Center for European Reform deputy director Simon Tilford said. “It’s already in a deflationary trap of the kind we saw in Japan in the 1990s, but it’s less well-equipped than the Japanese to deal with it.”
The situation in Europe does not appear to meet the classical definition of deflation — a widespread, protracted and self-sustaining decline in prices. The continued global collapse of crude oil prices also contributed significantly to the decline, blurring somewhat the implications of the inflation report for the eurozone.
However, the trend is dangerous. The low inflation environment was already a signal of a listless economy, with consumers spending little despite low prices and companies having scant incentive to invest in their businesses.
If prices actually fall for an extended period, consumers might delay purchases in the hopes of getting better deals later, and businesses would see little reason to make products that would be worth less with each passing month.
“We’re not yet in a self-sustaining spiral,” Bank of America chief European economist Gilles Moec said, “but we’re close.”
Analysts said on Wednesday last week that it was now a certainty that the European Central Bank would announce aggressive new measures when it meets in Frankfurt, Germany, on Thursday next week.
They expect the central bank to say it is ready to begin effectively printing money that it would use to buy eurozone government bonds, even if it does not put the measures into practice for several months.
In doing so, the bank would follow an unconventional policy similar to the quantitative easing used by the US Federal Reserve to stimulate the US economy.
However, quantitative easing is a divisive issue in Europe because of questions about how to allocate the bond buying among eurozone countries, and who would pay if a government defaulted on bonds held by the central bank. That uncertainty is a main reason Germany does not want to put its taxpayers at risk of having to bail out the bloc’s weaker neighbors.
The central bank has an official goal of trying to keep inflation at just below 2 percent, which it considers an optimal level for a healthy economy. However, the bank has not met that target in two years.
Japan’s experience in the 1990s showed that traditional monetary policy instruments are largely ineffective with nominal interest rates at zero — as they essentially are now in the eurozone.
Another way to address the problem might be for eurozone countries to drop their insistence on balancing budgets and to instead use tax cuts and public spending to create demand.
So far, however, European officials appear to be holding their course.
“Yes, the eurozone is going through a period of low inflation,” Dutch Minister of Finance Jeroen Dijsselbloem said in a statement in response to a query from the New York Times. “But one of the most important reasons for the current low inflation rate is the falling oil price. Core inflation — excluding oil prices — has recently slightly increased.”
The core inflation rate, which excludes energy and food prices, ticked up to 0.8 percent last month from 0.7 percent October, according to Wednesday last week’s data.
There is no question, however, that the eurozone is ailing. The bloc’s economy expanded 0.6 percent in the third quarter of last year on an annualized basis. That is far short of the US economy’s 5 percent growth, and recent data suggests that the pace of eurozone growth has been slowing.
That stark difference is one reason the value of the euro has been plunging against the US dollar in recent weeks. It fell again on Wednesday last week after the inflation report, declining more than 0.5 percent to US$1.1816 — the euro’s lowest level against the US dollar in nine years. As was the case the last time the euro was this low, fund managers are moving investments to the US in expectations of a better return on their money.
Consumer prices in the eurozone had not contracted on an annual basis since October 2009, when the slack global economy caused the bottom to fall out of the market for oil and other commodities. Last month’s negative rate was down from the 0.3 percent increase in November.
Well before eurozone consumer inflation fell below zero, the region’s low inflation rate had been raising alarms. Economists with the IMF warned early last year that the difference between ultra-low inflation, known as lowflation, and outright deflation was mainly a matter of degrees, as the weak price pressures could “scupper the nascent recovery and pressure the most fragile countries.”
Draghi said last week in an interview with the German newspaper Handelsblatt that the risk of deflation “cannot be ruled out completely, but it is limited.”
“We are not there yet,” he said. “But we need to tackle this risk.”
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