Eurozone slips into deflation

ScreenHunter_5689 Dec. 24 10.43

by Chris Becker

Normally, you should cheer on lower inflation as your disposable income becomes more valuable. And with oil prices falling and mortgage rates at record lows, its doubly cheerful! But in Europe, unless you’re German, tough luck.

Overnight we saw two very important prints that will shake the ECB up when it meets on the 22nd later this month. First, German unemployment fell to a twenty year low at 6.5% (even though jobs were lost over the month), while Italian unemployment was steady at a depressing 13.4%

This divergence is key to understanding why the German-dominated ECB has failed to act in arresting the depressing unemployment levels in peripheral Europe. Because as long as German unemployment and moreover, inflation, remains moderate and contained, the rest of the continent can go to hell.

However, the lack of demand outside the central power has now slipped the Eurozone into deflation:

The eurozone slipped into negative inflation in December, giving the European Central Bank as much of a shot in the arm as it needs to launch outright quantitative easinglater this month.

Consumer prices fell 0.2% on the year to December, far short of the ECB’s near-but-below 2% target (and if you want to know why this, according to the ECB, is still negative inflation, rather than deflation, read this).

Meanwhile, ECB measures announced during the past six months or so to pump liquidity into the system have so far failed to produce hoped-for results.

Which leaves the ECB with the option that the U.S. Federal Reserve, the Bank of England and the Bank of Japan have relied on to achieve the same result: buying government debt, or quantitative easing.

Even after stripping out the effect of plunging oil prices, which keeps the core CPI gauge just below 1% and significantly below the 2% target, the risk of a deflationary spiral as aggregate demand slumps is ever present.

More from Bloomberg on why we should expect some sort of QE soon, and probably repeated throughout 2015:

ECB Chief Economist Peter Praet told Germany’s Boersen-Zeitung last month that in an environment in which inflation expectations are “extremely fragile,” officials cannot “simply look through” the slide in energy costs. Praet makes a recommendation at the start of each monetary-policy meeting.

Central bank staff have worked on QE proposals in the past two months, and Dutch newspaper Het Financieele Dagblad reported yesterday that governors may be offered three different options to choose from at their Jan. 22 meeting.

“According to the ECB’s own logic, with sub-zero inflation, no sign of a material pickup on the horizon, and inflation expectations de-anchoring, there is a compelling case for further monetary easing,” said Teunis Brosens, an economist at ING Groep NV in Amsterdam. “The question no longer seems ‘if’ the ECB is going to announce QE, but ‘how’ it will be tailored.”

The ECB needs to act soon and for the sake of all Europeans, not just the Germans.

Comments

  1. GunnamattaMEMBER

    If we get a generation of the Eurozone playing Japan post 1990 then you would imagine the EU is unlikely to hold together.

    They have known this was on the cards for ages, and they have known that the schizophrenic approach of LTRO (to backstop their banking system) and Austerity on the fiscal side wasnt actually getting them traction on a demand turnaround. The one thing you could say for the US Fed is they made themselves perfectly clear from the get go – they would flood the system with money until they had growth – the ECB hasnt been in that position. The only way they turn things around from here for mine is to get the politics together to bring about fiscal transfers, or they get the politics together to get a deal with Turkey and Russia. They probably need to sort out Eastern Ukraine (the risks that carries for the fiscal side of the EC, as well as the sentiment for investment) as bad as the Russians do.

    • ECB has stated REPEATEDLY, although apparently no-one here at MB has been listening as it slams shut the interest rate cuts in Australia theory, that they will be engaging in a massive keynsian stimulus program, as will the US.

      It is beyond me why people are refusing to listen to this simple fact – there is NO OTHER ALTERNATIVE and it will eventually happen by design or by default.

      The US is already making ructions about fixing 600,000 pieces of dangerous infrastructure (bridges etc), high speed rail, freeways and more while EU is talking about massive power and telecommunications projects integrating all of Europe.

      This will put money DIRECTLY into the pockets of the middle class and put a rocket under demand and inflation. Everyone knows it – the only problem is admitting that keynsian works and socialism is important to functioning capitalism.

      The huge outlays in spending from government / private whatever will dry up the remaining credit supplies and force a global reckoning on credit whose impact will be felt on Australia interest rates – combine that with renewed spending demand from China, US and EU will decimate Australia.

      Edit : And I don’t mean resource demand.

      • Leviathan: why will this put pressure on Australian interest rates?

        What you are suggesting is fiscal stimulus by deficit spending. This will put downward pressure on the currency of whichever country enacts it, surely?

        If the US govt deficit spends, that will be more USD in circulation, that will mean lower USD? right?

        They surely wont fund this government spending with more taxes.

        They surely won’t raise interest rates to go along with this, as the idea is to increase inflation not reduce it

        There won’t be any effect on credit supplies: the central banks will simply print to fund the deficit spending

      • Coming

        The Oil Shale revolution has been the safety valve for the USD and allowed it to get away with their money printing. Similarly I suspect it will allow the ‘direct’ spending without blowing the USD to hell and gone and creating massive inflation. The increased government deficit may well the totally offset by savings on imported oil by the private sector. It looks to me likely that there won’t be too many more USD going around. I don’t have time to do the maths on that but it would be interesting if anyone had the time.
        The EU might not have the same experience without a significant resource input, which they don’t have, to back the spending. The danger is that the Euro may not have the same resistence to falls that the USD has. In which case there may well be disastrous effects to the ECB printing.

        Just thinking out loud.

      • Flawse: that doesn’t really answer my question though.

        If the US changes its stimulatory policy from monetary to fiscal, why should that have any ill-effects on Australia?

        In fact, if there were QE for mainstreet in the US, that would actually benefit Australia because now US consumers have money to buy chinese crap, and more commodities arerequired (iron ore, lpg)

        I don’t understand the mechanism behind what Leviathan is suggesting: if the US and Europe engage in fiscal stimulus, why should that affect Australian interest rates or credit availability?

      • Coming
        I think the US is going to be spraying a lot less USD around the world. Yes, as you say, the fiscal stimulus may mean buying more Chinese stuff but they will spend a whole lot less money on oil. Note i also think, for various reasons, the US may, in future, import RELATIVELY less from China – but that’s another whole book!
        I guess the US could go back to buying up the world! In the absence of that however i probably agree with Lev. There will be a lot of interest rate increases trying to shore up capital flows. Picture Aus, with its chronic CAD, in a world of scarce USD and nobody much wanting any more A$ in their pockets!
        (Note I’m not dogmatic on this score. I’m as confused on the net outcome as anybody! It’s just the way i see it.)
        The presumption that CB’s can forever, in both time and qwuantity, print money with impunity seems to me to be illusory.
        Certainly it isn’t going to be the smooth sailing that seems to be implied.

      • Fair enough

        I still don’t understand why US fiscal stimulus should result in greater demand for US dollars. Should be the opposite

        b) there’s no evidence that it is illusory – if demand does not outstrip supply, there is no inflation. Japan is proof of that (and needs imports even more than Australia does)

        But I agree on not knowing what the future holds. Cheers

      • Coming

        Just a point
        “if demand does not outstrip supply, there is no inflation. Japan is proof of that (and needs imports even more than Australia does)”

        Denmand may outstrip supply but the supply is made up by imports. This central bank printing may result in inflation (in whatever form) and /or a Current Account Deficit.
        I think this point is missed in current economic thinking because everyone believes Current Account deficits don’t matter. They’re wrong.

        Re Japan and imports. it needs imports but it has more than adequately covered them with exports running a consistent CAS for decades.
        As you’ll be aware my big problem with pretty much all modern economic thinking is time frame. Modern economists think that if something hasn’t happened in teh last 5 or 10 years then it cannot happen. The modern economic cycle has been going on for some 60 years. We’ve kept inflation low with Current Account Deficits. The cost to us as a society becomes more and more visible. The process will continue until it can’t. I believe that time will arrive as the Chinese demographoc curve turns down and its prosperity curve turns up.

      • ” still don’t understand why US fiscal stimulus should result in greater demand for US dollars. Should be the opposite”

        I agree. However i think that is just a part of the future. On balance USD may get to be a bit scarce for a year or two. If the US then engages in massive fiscal stimulus while maintaining a policy of just printing to cover any and everything the terminator dogs will have been let loose.

        It’s pretty impossible to hold all the possible outcomes in one’s head!!!!!
        Cheers

      • “Denmand may outstrip supply but the supply is made up by imports. This central bank printing may result in inflation (in whatever form) and /or a Current Account Deficit.
        I think this point is missed in current economic thinking because everyone believes Current Account deficits don’t matter. They’re wrong.

        Re Japan and imports. it needs imports but it has more than adequately covered them with exports running a consistent CAS for decades.”

        Well this is exactly why we have a floating currency (to allow self-determination of interest rates, and to compensate for Current account deficits.

        Also why I don’t understand people who complain about Chinese buying our overpriced homes – that allows us to deficit spend without having to worry about currency depreciation

  2. Macro Enthusiast

    Interestingly, 1-year inflation swaps are pricing in inflation of -0.5%. Inflation expectations were not this low during the heights of the global and European crises (to date). This is significant, because it means that the drop in oil prices is not driving the deflationary expectation exclusively. After all, oil fell more in the GFC, than it has to date!

    There is something very serious being priced in here, and it may go beyond Greece exiting. There are a few possibilities:

    1. Market is concerned that Draghi has exhausted his tool kit.

    2. Lower for longer growth is finally catching up to everyone as a deflationary force (although the supply-side destruction that is occuring in the peripherals is actually preventing massive deflation, and may even be inflationary long-term).

    3. Hard to argue that Cyprus was a one-off if Greece exits too. Deposit flight may not be under control in this scenario.

    • Cows_in_the_Cloud

      Could also be pricing in an ineffective Sovereign bond buying program from the ECB. If you were Germany, would you want to guarantee Italian bonds? If all Eurozone bonds can not be treated equally during the QE (bond repurchase) then it will not be effective.

    • Probably a short term phenomenon though doc? Mind you it might be a bit more than short term as we have a lot of debt to work through and increased demand probably will not be seen till we have worked through the debt.

      I don’t hold with the baloney that we need inflation to increase demand by bringing it forward – again it is a short term phenomenon with longer term negative ramifications. So I’m thinking the corollary is probably true.

  3. migtronixMEMBER

    Aaahhh. Economic conquest, much better “optics” than all goose-stepping isn’t it?

    • I’d argue that if there was anything that the goosesteppers (not just those in Germany) were good at, it was optics.

      • You can’t give it a replay – the point of any conjurer’s trick is to hide what’s really happening. An audience that already knows ‘the other side of the story’ can’t see it the way it’s meant to be seen.

    • US, UK, Japan did it, why can’t Ze Germany.

      Chinas long term economic stability resides in ubiquitous global warfare.

  4. In view of what happened in Japan and what is happening in Europe, I believe low interest rates are in fact driving deflation!

    Even though common sense & economy theory will suggest low interest rate should drive demand and inflation, zero or negative interest rate is making the money/investors to be lazy/risk adverse.

    Looks like free money AND zero interest rate is not a real motivator in long run.

    • migtronixMEMBER

      That’s what I’ve saying/thinking for a while. When you drop rates below nominal inflation you’re driving deflation and always will…

      • Ronin8317MEMBER

        I cannot think of an economic model where higher interest rate can stop deflation. In modern time (say, China 2000-2007), interest rate below inflation always leads to more inflation. It can be argued that when you’re close to the zero bound, lowering interest rate will not stop deflation. However, raising interest rate like what happened during the Great Depression will only make it even worse.

        I don’t believe creating more debt is a solution either. The debt overhang has to disappear.

      • “When you drop rates below nominal inflation you’re driving deflation and always will…”

        Mig – are you leaving out a step in teh logical process? Negative rates result in increased debt. This can, and has, gone on for a long time. That debt then becomes deflationary. Your inflationary/deflationary wave develops higher and higher frequency and amplitude leading to a crescendo of eventual destruction.
        ????

      • Mig

        Can I suggest an alternate view the cheap money allows large interest groups to buy and park assets to distort markets. It also allows big business to sideline regulations till they are caught and pay minimal fines, thus running assets beyond their capacity without the intended upkeep (associated jobs)

        Eg 3D1K other pinups the Koch Bros.
        http://www.rollingstone.com/politics/news/inside-the-koch-brothers-toxic-empire-20140924

        Meanwhile the banks
        http://www.rollingstone.com/politics/news/the-vampire-squid-strikes-again-the-mega-banks-most-devious-scam-yet-20140212

        That is why the oxfam report stated that only the rich are getting richer.

        What ya think?

      • migtronixMEMBER

        @flawse: My thinking is like this -> below inflation returns == less savings/money coming into the savings pool that’s been “earnt”.

        With a smaller base of “real” money (I know I know) the lenders will only finance new loans (deposits? Bwaaahahahaha) for sh#t that’s already highly priced so they have a veneer of collateral.

        Keep that show going for a while and the result is secular deflation with asset bubbles in my opinion.

        But I know DE/Skippy/Coming will tell me all we need is more money drops.

      • @ flawse at 1:30

        “Negative rates result in increased debt.”

        I don’t believe that it will flawse. If there was demand for credit then rates wouldn’t need to fall to a negative setting. What the economy then must lack is demand from consumers.

        The negative setting could possibly push some consumers to spend rather than save in a negative rate setting, but more than that consumers will appreciate the state of the economy and choose to save anyway because they are afraid to spend.

        I think that the world is at the point when governments must spend into the economy for worthwhile projects that will be an asset upon completion, then the added spending will create jobs and consumer demand through a greater confidence.

        I just don’t see the political will for that anywhere, especially here, but IMHO that’s what has to be undertaken to both rebalance the debt levels and stimulate the demand.

      • migtronixMEMBER

        I’m not so sure there’s much room for “savings” out there Fraser, unless you mean “building equity”/paying down interest. Probably a sever combination of boomers leaving the playing field of high-consumption, young families too strapped paying down debt, and young too f#cked over by stagnating wages and ballooning dwelling costs.

        No demand you say? Wonder why…

      • Peter
        “The negative setting could possibly push some consumers to spend rather than save in a negative rate setting,”
        Yes that is what happens
        ” but more than that consumers will appreciate the state of the economy and choose to save anyway because they are afraid to spend”
        That ios a purely ‘short’ term phenomenon. Look at the resulot of negative RAT to zero RAT interst rate policies in Aus over decades. What have you got? You have a mountain of private debt and most of your nations assets gone to finance excess consumption..

      • mig
        “My thinking is like this -> below inflation returns == less savings/money coming into the savings pool that’s been “earnt”.”

        Yep which equals debt which then causes the reduced demand they try to fix with lower rates. I don’t think we differ much except that it is debt’ driving the reduced consumption and resultant reduced demand (deflation) for stuff we don’t actually need.
        Of course, as you imply, we have less production of real stuff we NEED (misallocation) so we get inflation in that (generally speaking)

        Anyway intersting mental gymnastics!!!
        Cheers

      • migtronixMEMBER

        You have a mountain of private debt and most of your nations assets gone to finance excess consumption..

        I think that’s why Fraser is advocating the Govt eat more of the debt pie by spanning it on capital works, flawse.

        I agree with what my take of your position is, govt can give us capital works but we don’t have to do anything useful with it just because they build/finance it, but technically the govt slice of the debt pie will increase and that will give consumer a trickle down. Probably short term phenomenon again as it might halt the wage stagnation for a bit with lower UE but I can’t see it lasting long – its not exactly the same as China giving us USDs is it? That’s the thing with MMT, if we could print Euros and USDs and GBPs we’d have no problem whatsoever — but we can only print AUD.

      • @ Mig

        Re your generational attitude

        I’m extrapolating from a previous conversation that you posted about your time in UK (I think when you got out due to job losses there, so I presume due to your vast knowledge of all thing macro that you were in the banking sector)

        The banks operate through the vast number of highly intelligent young things eg the London Whale and the others that brought a number of London banks to their knees.

        The vast gaming of the LIBOR system etc

        To suggest that there is one culprit in these issue is pretty myopic.

        As I’ve said before your generation has never been as well educated, have the ability to see the world for what is and yet seems unable to get off the couch.

        Why??

      • migtronixMEMBER

        Bloody hell Mark I didn’t say anything about boomers being to blame just they that don’t have families to raise and houses to pay off any more….

    • “…Looks like free money AND zero interest rate is not a real motivator in long run…”

      Oh it is still a real motivator. In fact an awesome motivator.

      But only to the well placed insiders with access to credit, green lights to secure large, mostly public assets, and the protection of the public balance sheet if their bets go wrong.

      The problem is that the process of acquiring control of assets with cheap money does not generate many jobs or drive broad based economic activity.

      Did someone just say FIRE!

    • Inflation in everything you need…as they say! My thinking is that this will be true. Stuff you don’t need may deflate.

    • Yes..

      Basically MB grew to a point where we all needed to make decisions about what to do next . UE and H&H decided to become salaried employees of the company , I decided to continue working on other ventures ..

      In making that decision I took a back seat on the day to day blogging and got 4 hours a day of my life back

      Don’t worry , you may not notice, but I’m still very involved in MB.

  5. If you understand QE , you’ll understand it won’t stop deflation.. Deflation is a demand side issue not a supply one . Culture in Germany and retrenchment everywhere else means it’s all destined to be a EZ trip to Japan

    I explain a bit of this here

    http://www.macrobusiness.com.au/2012/09/central-banks-versus-the-people/

    “So QE and OMT are monetary programs that, in part, aim at increasing the leverage of the private sector, but they have only attempted to address the supply side of the equation. Fiscal policy in the EZ is continuing to lower the private sector wealth and by doing so is reducing the demand for credit which in turn is further weakening the economy. This dynamic appears to be more that offsetting the expansionary monetary program which is why you have seen the ECB’s response continue to become larger and larger over time. The Eurozone is therefore likely to continue to see poor economic outcomes even under the open-ended OMT because the insistence on the fiscal compact as a pre-cursor to renewed intervention is likely to be completely counter-productive.”

    • QE is actually deflationary, it takes away income earning assets from the banking and private sector.

      The world needs government spending on public works programs that can later be sold off to the private sector to make them net neutral or slightly profitable in the long term.

      But looking at the quality of politicians globally, it probably won’t happen.

      • ” it takes away income earning assets from the banking and private sector.”

        Private sector I understand but Banking? They get all the manufactured dough to funnel into the non-productive assets?

        I thought the evidence was pretty clear that banking sectors have exploded during the periods of QE (in its various forms) ?

    • There are politicians and economists out there, but funnily enough they are being completely sidelined, ridiculed or ignored completely by the mainstream media.

      On QE, If you mean its impact on aggregate demand, then yes, its been net deflationary in say the US and UK, but in terms of asset markets its been extremely inflationary.

      The solution lies in getting the unemployed working (and hence higher wages than the dole) on productive or even semi-productive projects coupled with widespread private debt writedowns to increase disposable income without having to reduce interest rates further (which they cant anyway).

      • CB,

        All one has to do is watch CNBC last night, with that one on one with Blankenfiend, to get an azimuth reading.

      • I have never seen it demonstrated that you write down debt without also confiscating savings and/or creating the environment for increased debt. I’ve been asking ever since Keen started advocating a debt jubilee – I’ve never got an answer.

        ‘Productive spending’ requirement is spot on but again we no longer seem to have the tools to be able to determine what that means. Most proposals for ‘productive spending’ in Australia just seem to mean more foreign debt.

  6. Central banks might want to ponder Woody Allen’s famous quip, If you want to make God laugh, tell him about your plans, for the actual real-world result of central banks easing, money pumping and zero interest rates is deflation.

    Central bank easing and zero-interest rate policy (ZIRP) fuel over-capacity which leads to declining prices: deflation with a capital D. The current oil glut is a primary example of this dynamic.

    • I’m thinking ZIRP and negative RAT lead to misallocation rather than, or as well as, overcapacity. We certainly consume more leading to a faster use of the world’s resources that belong to future generations. We get waste aka over-capacity?
      We consume more resources that really belong to future generations but at the saqme time we have not built the strucure necessary for the welfare (income) of future generations.

  7. Why are central bankers creating deflation? They want to crash the system and start another world war.

    This time everyone is trying to point the finger at Putin. Last time the finger was pointed at Hitler.

    My third finger is pointing at the banking elites!

  8. “In accordance to the principles of Doublethink, it does not matter if the war is not real, or when it is, that victory is not possible. The war is not meant to be won. It is meant to be continuous. The essential act of modern warfare is the destruction of the produce of human labor. A hierarchical society is only possible on the basis of poverty and ignorance. In principle, the war effort is always planned to keep society on the brink of starvation. The war is waged by the ruling group against its own subjects. And its object is not victory over Eurasia or Eastasia, but to keep the very structure of society intact.” Julia? Are you awake? There is truth, and there is untruth. To be in a minority of one doesn’t make you mad.