25 June 2019

'Deflation Threatens Europe. Policy Makers Wait.'

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Neil Irwin on the risks, and the alternatives, of central bank inaction:

"Europe is staring into the face of the kind of deflationary cycle that has paralyzed the Japanese economy for the better part of two decades. Prices are rising far more slowly than its central bank wants, against a backdrop of astronomical unemployment on much of the Continent.

Mario Draghi’s response: Give us another month.

Mr. Draghi, the president of the European Central Bank, did everything he could on Thursday to hint, insinuate and flag the possibility that the central bank will unleash some new tools to combat Europe’s drift toward lower prices. Just not now. Check back with us in June, he suggested. Really. Or at least probably.

The decision to wait, even as economic risks gather, highlights a pattern of behavior that has become common among central banks over the last few years — behavior that the banks themselves often come to regret. When faced with evidence that economic growth is weak and inflation too low, bankers have acted slowly and cautiously, often citing the risks of using untested tools and offering projections that better times are just around the corner.

But the mistakes the central banks have made since the crisis ended in 2009 have overwhelmingly been the opposite: not of acting too rashly in response to economic weakness, but of moving too slowly and being overly confident that things will turn around without a monetary boost. This pattern of caution is one reason the economies in the United States and Europe remain so weak almost seven years after the financial crisis began.

“There is consensus about being dissatisfied with the projected path of inflation,” Mr. Draghi said in a news conference in Brussels on Thursday. In the period from March 2013 to March 2014, prices rose 0.5 percent in the 18 countries using the euro. The central bank’s goal for inflation is slightly under 2 percent. “There is a consensus in not being resigned to this and accepting this as a fact of nature. Which would lead to having consensus about action, but after having seen the staff projections that will come out in early June.”

This low inflation is dangerous for Europe for a few reasons. It makes the large overhang of debts more onerous; repaying what they owe is harder for consumers, businesses and governments. It is intertwined with a rise in the value of the euro on currency markets, making European exporters less competitive on the global marketplace by increasing their costs relative to competitors in the United States or Asia. And it risks becoming self-fulfilling, as the Japanese know too well, as stagnant or falling prices lead people to hoard cash rather than spend freely.

The lowflation, as people have taken to calling it, is particularly dangerous in that it could easily turn into outright deflation, or falling prices, should one nasty shock come along. For example, if tension between Ukraine and Russia boils over into a full-scale war, it could easily tip the European economy back into recession and send prices tumbling.

Mr. Draghi gave every sign on Thursday that he agreed with the premise that the combination of low inflation and a strong euro was dangerous. He and his colleagues just want time and more data before doing anything about it.

A deliberative, cautious manner is, in general, desirable in a central banker. But what is dangerous about the E.C.B.'s sluggishness in the face of deflation risks is its asymmetry: The risks of too little action may be greater than the risks of too much."

Click here for the full column in the New York Times.

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