The threat of deflation?

Economists have now been saying for the last couple of weeks about how the ECB faces the “threat” of deflation, and that this should justify higher stimulus. Is there any truth in these statements? Not much.

First of all, we know that government statistics tend to undermine inflation, since it excludes prices of food and energy, for example.

The second thing we have to know, is that, though we are in a recession, this does not cause deflation. May economists argue that debt creation causes inflation, so conversely, debt deleveraging, what is going on to some extent now in europe, and typical of recessions, should create deflation. This is half-true. The key is how we define inflation.

Monetary inflation/deflation occurs when a currency looses /gains value. As a result of this, nominal prices will have to go up/down to adjust to the new reality. In todays economics, however, inflation is merely defined as a rise in prices. Debt creation, though it won’t change the value of a currency, can, in fact lead to localised price inflation in certain areas. The most clear case following the 08 crisis is houses. Houses increased massively in price. This wasn’t because there was inflation, but rather the result of an excessive amount of debt bidding up the prices. Therefore, we should not bu surprised when, as is happening now, when we are in the process of returning the debt (debt deleveraging) the opposite will happen, so house prices will fall.

Overall, the threat of deflation is way overestimated. Economists seem to think that deflation will refrain consumers from buying things since they will be expecting a lower price. This statement, though reasonable, does not apply to reality. For essential goods, this does not happen, and for non essentials either. Everyone knows an Ipad 2 will be cheaper a few months after its release, but that doesn’t stop people from buying them the day they come out.

In conclusion, the situation in Europe now is not deflationary, it’s not worrying, and it by no means justifies any further stimulus. As a whole, I think the Euroblock is performing as it should, recovering slowly, perhaps a bit ahead of estimates even.

 

 

 

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