Is the eurozone entering a “lost decade” with a conjunction of low growth and deflation? The prospect is unsettling. But the current debate triggered by the International Monetary Fund’s recent World Economic Outlook lacks three important points: an in-depth analysis of the forces driving inflation down; a clear distinction between “benign disinflation” and “bad deflation”, with a spiral of decreasing prices, wages and output triggered by negative expectations; and a better understanding of the European Central Bank’s approach.
Inflation in the eurozone fell in 2013. Low inflation in the eurozone since late 2013 has been driven by falling energy and commodity prices, the fading impact of past tax rises in some countries, the appreciation of the euro and relative price adjustments in countries such as Greece, Ireland and Portugal seeking to regain price competitiveness.
Inflation projections for this year by most institutions range from 0.9 to 1.5 per cent; for 2015, from 1.2 to 1.4 per cent; and for 2016 from 1.5 to 1.8 per cent. Against the backdrop of an expected gradual economic recovery and rising domestic cost pressure, ECB staff project inflation of 1.7 per cent at the end of 2016.
Current inflation of 0.5 per cent is interpreted as far below the ECB’s “target”, and deflation is seen as an imminent danger. The IMF advises the ECB, even if deflation is avoided, to fight ultra-low inflation. The reasoning is that ultra-low inflation makes it harder for some eurozone members to regain competitiveness; and that it increases real interest rates with negative effects on growth and the real value of debt.
Yes, inflation is low in the eurozone. But is it too low? Indeed, has it even reached dangerously low levels that would justify widespread concern about imminent deflation? There are no signs of deflation at the eurozone level. Only a few members have experienced negative inflation rates, mainly because of the ongoing and unavoidable adjustment process in relative prices in these countries. According to the IMF, Greece alone will register an inflation rate that is slightly negative in 2014.
It is likely we are living in an extended period of price stability. This is good news. It boosts real disposable income and will eventually support private consumption. Inflation expectations are well anchored, and there is no evidence households and companies are delaying purchases because of negative expectations. Warnings about outright deflation and calls for ECB action are misguided and irresponsible. The longer this discussion continues, and the more intense it becomes, the more likely the risk of a self-fulfilling prophecy.
On the ECB’s “short-term reaction function”, misunderstanding of its strategy and “target” remains. The assumption of many analysts and commentators is that the ECB – like other central banks – is targeting inflation on a relatively short time horizon, and that its target is “below, but close to, 2 per cent”.
This is incorrect. The ECB has never subscribed to inflation targeting. Its strategy is forward looking and medium-term oriented, taking into account the time lag between a monetary policy decision and its economic impact. The ECB does not react mechanically to data like other central banks. It does not react directly to the change in relative prices. And it does not target inflation at a relatively short and fixed-term horizon.
This strategic approach is mirrored in the ECB’s definition of price stability. This has remained unchanged since 1998-99 as a year-on-year inflation rate of below 2 per cent. The ECB clarified in 2003 that, “within this definition”, it aims to keep inflation rates below, but close to, 2 per cent over the medium term.
With the economic recovery in the eurozone stabilising, and leading indicators pointing upwards, the most likely medium-term scenario is stable prices and a modest upturn over the next two years. No further action by the ECB is required.
Any further action would be of questionable impact, and would lead to an unjustified ultra-loose monetary policy stance for too long, with unintended medium-term consequences. Moreover, it would dramatically complicate the exit from low interest rate and liquidity-providing policies. To prevent a lost decade, structural reforms, sound fiscal policies and a strong and well-capitalised banking sector are crucial instead.
Jürgen Stark is a former European Central Bank board member
Fonte: FT
