8/12/2019 Ft.com-The Spectre of Eurozone Deflation

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8/12/2019 Ft.com-The Spectre of Eurozone Deflation

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inflation in core countries is low, then inflation in crisis-hit countries must be close to zero or negative.Angel

Ubide of the Peterson Institute for International Economics notes that average inflation in surplus countries is only

1.5 per cent, against 0.6 per cent in the adjusting economies. While falling prices would improve competitiveness,

they would raise the real burden of private and public debt. This might well create another round of financial

stresses.

"The eurozone is just one negative shock away from deflation. The cushion is far too small"

If average inflation stood at 2 per cent, with the surplus countries on (say) 3 per cent and the adjusting countrieson 1 per cent, the eurozone would be in far better shape: real interest rates would be lower, the economy would

be stronger and internal adjustment would be faster. If average inflation reached 3 per cent (roughly the level that

the Bundesbank achieved in Germany over the period from 1980 to 1995), it would be still better.

The ECB has allowed the eurozone to fall into a deep and entrenched slump. It is failing to hit its inflation target

and the economy is even flirting with deflation. The bank has also allowed the supply of money and credit to

stagnate. The Bundesbank used to focus on these variables because over time they can put upward pressure on

activity, wages and prices. But the ECB appears to be ignoring them. It is failing to do its job.

What, then, can be done? The aim must be to raise demand and inflation in the eurozone as a whole, particularly

in surplus countries. The aim must also be to improve credit markets.

To achieve this, the ECB should announce a symmetrical inflation target of 2 per cent, indicating that it will

henceforth view excessively low inflation as a problem no less serious than rapidly rising prices. It should

implement a programme of quantitative easing, purchasing the bonds of member governments in proportion to

shares in the central bank. Finally, it should announce a longer-term refinancing operation to unblock the flow of

credit to small and medium-sized enterprises. Other possibilities, such as negative deposit rates, are also worth

considering.

Difficulties arise. It is unlikely that such measures would raise demand in the surplus countries very much: the

rate of interest on German Bunds is already very low. The benefits would be felt mainly on the periphery

cementing the idea that profligate crisis-hit economies are being rescued by the back door. Large-scale

purchases of the bonds of crisis-hit countries are legal but may well trigger hysteria in surplus Europe. The ECB

would probably suffer a deep internal split if it sought to adopt such a policy. That could jeopardise its political

legitimacy. The fear is that the ECB may be forced to pretend that low inflation is not a threat because it cannot

agree on what to do about it.

The eurozone crisis is not over. Despite the emergence of a degree of stability, the situation remains very fragile.

The ECB might in fact be able to do very little about this. That is partly because the measures it would need to

take are controversial. It is also partly because of the view held by some that its job is to stabilise not the

eurozone but the German economy. That is not a European currency union. It is something quite different.

martin.wolf@ft.com

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