Business World

Friday 22 August 2014

Deflation 'ogre' threatens to derail Europe's fragile recovery

Sarah McCabe

Published 14/03/2014 | 02:30

  • Share

ARE we facing a deflation crisis?

  • Share
  • Go To

That's the big question plaguing Europe's smartest economists today.

The news that Irish consumer prices have swung into their first annual fall since 2010 is just the tip of the iceberg in a problem that threatens to derail Europe's recovery and hurt retailers from Dublin to Dusseldorf.

IMF boss Christine Lagarde describes deflation, categorised as a general decline in prices, as nothing less than "an ogre, which must be fought decisively."

And securing a healthy rate of inflation is understood to be the Department of Finance's single biggest fiscal priority this year.

Some, perhaps influenced by the memory of German hyperinflation in the aftermath of the World War I, where it took baskets full of money to afford a loaf of bread, see deflation as a good thing. What's wrong with prices falling, they ask? But deflation can wreak havoc on an economy, particularly one that's only showing nascent signs of recovery. As economist Paul Krugman puts it: "When people expect falling prices, they become less willing to spend, and in particular less willing to borrow. After all, when prices are falling, just sitting on cash becomes an investment with a positive real yield."

European Central Bank President Mario Draghi has gone to great efforts to calm fears in recent weeks, even though eurozone inflation has been stuck at 0.8pc since December, well below the ECB's preferred target of "below but close" to 2pc.

Cutting interest rates is its single biggest weapon against deflation because low or no interest on deposits means there is no motivation for people to save, encouraging them to spend instead.

But the ECB refrained from cutting interest rates or implementing any additional stimulus measures at its most recent Governing Council meeting, saying the recovery was on track and needed no extra push for now.

Yet a poll carried out this week by Reuters found that a significant number of economists have doubts about the ECB's view that deflation is not a threat and that the recovery will take hold without any more action.

Some 18 of the 45 economists surveyed, 11 of whom work for European banks, said the ECB should take further steps to support the economy right away.

"It is not a negligible risk. Further appreciation of the euro will be an enormous factor playing against the growth recovery and adding to the risk of deflation," said Frederic Pretet, strategist at Scotiabank.

Irish Independent

Read More

Editors Choice

Also in Business