Social Europe

politics, economy and employment & labour

  • Themes
    • European digital sphere
    • Recovery and resilience
  • Publications
    • Books
    • Dossiers
    • Occasional Papers
    • Research Essays
    • Brexit Paper Series
  • Podcast
  • Videos
  • Newsletter

Euro Deflation And How To Interpret It

John Weeks 12th October 2015

John Weeks

John Weeks

If you read Larry Summers in the Financial Times, you know that recent data confirm falling prices in the euro zone.  Summers argues that the deflation indicates global stagnation, though we find disagreement on the appropriate interpretation. For some it is no more than the transitory effect of falling petroleum prices.

The focus on petroleum prices indicates the analytical limitations of composite price indices for understanding what is unfolding in the euro zone. A professed function of these indices is to serve as an indicator for central bank inflation targeting. The relationship is well-known. Central banks take a rise in the composite price index above some arbitrary guideline to indicate the need to increase interest rates. The increase in the central bank rate allegedly curtails credit growth and dampens inflationary pressures.

Even should one believe the interest rate to inflation causality, a composite price index is not the appropriate indicator for central bank action be it measured for consumers, producers or GDP as a whole. Composite indices all mislead more than they inform.

The misleading effect of composite prince indices is especially serious for the euro zone. First and most obviously, euro zone price indices conceal variations in inflationary pressures across member countries.

The chart below shows this variation by year for fifteen euro zone countries, 2000-2014. In 9 of the 15 years inflation rates across countries were less than their variation, casting into doubt the justification for a common policy. For example, in 2014 the lowest rate was -2.9% (Estonia) and the highest 3.6% (Ireland).

Our job is keeping you informed!


Subscribe to our free newsletter and stay up to date with the latest Social Europe content.


We will never send you spam and you can unsubscribe anytime.

Thank you!

Please check your inbox and click on the link in the confirmation email to complete your newsletter subscription.

.

Average rate of change of the GDP price deflator across 15 euro zone countries & the relative variation*, 2000-2014 (15 countries)

1

*Relative variation measured by the coefficient of variation, standard deviation divided by the average. Source: www.oecd.org/statistics

Even were the across country variation quite small, a composite price index delivers misleading information. The serious limitations result from composite indices including prices determined in at least three quite different ways, in external markets (imports), by administrative or contractual regulation (“sticky” domestic), and in domestic spot markets (“flexible” domestic).

Among imported commodities petroleum is the most important for Europe. In an open economy with flexible exchange rates, as is the case for the euro zone, no domestic policy instrument has a substantial impact on import prices.


We need your support


Social Europe is an independent publisher and we believe in freely available content. For this model to be sustainable, however, we depend on the solidarity of our readers. Become a Social Europe member for less than 5 Euro per month and help us produce more articles, podcasts and videos. Thank you very much for your support!

Become a Social Europe Member

The second category, sticky domestic prices, includes those under public sector regulation (e.g. utility rates) and private sector contracts (e.g. wage bargains and futures contracts). These prices respond sluggishly to short-term economic conditions if at all.

For both imports and sticky domestic prices attempts to constrain price increases results in quantity adjustment – a fall in amounts purchased by domestic buyers.

Commodity and service prices set in the very short term, “spot prices”, most closely to the neoclassical economics fantasy world of “perfect competition”. The most important of these prices is wages of unorganized workers.

It should be obvious what happens when the European Central Bank, the US Federal Reserve or any other central bank adjusts interest rates to constrain price increases. Almost the entire burden of adjustment falls on the flexible domestic prices, especially wages of unorganized, low-wage workers.

In the euro zone price indices may now convey consistently wrong information for an additional reason. Five years of stagnation appear to have broken the link between inflation and economic expansion. This takes us back to Larry Summers’ “global stagnation”.

Stag[de]flation In The Euro Zone

Since the end of World War II in the advanced countries the cycle of expansion and recession typically took the pattern of a positive relationship among output, employment and inflationary pressures. When economic growth brought the economy close to full capacity, the tightness of the labor generated rising money wages, which in turn put upward pressure on prices.

In the countries with large economies, e.g. United States, Japan, United Kingdom, Germany and France, the growth-capacity-inflation link was primarily domestic until the share of trade in GDP began to increase sharply in the 1990s. The only notable exception to this pattern occurred in the second half of the 1970s when sharply rising oil prices had the dual effect of undermining growth rates and increasing composite price measures. This combination of recession and “inflation” prompted the term “stagflation”.

The recently released statistics on price changes and growth in the euro zone suggest that the term be qualified to refer to two different manifestations of the malady. In the 1970s the advanced market economics suffered from inflation and unemployment, “stag[in]flation”; now, the euro zone – and the global economy according to Summers – suffer from recession and falling prices, “stag[de]flation”.

The chart below shows the unfolding of this market malady. The percentage rate of change of non-energy prices across 19 euro zone countries is measured on the vertical axis and the growth rate of GDP on the horizontal (both as annual equivalent rates) for the 14 quarters from the beginning of 2012. I take the non-energy index to be an indicator of domestic prices, both flexible and “sticky”.

Inspection of the chart reveals an unexpected relationship – a rising growth rate is associated with lower rates of price change. This relationship over the last four-and-one-half years might prompt supporters of fiscal austerity to think that the euro economy has reached the promised land of growth and low inflation.

Quite the contrary is the case. The chart shows that the persistently low growth rates of GDP have inculcated a regime of economic stagnation. Over the 14 quarters every annualized growth rate was 1.5% or lower, far too low to sustain employment levels. Indicators strongly suggest that the rate for 2015Q3 will come in below that for the second quarter, perhaps below one percent (German exports fell by over 5% in August).

With output stagnating, how can we explain the increases in non-energy prices? The most obvious cause is so-called Quantitative Easing, which fuels domestic and international commodity speculation while doing nothing to simulate output (Summers is especially clear on the latter).

Other processes reinforce the QE effect: 1) sub-optimal level of capacity utilization that that raises unit production costs; 2) low investment that accentuates productivity decreases; and 3) imported inflation working through inputs to output prices.

Interaction of changes in non-energy prices and GDP growth rate, 2012Q1-2015Q2

2

Source: Eurostat

No Way Out?

Stimulating aggregate demand offers the only effective way to exit stag[de]flation. In contrast to fiscal austerity that has inverted the price-output relationship, fiscal expansion would initially combine rising GDP with stable prices as output growth raised productivity and stopped QE.

The euro zone countries, led very much from the front by the German government have “structurally-reformed” themselves into the cul de sac of institutionalized stagnation. Labor market “reforms”, fiscal cuts and reduction in the progressivity of tax structures all weaken automatic stabilizers and undermine the countercyclical mechanisms that prevent an integrated economic system from partially healing itself out of recession.

The way out is obvious to those not blinkered by the austerity ideology. But the blinkered austerity dwellers, the fiscal troglodytes, hold government throughout the euro zone. Indeed, the Trogs successfully saw off in Greece the only serious challenge to their stag[de]flation strategy.

For the foreseeable further there is no way out. It is that simple.

John Weeks

John Weeks is co-ordinator of the London-based Progressive Economy Forum and professor emeritus of the School of Oriental and African Studies. He is author of The Debt Delusion: Living within Our Means and Other Fallacies (2019) and Economics of the 1%: How Mainstream Economics Services the Rich, Obscures Reality and Distorts Policy.

Home ・ Economy ・ Euro Deflation And How To Interpret It

Most Popular Posts

schools,Sweden,Swedish,voucher,choice Sweden’s schools: Milton Friedman’s wet dreamLisa Pelling
world order,Russia,China,Europe,United States,US The coming world orderMarc Saxer
south working,remote work ‘South working’: the future of remote workAntonio Aloisi and Luisa Corazza
Russia,Putin,assets,oligarchs Seizing the assets of Russian oligarchsBranko Milanovic
Russians,support,war,Ukraine Why do Russians support the war against Ukraine?Svetlana Erpyleva

Most Recent Posts

Gazprom,Putin,Nordstream,Putin,Schröder How the public loses out when politicians cash inKatharina Pistor
defence,europe,spending Ukraine and Europe’s defence spendingValerio Alfonso Bruno and Adriano Cozzolino
North Atlantic Treaty Organization,NATO,Ukraine The Ukraine war and NATO’s renewed credibilityPaul Rogers
transnational list,European constituency,European elections,European public sphere A European constituency for a European public sphereDomènec Ruiz Devesa
hydrogen,gas,LNG,REPowerEU EU hydrogen targets—a neo-colonial resource grabPascoe Sabido and Chloé Mikolajczak

Other Social Europe Publications

The transatlantic relationship
Women and the coronavirus crisis
RE No. 12: Why No Economic Democracy in Sweden?
US election 2020
Corporate taxation in a globalised era

Eurofound advertisement

Living and working in Europe 2021

The Covid-19 pandemic continued to be a defining force in 2021, and Eurofound continued its work of examining and recording the many and diverse impacts across the EU. Living and working in Europe 2021 provides a snapshot of the changes to employment, work and living conditions in Europe. It also summarises the agency’s findings on issues such as gender equality in employment, wealth inequality and labour shortages. These will have a significant bearing on recovery from the pandemic, resilience in the face of the war in Ukraine and a successful transition to a green and digital future.


AVAILABLE HERE

Foundation for European Progressive Studies Advertisement

EU Care Atlas: a new interactive data map showing how care deficits affect the gender earnings gap in the EU

Browse through the EU Care Atlas, a new interactive data map to help uncover what the statistics are often hiding: how care deficits directly feed into the gender earnings gap.

While attention is often focused on the gender pay gap (13%), the EU Care Atlas brings to light the more worrisome and complex picture of women’s economic inequalities. The pay gap is just one of three main elements that explain the overall earnings gap, which is estimated at 36.7%. The EU Care Atlas illustrates the urgent need to look beyond the pay gap and understand the interplay between the overall earnings gap and care imbalances.


BROWSE THROUGH THE MAP

Hans Böckler Stiftung Advertisement

Towards a new Minimum Wage Policy in Germany and Europe: WSI minimum wage report 2022

The past year has seen a much higher political profile for the issue of minimum wages, not only in Germany, which has seen fresh initiatives to tackle low pay, but also in those many other countries in Europe that have embarked on substantial and sustained increases in statutory minimum wages. One key benchmark in determining what should count as an adequate minimum wage is the threshold of 60 per cent of the median wage, a ratio that has also played a role in the European Commission's proposals for an EU-level policy on minimum wages. This year's WSI Minimum Wage Report highlights the feasibility of achieving minimum wages that meet this criterion, given the political will. And with an increase to 12 euro per hour planned for autumn 2022, Germany might now find itself promoted from laggard to minimum-wage trailblazer.


FREE DOWNLOAD

ETUI advertisement

Bilan social / Social policy in the EU: state of play 2021 and perspectives

The new edition of the Bilan social 2021, co-produced by the European Social Observatory (OSE) and the European Trade Union Institute (ETUI), reveals that while EU social policy-making took a blow in 2020, 2021 was guided by the re-emerging social aspirations of the European Commission and the launch of several important initiatives. Against the background of Covid-19, climate change and the debate on the future of Europe, the French presidency of the Council of the EU and the von der Leyen commission must now be closely scrutinised by EU citizens and social stakeholders.


AVAILABLE HERE

About Social Europe

Our Mission

Article Submission

Membership

Advertisements

Legal Disclosure

Privacy Policy

Copyright

Social Europe ISSN 2628-7641

Social Europe Archives

Search Social Europe

Themes Archive

Politics Archive

Economy Archive

Society Archive

Ecology Archive

Follow us on social media

Follow us on Facebook

Follow us on Twitter

Follow us on LinkedIn

Follow us on YouTube