Like a good ghost story, fear of deflation is used as a bogey-man to scare the unwary that the hoof beats of four riders of the economic apocalypse can be heard in the distance and that great calamity will shortly be upon us…
As fears go, deflation in the Eurozone is greatly overdone, in my opinion. Deflation is the mirror image of inflation and simply means that prices are falling, rather than rising. In the long-term, deflation is seen to be a bad thing, in economic circles, because downward trending prices can lead to a decline in current demand for goods and services since consumers may defer purchases in the knowledge that costs will be lower at a later date. This has been blamed for the stagnation of the Japanese economy and is, potentially at least, a real fear. However, consumers in the Western world are very much interested in “instant gratification” and waiting to purchase something until it is cheaper, or until it has been saved-up for is an anathema to most. For this reason, deflation is more likely to boost consumption in the West rather than stymy demand as punters rush to buy cheaper goods today (particularly since the rate of price decline is, in the main, marginal).
However, the spectre of deflation within the Eurozone has again reared its ugly head. Prices within the bloc fell by 0.1% over the year to September, mainly on the back of an 8.9% decline in energy costs, largely due to the continuing weak crude oil price. Indeed, if energy and food costs are stripped from the data, then core inflation is seen to have risen by 0.9%, year-on-year; unchanged from the August level. The ECB is predicting that inflation for 2015 will come in just above zero at 0.1%, far from the target value of 2%. However, the bank predicts that it will pick up to 1.5% next year and probably come in at 1.7% the following year.
The ECB is currently engaged in a quantitative easing (QE) programme which sees €60 billion worth of asset purchase per month. The aim of this is to boost liquidity (and hopefully lending to businesses) within the Eurozone and will increase inflation incrementally by enhancing the money supply. To this extent QE is akin to a reduction in interest rates.