Arab Today, arab today debate rages over whether deflation \ogre\ is real
Last Updated : GMT 06:16:24
Arab Today, arab today
Arab Today, arab today

Debate rages over whether deflation \'ogre\' is real

Arab Today, arab today

Arab Today, arab today Debate rages over whether deflation \'ogre\' is real

Paris - AFP

Ultra-low inflation in the eurozone has sparked a divide among officials and analysts over whether the risk of deflation is a real "ogre" or just a phantom menace. The head of the IMF, Christine Lagarde, warned this past week of the "rising risks" of deflation, which she called "the ogre that must be fought decisively". "With inflation running below many central banks' targets, we see rising risks of deflation, which could prove disastrous for the recovery," Lagarde said. Data released this past week showed that the annual inflation rate in the 18-nation eurozone dipped to 0.8 percent in December, considerably below the European Central Bank's target of just below 2.0 percent. That masks large differences between countries, however. While average inflation came in at 2.6 percent in the Netherlands in 2013, it was just 1.0 percent in France, the eurozone's second largest economy. In crisis-hit Greece, prices actually fell by 0.9 percent on average over 2013, according to data from EU data agency Eurostat. An extended period of deflation -- falling prices in real terms -- can encourage consumers to put off buying goods in the expectation that if they wait, they will become cheaper. That in turn weakens the economy as companies reduce output accordingly, hitting employment and demand, thereby setting off a very damaging downward spiral. Over the past months there has been increasing debate about the risk of deflation in the eurozone as the rate of inflation has slowed rapidly, with an emerging rift between the European Central Bank and the International Monetary Fund. While the IMF urges vigilance, the ECB has downplayed the risk, even though it was seen as being behind the surprise rate cut in November to a record low 0.25 percent rate. But for the head of Germany's Bundesbank, Jens Weidmann, "the risk is limited that we'll see broad-based deflation in the euro area." Weidmann, who also sits on the ECB board, said the eurozone was on the brink of an economic recovery, which would tend to push up prices. The ECB forecasts a modest recovery in growth of 1.1 percent for the eurozone in 2014 after contracting in 2013. Weidmann's scepticism is shared by economist Holger Schmieding at Berenberg Bank. "The widespread concerns that the eurozone could fall victim to malign deflation are overdone," he said in a recent note to clients. He said a drop in energy prices was responsible for most of the recent slowing in inflation, which was a big positive as it boosts incomes. The strong euro has also been contributing as it makes the price of imported goods cheaper. Analysts often point to Japan as being an example of the dangers of deflation, but Schmieding said it was not falling prices that led to a decade of stagnation but the failure of the government to undertake reforms. Switzerland has lived with occasional periods of falling prices without problems for decades, he said. Other analysts warn that deflation could pose a greater risk to fragile eurozone countries. London-based Capital Economics said "while negative inflation may be avoided at the aggregate level, sharp falls in prices in some of the heavily indebted peripheral economies will hinder their fiscal consolidation efforts and maintain the danger of a renewed bout of market instability." Falling prices, even without consumers holding off from purchases, tend to depress government revenue. Moody's Analytics economist Zach Witton noted recently that Spain is facing "a period of mild deflation which, if prolonged, could prevent the recovery from gaining traction." Economist Alan McQuaid at Merrion stockbrokers in Dublin said that "at this point in time it looks like deflation rather than inflation is the bigger threat to the economy, and it is not just in Ireland." Moreover, the countries that have been making the biggest progress in reducing deficits have been doing that with austerity policies of cutting spending, which has also dampened prices. "What is strange is that the question is only being posed now because the European strategy is profoundly deflationist," said Isabelle Job-Bazille, head of economic research at the French bank Credit Agricole. She warned against relying too much on medium-term inflation expectations, which have so far remained anchored near the ECB's two percent target, as deflationary tendencies could set in by the time such expectations change. Deutsche Bank's chief economist, Gilles Moec, sees a change in these expectations as being something of a canary in the mine. Lower inflation and growth expectations means consumers and business would want to hold less debt, as the real cost of debt increases, leading to a selloff of assets that further reduces domestic demand. "Deflationary bubbles have a nasty habit of being self-reinforcing," Moec said. Such a selloff is already a risk for the eurozone this year given the ECB's review of banks could push them to unload assets.

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