Eurozone at risk of home-made deflation and recession

Pierre Moscovici, Member of the EC in charge of Economic and Financial Affairs, Taxation and Customs, gave a press conference on the Winter European Economic Forecasts for 2014, 2015 and 2016. (EC Audiovisual Services, 05/02/2015, Brussels — EC/Berlaymont).

Tomorrow Tuesday, 5th April, the European Commission will present its ‘Spring European Economic Forecast’ including assessments and predictions about GDP, inflation, employment and government finance for 2014, 2015 and 2016. Good providence made sure that last Thursday Eurostat released its flash estimate of April inflation standing at the edge of zero percent, up by an insignificant decimal point of one percentage unit in relation to the March figure of — 0.1%. Theoretically, this is a step towards the right direction, possibly indicating that Eurozone has abandoned the mine field of the negative inflation (deflation) region.

However, this meager change of the inflation rate would constitute a shallow base if the Commission uses it to beautify the prospects of the European economy. One decimal point of a percentage unit is actually nothing compared to the formal inflation target of something less than 2%. This benchmark has been set by the European Central Bank, as being the optimum rate of change of consumer prices. The fact that inflation stood at zero from the negative part of the chart is no kind of consolation. It can turn again downwards any time.

Falling prices

Let’s see why this is not just a prophesy. Eurostat’s data ascertain that the services price index follows a long-term downward trend (April 2014 1.6%, November 2014 1.2%, January 2015 1%, March 2015 1%, April 2015 0.9%). If the prices of services continue dropping, following this twelve month old downward tendency, then at any moment in the immediate future, Eurozone can return to the negative part of the inflation chart. The services are the largest single sector of the economy and carry a massive weight on the overall consumer inflation, accounting for 434.7 thousandths (434.7/1000). There is more to it.

Until now the negative inflation figures could be attributed almost entirely to the exogenous factor of the falling prices of oil and energy in general. If however the services index continuous on this downward course, Eurozone may find itself in a dreadful fully home-made deflationary trap. So the EU Commission has nothing to celebrate over inflation having stood at zero. Let’s dig a bit deeper in that.

What recovery?

The much advertised recovery of the European economy, as it statistically appeared with an increase of just a few decimal points of the GDP in the second quarter of 2013, is now about to enter in its third year. Yet, it still remains not only fragile, but there are strong signs from the persistently very low or negative inflation, that growth remains pretty uncertain. The internal drivers of growth like investments and consumption are always subdued and the only positive support comes from exports. But the rest of the world doesn’t seem capable of continuing to cover for Europe’s shortcomings due to the collapse of oil and raw material prices.

That’s why the Governing Council of the European Central Bank overcame the objections of Germany and embarked on a strong quantitative easing program. Under this new scheme the ECB has undertaken to print and distribute €1.14 trillion in eighteen months, through purchases of government bonds and asset backed securities. Obviously, the target is that this cash bonanza sets the economy in motion. The program started this March with an injection of €60 billion through purchases of government bonds and asset backed securities. It will continue injecting the same amount of freshly printed money every month until September 2016.

Money only for the bankers

In short, the only positive factor that currently functions well in Europe is ECB’s money printing machine and of course this doesn’t pertain to the real economy. This extra cash is primarily and exclusively pocketed by the financial sectors, and only in a second or third stage the banks are supposed to pass a part of this bonanza to the real economy, by granting loans to businesses and consumers. Quite predictably the banks will use large parts of this money to play their own risky games in the derivative and other perilous markets. Only then the lenders will start to contemplate if the loans to producers and consumers make any sense for their balance sheets.

Unemployment at crisis levels

Coming back to the x-ray of the real economy, Eurostat found that unemployment in Eurozone was obstinately stuck at 11.3% in March, stable in comparison with February and only four decimal points down from March 2014 (11.7%). Needless to say, that those few decimal points fall well into the region of statistical error. Understandably then, unemployment remains at record levels equal to the crisis levels. To be reminded that the euro area unemployment rate at the peak of the last crisis in 2012 was estimated at 11.3%. No need to elaborate on the hideous rates of jobless youths.

Now let’s turn to Eurostat’s newly established research line focusing on household real income and consumption. Last Thursday Eurostat published for the first time ever the relevant data. It found that “In the euro area (EA18), in real terms, household income per capita increased by 0.1% in the fourth quarter of 2014, after an increase of 0.6% in the previous quarter. Household real consumption per capita increased by 0.1% in the fourth quarter of 2014, after an increase of 0.4% in the previous quarter”.

Households’ share shrinks

For one thing, real incomes and consumption amelioration looks like it has been fading during the last six months of 2014. Eurostat also published a very interesting graph showing the rate of change of real household income and consumption for the previous twelve years 2003–2014. The graph shows that all along that period the rate of growth of real per capita household income and consumption oscillated invariably around zero. This means that the per capita household income and consumption didn’t gain anything from the real increase of the overall GDP that actually happened all along that period.

Obviously, somebody else pocketed the economic gains of that whole era, further deteriorating the unequal distribution of income to the detriment of households. Not surprisingly then, every self-respecting economist from Janet Yellen, the Governor of the US central bank, the Fed, to the Nobel laureate Joseph Stiglitz all agree that the growing inequality of incomes is at the base of today’s problems of the Western economic volume.

All in all, tomorrow the European Commission has nothing to celebrate over the economic situation of Eurozone and the policies followed during the past decade. The fast growing inequality of incomes distribution is now about to test even the basics of the social contract on which the West has prospered after WWII.


Originally published at on May 4, 2015.

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