Thomas Fazi is the author of the new book The Battle for Europe (Pluto, 2014). Find out more, including how to buy it, on our website.
Thomas’s latest article around the book has appeared in the Green European Journal this week. In it he argues that despite some positive signs, the European economy remains extraordinarily weak. To escape deflation and solve problems like unemployment, what is needed is a whole new approach to getting money into the economy.
We’ve reproduced an extract of the article below. You can check it out in its entirety on the Green European Journal website.
It’s official: the eurozone is a step away from deflation. With a low and rapidly falling average inflation rate of 0.7% (as of January 2014) – well below the ECB’s inflation target of ‘below, but close to, 2%’ – and most periphery and Eastern countries of the currency bloc already in outright deflation, the continent may be about to enter the most critical phase of the crisis yet. While our political leaders never tire of reminding us of the dangers of excessively high inflation, the dangers of excessively low inflation – or even worse, outright deflation (negative inflation) – are too often ignored. Deflation denotes a self-reinforcing economic vicious circle in which low demand leads to a decrease in prices, which leads to lower production, which leads to lower wages and even lower demand, which in turn leads to a further decrease in prices, which leads to growing unemployment, and so on. Moreover, by increasing the real value of the debt, low inflation also makes it increasingly difficult for countries to pay back their public debt.
Importantly, once a deflationary spiral sets in, it’s very difficult to drag one’s self out of it, and the political consequences can be devastating – as Europeans should know better than anyone else. Many historians agree that it was precisely the deflationary policies pursued by many European countries – and Germany in particular – in the 1930s that led to a deepening of the Great Depression, to the breakdown of democratic systems across the continent, and ultimately to war.
A EUROPEAN ECONOMY THAT IS STILL TOO WEAK
The lesson here is that deflation doesn’t just ‘happen’; it’s the result of flawed, albeit interested, political decisions. And today we are repeating the same mistakes of the 1930s: as should be clear to everyone by now, by choosing the class-based and creditor-led path of demand-crushing austerity, internal devaluation and asymmetric adjustment (as deficit/debtor countries deflate but surplus/creditor countries don’t inflate), the European elites have pushed the continent into recession and entire countries into outright depression, widened the core-periphery gap, transformed an economic crisis into a full-blown social crisis, sent public debt levels through the roof. Let no one be fooled by talks of ‘recovery’; under the present macroeconomic policy settings, economic fundamentals – in particular unemployment and public debt levels – in the eurozone are bound to get worse in the coming years, with long-term stagnation the most optimistic prospect.
And, as mentioned, the situation could precipitate very rapidly if a shock of some kind were to send Europe spiralling into deflation. As even the IMF’s Christine Lagarde recently warned in Davos: ‘We need to be extremely vigilant. The deflation risk is what would occur if there was a shock to those economic now at low inflation rates, way below target. I don’t think anyone can dispute that in the eurozone, inflation is way below target.’
THE REAL ECONOMY NEEDS MONEY
So, what to do? While it is clear, as the European Green Party advocates, that in the medium-long term Europe needs a ‘Green New Deal’ – a radical change of course based upon the three pillars of financial reform, sustainably industrial renaissance and social justice –, we also need to address the immediate threat of deflation and mass unemployment, by boosting demand and kick-starting the economy. To do that, we need to find ways to channel more money into the pockets of businesses and households.
Usually that job is up to banks. As we all know, though, banks are not lending; in fact, the pace of credit contraction in the eurozone is now greater than ever before. The response of the central banks of most advanced countries – most notably, the United States, the UK and Japan – has been to resort to what we shall call conventional unconventional monetary policy, or ‘quantitative easing’ (QE), by which the central bank aims to ease financial conditions by buying mortgage-backed securities and other securities, such as government bonds, from private banks in the hope of spurring bank lending. The ECB, on the other hand, has refused to engage in QE and has limited itself to what we shall call conventional conventional monetary policies: lowering its key interest rate and extending the maturity of its Long Terms Refinancing Operations (LTROs), through which banks are able to borrow unlimited funds at exceptionally low interest rates, as long as they can provide eligible collateral.
The ECB’s measures, though, have clearly failed to get banks in the currency area to start lending again – let alone revive the economy. Thus, given the relatively faster recovery of those countries that have engaged in QE, various commentators argue that is time for the ECB to follow suit. But others claim that the case for QE is much less clear-cut. They note that relative to the massive injection of ‘base money’ (central bank reserves) into the banking system in countries like the United States and the UK, the money supply that drives aggregate demand – namely, loans to businesses and households – has increased very marginally.
In short, the money has not ‘trickled down’ to those that need it the most, but instead, by inflating the prices of assets (such as government bonds), has almost exclusively benefited the wealthiest members of society who control the overwhelming majority of those assets, thus leading to even higher levels of inequality compared to the pre-crisis levels. As Krugman writes of the United States, ‘95 percent of the gains from economic recovery since 2009 have gone to the famous 1 percent.’ The reason is that conventional unconventional monetary policies such as QE, just like the ECB’s conventional conventional monetary policies (the cutting of the central bank’s key interest rates), are based on a fallacious view of how our monetary system works.
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