Fazi vs. Stark on European Deflation

Thomas-FaziPluto author and European reform activist, Thomas Fazi, has issued a stern rebuke to views expressed by former European Central Bank (ECB) board member, Jürgen Stark, regarding the threat of deflation in the Eurozone and the prospect of a “lost decade”. Writing for the Financial Times, Stark had derided fears about Eurozone deflation which had surfaced following calls by the International Monetary Fund for the ECB to take action to counter broad deflationary trends. According to Stark there were “no signs of deflation at the Eurozone level” and those claiming otherwise lacked “in-depth analysis”, “a clear distinction between ‘benign disinflation’ and ‘bad deflation’” and even “understanding of the European Central Bank’s approach”. Stark’s analysis shifted the frame of debate to individual member countries rather than the Eurozone as a whole and therefore placed the balance of responsibility with national governments rather than intra-national bodies such as the ECB with calls for further Eurozone-wide action being described by Stark as “misguided and irresponsible” .

There was a sense here of the old guard being enlisted in defence of the status quo but who would challenge this apparently authoritative statement? Enter Fazi. His latest book The Battle for Europe: How an Elite Hijacked a Continent takes aim precisely at institutions such as the European Central Bank whose “monetary orthodoxy” he claims “played a crucial role in the onset, and worsening, of the Euro crisis”. Strong words, but his apparently radical position is now looking significantly more respectable as major institutions such as the IMF, the OECD and the German Institute for Economic Research (DIW) – all traditional supporters of the ECB’s “monetary orthodoxy” have now said “the ECB should act rapidly to avert Japanese-style deflation”. The reference to Japan evokes precisely the “lost decade” which Stark claims Europe is not embarking upon, the term usually being used to described the period between 1991 and 2001, which followed Japan’s own asset bubble crisis, when both the Bank of Japan and the formerly dubbed “Mighty Miti” (Japan’s interventionist Ministry of International Trade and Industry) were apparently unable to restimulate the perpetually ailing Japanese economy.

Having remained ahead of the curve in his analysis on Europe thus far, there is good reason to want to hear what Fazi will have to say on the latest developments and we are excited to reproduce his analysis below, which originally appeared on the website of the Social Europe Journal and we will be sure to keep you updated on any developments in this widening debate:



In a recent article published in the Financial Times, Jürgen Stark, a former member of the ECB’s executive board, brings the anti-inflation paranoia that the German establishment has accustomed us to since the start of the crisis to a whole new level. In his commentary, he rebuts the need for a more expansionary monetary policy for the monetary union and states that “there are no signs of deflation at the eurozone level”, thus concluding that “no further action by the ECB is required”.

Stark concedes that inflation has been low in the eurozone since late 2013, but asserts that this has been driven solely by “by falling energy and commodity prices, the fading impact of past tax rises in some countries, the appreciation of the euro and relative price adjustments in countries such as Greece, Ireland and Portugal”. Regrettably, he forgets to mention that low inflation (or outright deflation in some countries) is largely a result of the hyper-restrictive and demand-crushing recessionary fiscal policies imposed on European countries – and especially those of the periphery – since the start of the crisis, and now crystallized and institutionalized ad infinitum through the Fiscal Compact.

The IMF’s mea culpa on the recessionary effects of the so-called fiscal multiplier should have shed any lingering doubts about this. Stark acknowledges the deflationary effects of the “relative price adjustments in countries such as Greece, Ireland and Portugal”, but implies that this is a good thing – “benign disinflation” he calls it. The “morality play” underpinning Stark’s assumption is that the huge intra-euro trade imbalances that emerged following the creation of the monetary union are the sole responsibility of the countries of the periphery – which supposedly “lived beyond their means” by letting their wages rise to excessive (inflationary) levels – and that they should thus be the ones to shoulder the burden of readjustment by pursuing internal wage devaluation.

This is only part of the story, though. While it is certainly true that periphery countries overshot the EMU’s commonly agreed inflation target of 2 per cent by letting their unit labour costs (ULCs) rise above that level, it is also true that Germany undershot its target by an even greater degree. If we compare Greece to Germany, for example, we note that in the post-euro years Greece experienced a 2.7 per cent ULC growth rate compared to a rate of just 0.4 per cent in Germany. In other words, Greece (and other periphery countries) violated the rule to a much lesser degree quantitatively than Germany.

As progressive economists Costas Lapavitsas and Heiner Flassbeck write, “in view of this scale, the conclusion about wrongdoers and misbehaviour is obvious: […] given this target and the overriding importance of unit labour costs for inflation, Germany headed towards a clear violation of the common target once its government started putting enormous pressure on wage negotiations to improve the country’s international competitiveness, inside and outside EMU”. And, of course, the reason Germany could afford to “live below its means” is that others in Europe were living beyond them – thus providing the German economy with consumers.

That said, even if one agreed to go along with the myth that the periphery countries are solely responsible for their current uncompetitiveness vis-à-vis Germany, the notion that there is something “benign” about the ongoing – and “unavoidable”, stresses Stark – process of asymmetric readjustment is laughable. As a result of the reduction of ULCs in periphery countries in recent years we have indeed witnessed a drastic rebalancing of intra-euro trade balances, with periphery countries registering a sharp decrease in their pre-crisis intra- and extra-euro trade deficits. This, though, is just as much a consequence of increased exports as it is of decreased imports, because of the drastic reduction in demand.

The benefits of increased exports for these countries are in fact been offset by the devastating effects on the wider economy – exemplified by very low or even negative (Spain, Greece) inflation rates – of stagnating or falling wages, compounded in turn by the effects of austerity at the budgetary level. This is especially so since the export share of periphery economies is rather low, amounting to 27, 32 and 39 per cent of GDP in Greece, Spain and Portugal respectively, compared with 52 per cent in Germany.

In other words, internal deflation is akin to killing the patients in order to cure them. This becomes evident when we look at the data for industrial production, which in most periphery countries is down between 25 and 40 per cent from pre-crisis levels. An even more shocking indicator is the one relating to insolvency rates, which between 2010 and 2011 saw an increase of 7 per cent in Ireland, 17 per cent in Italy and Portugal, 18 per cent in Spain and 27 per cent in Greece, according to the German-based Creditreform.

This points to the fact that the current deflationary policies are reaping devastating long-term effects on the productive capacities of these countries, which far from increasing their competitiveness will hinder it for years to come. And this is not to mention the effects of “lowflation” or even deflation on the public debt of periphery countries: according to a study by the Bruegel Institute, in a “low inflation” (zero per cent) environment countries like Italy and Spain (not to mention Greece) will see their public debt levels explode even if they stick to the Fiscal Compact’s budgetary prescriptions.

According to Stark, though, these war-like numbers are no cause for concern, because “the economic recovery in the eurozone [is] stabilising” and “there are no signs of deflation at the eurozone level”. Even if this were true – which it clearly isn’t, if we are to believe such left-wing bastions as the IMF, the OECD and the German Institute for Economic Research (DIW), all of which have stated that the ECB should act rapidly to avert Japanese-style deflation – one would be justified for considering Stark’s choice to obfuscate the dramatically asymmetric nature of the “recovery” (and the fact that the current policies have hugely benefited the continent’s creditor and surplus countries, first and foremost Germany), by focusing solely on the European average, as more than simple ideological blindness – and as a deliberate attempt to conceal what George Soros has described as the plan to create “a German empire with the periphery as the hinterland”.

Such conspiratorial musings are unwarranted, though. It’s a well-known fact that certain elements of the German establishment have an almost unbound capacity for denial, even in the face of overwhelming evidence – and even for matters that directly concern them. Most historians agree that it was the deflation of the 1930s, and the resulting record-level unemployment rate – a direct result of chancellor Brüning’s austerity and wage compressing policies – that led to the breakdown of democracy and the rise of Nazism, and not the hyper-inflation of the 1920s.

Yet most Germans to this day are still convinced of the contrary. Which helps explain why, eighty years on, Germans such as Stark still insist on other countries pursuing the same deflationary policies pursued by chancellor Brüning at the time. It’s true: we don’t risk the rise of a new Hitler today. But the risk of a prolonged period of economic, political and social regression, leading to a surge of fascist and reactionary movements and to a possible disintegration of the European integration process is real – and is arguably already happening.

Stark writes that “to prevent a lost decade, structural reforms, sound fiscal policies and a strong and well-capitalised banking sector are crucial”. The reality is that Europe has already lost half a decade – and is on the way to lose much more than that – and this is the direct result of the failed policies promoted by ideologues such as Stark.

We are still in time to avert the worst-case scenario – as long as we are capable of challenging the dominant and tragically flawed economic and monetary orthodoxy – but we need to act fast. It would be truly unforgivable if we allowed the German monetary-political establishment that Stark represents (and which even the hawkish Jens Weidmann seems to be distancing himself from) to make again the mistakes of the 1930s. As the former German foreign minister Joschka Fischer stated in 2012: “Germany destroyed itself – and the European order – twice during the 20th century, and then convinced the West that it had drawn the right conclusions. Only in this manner – reflected most vividly in its embrace of the European project – did Germany win consent for its reunification. It would be both tragic and ironic if a restored Germany, by peaceful means and with the best of intentions, brought about the ruin of the European order a third time”.

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