Deflation has arrived in at least five Eurozone countries, including Finland and the Netherlands
Mario Draghi will have to push for wage increases as disinflation continues, in the Eurozone and as quite some countries are already experiencing deflation. Deflation is vicious – especially when, like in the euro zone, debt levels are high while nominal debts are highly rigid and sticky. On the Eurozone level, there has been quite some disinflation and during the last 9 months inflation was in fact close to zero. And while I do not expect a prolonged period of average deflation as long as average nominal wages keep increasing with about 1%, even ‘lowflation’ will be devastating for the possibilities of quite some countries to pay back their debts. Especially as zero average inflation will, arithmetically, mean that quite a number of countries are actually having deflation. The only way out is not monetary policy (which takes to long to work, if it works at all) but higher wage increases, especially in the Eurozone ‘core’.
Below, data on seasonally adjusted domestic demand inflation in the Eurozone and in individual Eurozone countries. Domestic demand inflation is a broader concept than consumer prices and also includes prices of real investments and government purchases. What do these graphs show?
A) There has been (as we all know) quite a bit of disinflation in the Euro area (graph 1). However – post 2009 there seems to be a new seasonal effect in the prices which is not yet filtered out by the seasonal adjustment procedure.
B) Looking at individual countries (graph 2) there are already a number of countries there are already a number with deflation. This is seasonally adjusted data. What I did was, somewhat unusually but this is why we have seasonally adjusted data, comparing the price level in Q 4 with the price level in Q1. See, however, the caveat above. Remarkably, deflation is not just characteristic for countries like Spain and Greece (not in the graph because of data problems, but GDP deflator deflation was about -1,8% in this period and -3,6% in the last five quarters) but also in the Eurozone ‘core’.
C) Recent January and February data on inflation (consumer prices, factory gate prices) show that the disinflation trend continued (‘core’ Eurozone inflation declined less than headline inflation – but was already quite low for quite some time).
D) Wages are the most important price in a modern economy. Wage increases in the EZ are, though on average fortunately still positive, at a historical low while productivity increases seem to pick up, again. And Mario Draghi, in his last speech, still pushed for more ‘flexible’ labour markets, i.e. lower wages (no, no explicitly – but with unemployment as high as it is more ‘flexibility’ will not really increase wages. And, by the way, Greek wages declined with 30% compared with Italian wages – which did not lead to any kind of boost of Greek exports but which did lead to a dramatic decline of domestic demand and GDP). Higher average wage increases are pivotal to prevent lowflation or deflation and a situation which makes private and public debts spiral out of control (I understood that government wages in Germany have been increased with 3% – a shimmer of light!).
Estonia in fact shows the way out. The high level of Estonian inflation makes it a lot easier for this country to pay back its debt, despite its present economic troubles.