Home > Uncategorized > Will the ECB push Europe over the deflation cliff?

Will the ECB push Europe over the deflation cliff?


Technical detail: ’72 per. Zw. Gem’ is ’72 month running average’

Inflation in the Euro Area is getting lower and lower – the Euro Area is only one shock away from ‘ugly’ deflation, a persistent and self reinforcing decline of incomes and expenditure which, for one thing, disables debtors to pay back their debt. Greece is already experiencing considerable income deflation – thanks of course to persistent deflationary policies aimed at cutting wages, pensions and employment. And we’re all aware of the consequences… I’m not a believer in the omnipotence of monetary policy. But a Grexit might pull the Eurozone over the deflation edge into unpredictable financial turmoil – and the ECB is totally able to prevent a Grexit. And it should do so, because of its price, prosperity and financial stability mandates. A Grexit will cause additional deflationary pressure, crisis and financial turmoil. As the ECB can prevent this it should prevent this, Because of its mandates. Moral hazard? Moral hazard? Please, do your homework and read a little about all the money which went to the banks.

The ECB mandates can be discussed. In a world were money is not just used for household consumption but also for investments and to pay for collective consumption (education, street lights) it does not make sense to focus, as the ECB and many other central banks do, exclusively on consumer price inflation. And in a world where ‘money’ is intimately intertwined with ‘debt’ and ‘banks’ it makes no sense to restrict the mandate of a central bank, like the ECB tried to do, to monetary stability (prices). Financial stability (the long term ability to pay down existing debts or to acquire new loans) is surely as important. Interestingly, Claudio Borio, a monetary historian from the Bank of International Settlements, states that no monetary regime (Golden Standard, Bretton Woods, Monetary Targeting, Inflation Targeting, Exchange Rate Targeting) has ever succeeded in guaranteeing monetary and financial stability at the same time… Fortunately, Mario Draghi understands the importance of financial stability, look here and here. But he should act accordingly, surely as there is, at this time, no trade off between the monetary and the financial mandate. The official ideology of the ECB still states that the bank has one and only one mandate: low and stable medium run inflation. But the European treaties state otherwise, look here. The bank surely has a duty to enable people to pay back debts, by ensuring financial stability and promoting growth. But when we leave that aside it’s clear that the ECB is even failing its own ideology. It does not matter if we look at core or headline inflation or at the short or the medium run (which, in accordance with ECB documents, is set at 6 years, i.e. between the five and eight years stipulated in these documents). The ECB should not create the financial instability shock which pushes the Euro Area over the deflationary edge.


  1. Helge Nome
    February 2, 2015 at 11:23 pm

    The ECB is caught in a web of relationships between self interested economic entities,
    each with a goodly amount of tunnel vision.
    Europe is, once again, at the crossroads of History.

  2. Leave
    February 3, 2015 at 9:31 am

    As usual the ECB Power is exaggerated, to suit what psychological needs? Something to make a talking Point around with which to ignore other issues, is a good bet.
    Deflation is good. I can buy a similar Product to a lower prize in the future. It can be the result of multiple things. Either the consumers credit lines have been cut, and/or the stores have filled their stocks to much and now they need to sell out for the next generation of Products. Or people are starting to reign in their consumption in order to repay their mortages. In this case Money demand is going down, while capital balance is going up. Who swims naked?

  3. Ton Notermans
    February 3, 2015 at 10:40 am

    Yes, indeed, deflation would be an economic disaster on top of the one we already have. I am not sure about two points you make though. (1) That a Grexit might push the Eurozone over the deflation edge. Perhaps a relevant analogy here would be the Great Depression where leaving the then common currency – the Gold Standard – proved a prerequisite for halting deflation. Grexit, which would most likely imply a massive devaluation of the new Drachme would not only import a price increase but boost prospects for the productive sector in Greece and might halt the destructive spiral going on there. (2) To the extent that the nominal wage and not the volume of money is the anchor of the price system, as Keynes argued in the GT, it might actually not be that easy for a Central Bank to halt deflation in an environment of massive unemployment combined with policies aimed at improving “flexibility “ in the labour market. Again the experience of the Great Fepression might be of relevance here as the exit from the gold standard, in many countries, was combined with policies that sought to put a floor under nominal wages; i.e. increase labour market rigidity instead of reducing it.

  4. February 3, 2015 at 4:56 pm

    Better take the correct formulas
    Comment on ‘Will the ECB push Europe over the deflation cliff?’

    The simplified formula for the market clearing price in the consumption good industry is given by:

    Roughly, the formula says that the consumer price index declines if (i) the average expenditure ratio falls, (ii) the wage rate falls, (iii) the productivity increases and (iv) the employment in the investment good industry shrinks relative to the employment in the consumption goods industry. The formula follows from (2014, Sec. 5).

    The more differentiated and therefore better testable formula is given by:

    The crucial message is that the nominal wage is the numéraire of the price system as Keynes argued in the GT. If at all, the quantity of money plays an indirect role via the expenditure ratio and the employment relation of the investment good and the consumption good industry.

    The rule of thumb says: if wage increases for the business sector as a whole lag behind productivity increases deflation occurs (the rest of the formula kept constant).

    Note that monetary profit for the business sector as a whole is given by:

    That is, total profit does not depend on the wage rate. Most economists do not know the correct profit formula (2014, Sec. 3).

    Egmont Kakarot-Handtke

    Kakarot-Handtke, E. (2014). The Three Fatal Mistakes of Yesterday Economics:
    Profit, I=S, Employment. SSRN Working Paper Series, 2489792: 1–13. URL

  5. February 3, 2015 at 6:10 pm

    Yes, very interesting, thank you.

    I left a response yesterday about the quick mention of growth but inadvertently erased it. The gist was that economists have fallen behind with this concept and need to catch up with other areas of study which are discussing these issues without referring much to whatever economists are saying.

    Today, instead of my fictional character representing sociology, biology, and physics, we are presented with distinguished professor of anthropology and geography at the CUNY Graduate Center, David Harvey


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