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.