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DEFLATION: AN OLD SPECTRE IS COMING BACK UEB/CITUB SOFIA, JANUARY 2015 [email protected] PRESENTATION • RECALLING THE BASICS • STATE OF DEFLATION TODAY • HOW DID WE GET INTO THIS MESS? • (HOW) DO WE GET OUT? RECALLING THE BASICS • DEFINITION: GENERAL LEVEL OF PRICES KEEPS ON FALLING • COULD BE BECAUSE OF • A LACK OF AGGREGATE DEMAND • WAGE CUTS • OR A COMBINATION OF BOTH DEFLATION TRIGGERS THREE MECHANISMS THAT REDUCE AGGREGATE DEMAND (FURTHER) • HOUSEHOLDS AND BUSINESS POSTPONE CONSUMPTION AND INVESTMENT • DEFLATION PUSHES UP REAL INTEREST RATES…… TAKING ON NEW DEBT BECOMES MORE COSTLY….. DISCOURAGES NEW INVESTMENT AND PURCHASING OF DURABLES • DEFLATION INCREASES REAL BURDEN OF EXISTING DEBT ONCE YOU’RE IN DEFLATION, IT’S DIFFICULT TO GET OUT … • SEE PREVIOUS THREE MECHANISMS…… BUT THERE IS MORE…. • INFLATIONARY EXPECTATIONS MATTER A LOT: THEY ACT LIKE A « SELF FULFILLING » PROPHECY; IF A BUSINESS EXPECTS GENERAL PRICES TO GO DOWN, THEY WILL DECREASE THE PRICE OF WHAT THEY THEMSELVES PRODUCE… • ZERO NOMINAL BOUND ON INTEREST RATES…… REAL INTEREST RATES ARE AUTOMATICALLY BEING PUSHED UP AND MONETARY POLICY CAN’T DO MUCH ABOUT IT (LOOSING « TRACTION ») ECONOMICS 101 • KEEP THE ECONOMY AT ALL TIMES WELL AWAY FROM DEFLATION AND ZERO INFLATION • THIS IS WHY ALL CENTRAL BANKS HAVE A POSITIVE INFLATION TARGET OF AT LEAST 2% (« SAFETY MARGIN ») • THIS IS WHY IT IS WIDELY ACCEPTED THAT MONETARY POLICY SHOULD BE « A SYMMETRICAL » : BE MORE WORRIED AND ACTIVE WHEN INFLATION IS FALLING AND HEADING FOR ZERO INFLATION THAN IN CASE OF INFLATION EXCEEDING THE CENTRAL BANK PRICE STABILITY TARGET JAPANESE EXPERIENCE IS INTERESTING • END EIGHTIES, ASSET PRICE BUBBLE PRICKED, CRISIS, DEFLATION • BUSINESS REACTED TO FALLING PRICES BY PUSHING WAGES DOWN • THEY DID SO IN TWO WAYS • REPLACE REGULAR JOBS WITH PRECARIOUS ONES • WITHDRAW FROM COORDINATED ECONOMY WIDE WAGE NEGOTIATION ROUNDS • RESULT: WAGE CUTS AND THESE PROVIDED THE BASIS FOR DEFLATION TO CONTINUE…. FOR TWO DECADES…. • « ABENOMICS »: RESTAURING COORDINATION OF WAGE BARGAINING TO GET JAPAN OUT OF DEFLATION STATE OF DEFLATION IN EUROPE • …. MAINLY EURO AREA THE KEY CONCERN: NOT JUST INFLATION….. BEHIND EU AVERAGES: 14 IN DEFLATION,11 IN « LOWFLATION » INFLATION YEAR ON YEAR DECEMBER 2014 1.5 1 0.5 0 BE -0.5 -1 -1.5 -2 -2.5 -3 BG CZ DK DE EST IRE EL ES FR HR IT CY LV LT LUX HU MT NL AS PL PT RO SL SK FIN SW UK …. BUT INFLATIONARY EXPECTATIONS: ALREADY «UNANCHORED » (OR SHOULD WE SAY « COLLAPSED » ?) ROLE OF (COORDINATED) WAGE BARGAINING • WITH DEFLATION/LOWFLATION, EMPLOYERS HAVE A POWERFUL ARGUMENT NOT TO INCREASE WAGES … • …. « INFLATION IS LOW OR ZERO, SO WHY INCREASE NOMINAL WAGES AT ALL »…. • ….HOWEVER, IF WAGE INCREASES ARE ZERO/VERY LOW….INFLATION WILL BE ZERO/NEGATIVE IN THE NEXT ROUND • ALREADY INDICATIONS OF THIS STARTING TO HAPPEN IN AUSTRIA, GERMANY • AGAIN, A MECHANISM THAT REPRODUCES/INTENSIFIES THE PROBLEM EURO AREA « PERIPHERY » IS IN A DEBT TRAP 1 FI MT 0.5 SK Inflation / deflation in % 0 DE EST LT FR IT SL LV NL PT -0.5 IE BE -1 CY LU ES -1.5 -2 -2.5 EL -3 0 50 100 150 200 250 Total Debt ( public plus private) as a % BBP 300 350 400 450 500 THE DEBT TRAP IN BULGARIA CONSOLIDATED PRIVATE SECTOR DEBT IN % OF GDP,2013 200 180 160 140 120 100 80 60 40 20 0 BG EL DE IT FR UK HOW DID WE GET IN THIS MESS? THEIR OBSESSION WITH WAGE COMPETITIVENESS : UNIT WAGE COSTS SINCE 1999 60 50 DE 40 IE EL ES 30 IT CY 20 LU MT SL 10 SK 0 2001 -10 2002 2003 2004 2005 2006 2007 2008 2009 2010 THE GERMAN MODEL GOES EUROPEAN: WAGES IN MUCH OF THE REST OF EURO AREA BEING DRAGGED DOWN 45 40 35 30 IE 25 EL ES 20 FR BE 15 DE 10 5 0 1 -5 2 3 4 5 6 7 8 9 10 11 12 13 14 ZERO UNIT WAGE COSTS EQUAL ZERO INFLATION ZERO UNIT WAGE COSTS EQUAL ZERO INFLATION (HOW) DO WE GET OUT? THE ECB’S WALL OF 1 TRILLION MONEY ... • ECB DECIDED TO PRINT 1 TRILLION OF EURO’S TO BUY FINANCIAL ASSETS (MAINLY SOVEREIGN DEBT) • WILL THIS WORK? • CRUCIAL QUESTION: WILL MONEY FLOW INTO REAL ECONOMY/ INVESTMENT ? EXPERIENCE FROM UK • 375 BILLION £ PRINTED • ECONOMY PLUS 1,5 % • VALUE OF SHARES GONE UP BY 20% • 40% OF ALL SHARES OWNED BY 5% OF POPULATION • THESE HOUSEHOLDS HAVE EACH BECOME 128,000£ BETTER OF…. • … MEANWHILE WAGES HAVE COLLAPSED IN THE UK, PRECARIOUS WORK ABOUNDS « RUNNING TO STAND STILL ? » (DRAGHI QUOTE)…. • ….OR RUNNING TO FALL INTO THE ABYSS OF DEFLATION? • ECB (AND COMMISSION AND MEMBER STATES OBLIGE ECB IN THIS) KEEPS ON PUSHING FOR MORE AND « RADICAL » STRUCTURAL REFORMS TO BE « IMPOSED » • THIS IS HIGHLY CONTRADICTORY • IT IS PUSHING ECONOMY FURTHER INTO DEFLATIONARY TERRITORY…..WHILE HOPING THAT QUANTITATIVE EASING WILL MORE THAN OFFSET THIS… VERY RISKY ETUC PROPOSALS • EUROPEAN INVESTMENT PLAN: WITH A FOCUS ON THE MOST TROUBLED ECONOMIES (NOT THOSE THAT AREA ALREADY STRONG) • YES TO QUANTITATIVE EASING BUT ITS SHOULD BE « (PUBLIC) INVESTMENT EASING » • REFORM THE STRUCTURAL REFORM AGENDA: FOCUS ON WAGES AND COLLECTIVE BARGAINING AS AN ANCHOR FOR PRICE STABILITY/ AS A CIRCUIT BREAKER OF DEFLATIONARY TRENDS