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Home Publications Blogs Beat the Press NYT Gets Just About Everything Wrong In Discussing Euro Zone Inflation

NYT Gets Just About Everything Wrong In Discussing Euro Zone Inflation

Tuesday, 27 May 2014 04:31

A NYT piece on the problem of low inflation and weak growth facing the euro zone got just about every aspect of the issue wrong. Near the beginning the piece tells readers:

"the euro zone is at risk of sliding into deflation, a downward price spiral that can ultimately destroy corporate profits and the ability of businesses to hire."

Actually the euro zone already faces a crisis because the low inflation rate means that the real interest rate (the nominal interest rate minus the inflation rate) is much higher than would be desirable given the weakness of the euro zone's economy and the high unemployment rate. Since it is difficult to make the nominal interest rate negative, the only way to reduce the real interest rate is with a higher inflation rate.

This problem becomes worse when the inflation rate falls, however there is no particular consequence to it turning negative. In this sense, the problem is now, not some hypothetical bad scenario that could happen in the future. The notion of a "downward spiral" suggested in the piece has literally never happened in a wealthy country in the last 70 years. Even Japan, the only major country to experience a prolonged period of deflation, never experienced anything resembling a downward spiral. Its deflation rate was always modest and never exceeded minus 1.0 percent for any substantial period of time.

The idea that deflation will "destroy corporate profits and the ability of businesses to hire," is also silly. Profits have largely recovered from pre-recession levels. The concern is that lower inflation will reduce the desire to invest. If firms can anticipate that the goods and services will sell for 15 percent more in five years then they will have considerably more incentive to invest than if they anticipate that prices will be unchanged or even lower in five years. 



The piece also told readers:

"A negative deposit rate would tend to push down the value of the euro against the dollar and other currencies, because investors would earn little or no return on euros. In his speech on Monday, Mr. Draghi said the increase in the euro’s value against the dollar since 2011 had driven down the price of commodities like fuel in euro terms, contributing to low inflation."

Actually the main advantage of a fall in the value of the euro is that it will make goods and servcies produced in the euro zone more competitive internationally, thereby increasing net exports and boosting demand.



Comments (5)Add Comment
written by pete, May 27, 2014 10:15
The quoted line is correct. If prices rise slower than wages, or even fall, then clearly corporate profits are going to fall. The opposite, of course, is the use of inflation to generate corporate profits (and higher employment), by allowing prices to rise faster than wages. This was point 2 of Krumgan's recent presentation, standard Keynesian fare.

Also, you fail to use the term "expected". Inflation must rise more than expected to have an impact on the real interest rate, profits and employment. But of course, for investment, the issue is the expected real rate of return, not the expost real interest rate, which you seem to be discussing. Thus the real trick is to get firms to have higher inflationary expectations than workers.
And if you get the interest rate just right
written by joe, May 27, 2014 11:07
then everyone in the eurozone will run right out a borrow money and spend it.. On what? Nevermind that, all kneel before the almighty interest rate.
written by bananaguard, May 27, 2014 11:57
"Inflation must rise more than expected to have an impact on the real interest rate,..." Well, no, not really. The real interest rate is the nominal rate minus inflation, if that's the way we decide to define it. Often, for the purpose of discussion of monetary theory, we define "real" in relation to expected inflation, but that's because the theory in question involves expectations. For purposes other than discussions of monetary theory, it's entirely reasonable to use the actual rate of inflation. Sticky wages and the zero bound both make the realized rate of inflation (or deflation) an important issue. When correcting the statements of others, we ought always to strive to correct them with true stuff.
written by blorch, May 27, 2014 3:24
Downward spiral is hyperbole.
written by pete, May 28, 2014 2:09
High inflation in the 70s was not a great time for anyone. The level does not matter per se, it is the expected inflation rate versus that more or less implied by the nominal rate. Firms will (over) invest if they think interst rates do not represent their expectation of future inflation. On the flip side, workers will work more if they think future inflation will be lower than their wage increases. It is not rocket science.

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About Beat the Press

Dean Baker is co-director of the Center for Economic and Policy Research in Washington, D.C. He is the author of several books, his latest being The End of Loser Liberalism: Making Markets Progressive. Read more about Dean.