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Prices are Falling in the Eurozone, but is it “Real” Deflation?

Sunday, January 18, 2015 10:58
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B4INREMOTE-aHR0cDovLzQuYnAuYmxvZ3Nwb3QuY29tLy1oRTZSTmtJbVBLYy9WTHZWa09WeC1RSS9BQUFBQUFBQUFrWS83S3JuQjAxY05Nay9zMTYwMC9QMTUwMTE3LTEucG5nThe Eurozone has been on the brink of deflation for months. The latest data show that for the first time, consumer prices for the currency area as a whole (and for 12 of its 19 member countries) were actually lower in December than a year earlier. But is it “real” deflation?


In a pair of posts [1] [2] last fall, when EZ inflation was merely low, but not yet negative, I explained that there are two kinds of deflation.
The nasty kind of deflation, which everyone rightly fears, is driven by falling aggregate nominal demand. As demand collapses, it drags both real output and the price level down with it. There is a serious risk of a self-reinforcing downward spiral in which debtors can’t repay their loans, defaults and falling asset prices undermine the financial system, zero interest rates render monetary policy powerless, and rising unemployment sparks social unrest.

However, there is also a benign kind of deflation, driven by rising productivity. In that scenario, conservative monetary policy restrains the growth of nominal GDP while real output surges ahead. The rate of inflation is negative, but growing output provides borrowers with the cash flow they need to repay their loans, rising productivity allows real wages to rise, and nominal interest rates, although low, do not need to fall all the way to the zero bound. In the US and UK, such productivity-driven deflation was the norm during much of the nineteenth century and reappeared again, more briefly, in the prosperous 1920s.

So which kind of deflation is Europe facing now? The bad, demand-driven kind,  or the good, supply-driven variety? A little of each, it seems. >>>Read more

Follow this link to view or download a slideshow-tutorial, “Why Fear Deflation?”.

 



Source: http://dolanecon.blogspot.com/2015/01/prices-are-falling-in-eurozone-but-is.html

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