By James Saft
Jan 9 Here is some unwelcome news for the likes
of Greece, Ireland and Cyprus: Apparently it isn't really
deflation if you deserve it.
That's the takeaway from remarks by ECB chief Mario Draghi,
who despite persistently falling prices in some euro zone
peripheral economies, was at pains on Thursday to define the
"We define deflation as a broad-based self-fulfilling,
self-feeding fall in prices." he told a press conference after
the ECB left rates on hold. "We don't see that in the euro area.
We may see negative inflation rates in one or two countries, but
we should also ask the question of 'How much is due to the
necessary rebalancing of an economy which lost competitiveness
and had gone into financial and budgetary crisis and how much is
due to actual true deflation?'"
This strikes me as being an unnecessarily narrow definition,
though useful for a man in Mr. Draghi's predicament. Not only is
euro zone-wide inflation, at just 0.7 percent, well below the
ECB's target of just under 2.0 percent, but both Spain and
Portugal are teetering on the edge of deflation, with yearly
inflation increases of, well, nothing.
While it is true that the self-perpetuating effect of
deflation - the tendency to put off to tomorrow what may well be
cheaper - is particularly pernicious, the fact remains that
prices are falling in significant areas of the euro zone due to
a huge slump in demand and, as Draghi implies, as countries
attempt to make themselves competitive without being able to
sink their currencies.
This is no benign 19th century deflation, due to
improvements in productivity or the opening of the American
grain basket. This is a grinding process under which wages and
living standards fall abruptly.
Draghi is right that there are huge differences between
Japan in the 1990s and Europe today: corporate and financial
sector balance sheets are healthier. Although efforts to reform
the banking system in the euro zone are to be praised, it is
also true that getting from here to there will involve further
None of this is to say that Greece, Ireland, Portugal and
the rest weren't partly or principally responsible for their
downfall. Obviously they were and are. But they are also,
patently, suffering through a deflation, a deflation that is
self-reinforcing and that current monetary policy is inadequate
Perhaps the better way to understand this treatment of
deflation is as a tacit acknowledgment of the ECB's untenable
Draghi is hemmed in. While he stressed forward guidance,
money market rates show that the ability of talk to steer rates
near the zero bound is limited. On top of that, there is a
rather large de-leveraging going on. Not only are banks repaying
debts incurred under the ECB Longer-Term Refinancing Operation,
they are shedding assets to prepare for new tougher standards
under banking union. That is having, and will have, a further
depressing impact on the euro-zone, and not just in Ireland or
Given these realities, and given a real reluctance at the
central bank to engage in outright quantitative easing, Draghi's
options are limited. His ability to respond to deflation - for
that is what it is - in weaker euro zone states is perhaps even
more limited, both practically and politically.
What Draghi's remarks tell us, then, isn't so much about the
real state of the euro zone economy, but about the real limits
on his powers. More liquidity provision in coming months is
likely, and it is very possible that the ECB lowers benchmark
rates, now 25 basis points, even closer to zero.
But it will take more than pain on the fringes to get the
ECB to engage in outright quantitative easing. While the ECB is
allowed to buy assets in secondary markets, doing so would be
extremely divisive, and, to judge by the U.S. experience, might
do more for people with large portfolios of financial assets
than struggling school teachers in Athens.
For QE in the eurozone to become a reality then, we'd need
not just deflation in the places that "deserve" it, but more
evidence of emerging deflation elsewhere. For the time being,
prices are likely to continue to fall in places like Greece and
Cyprus. Call that whatever you like.