Philip Delves-Broughton

How to fight Europe’s demons of deflation

It’s a real problem, but the answer has less to do with bond-buying than with applied psychology

Deflation terrifies economists because once it starts, they have no idea what to do about it. When demand in an economy shrinks, companies cut jobs, and with fewer employed demand shrinks even more. The deflationary spiral is self-reinforcing. Central banks can cut interest rates to near zero and slosh money around like drunken lottery winners, but once hope flickers and dies, there is nothing they can do to persuade anyone to invest in the economy. Deflation took hold in Japan in the early 1990s and despite the government straining every sinew, its economy is still ailing 20 years on.

Europe is right, then, to be in a panic. Inflation across the eurozone is just 0.4 per cent and over the past year eight of its economies, including Greece, Hungary, Sweden and Poland, have recorded annualised rates of negative inflation, falls in wages and prices of a kind Britain has not seen since 1960. If these rates persist, we may well be in ‘last-chance Europe’, as Jean-Claude Juncker described it last month before becoming President of the European Commission. A great chunk of the eurozone risks the Japanese curse, an economic malaise which lasts a generation. Britain’s economy and inflation rate may seem the healthiest in Europe, but that could easily change if its neighbours tip into persistent deflation.

Mario Draghi, President of the European Central Bank, said last year that he had studied Japan’s experience of deflation and decided that the EU was not at risk of suffering a similar fate. Recent months have changed his mind. The ECB said this week that it was ready to fire a trillion euros into the EU’s financial system, by buying both government and private bonds. Or was it a gazillion? After so much quantitative easing around the world in recent years, it is hard to keep count.

The Germans are sweating, as they tend to, caught between their prim attitude to credit and a need to keep the eurozone together.

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