By Thomas Cullen,
International Business Writer
The International Monetary Fund warned economies around the world about the risk of low inflation having the possibility of dipping into deflation.
CNN reports that the inflation rate in Europe fell to 0.7 percent this past November, which is alarming because an economy cannot recover if the currency does not have sufficient inflation to encourage spending.
Christine Lagarde, the head of the IMF, outlined her views on economic recovery to BBC by saying that “If inflation is the genie, then deflation is the ogre that must be fought decisively…Overall, the direction is positive, but global growth is still too low, too fragile, and too uneven.”
The Guardian reported that the IMF’s chief economist, Olivier Blanchard, predicted that there will be a global economic growth of 3.7 percent in 2014, which would be an improvement on the 3 percent rate in 2013. It is believed that the UK will have the highest rate at 2.4 percent, which is the highest projected rate out of all G7 countries. Following the UK in the list is Germany with a growth rate of 1.6 percent and France coming in at 0.9 percent. Blanchard said that there are a number of factors contributing to growth in these countries. This includes the fact that the push for austerity cuts has slowed, there is less uncertainty in the economy, and money in the financial markets has started to move again.
Blanchard outlined concerns about the recovery which could jeopardize the fragile recovery. The first issue in his mind is that the good news about the recovery could signal fiscal budget and monetary policy leaders to start to pull back stimulus-oriented programs and to allow interest rates to rise in the name of fiscal responsibility. His second concern is that the pullback in spending will cause the inflation rate to start slipping which has the possibility of turning into deflation.
Paul Krugman, an economist who writes for the New York Times, provides three reasons why deflation is destructive to an ailing economy. His first point is that people are more likely to hold onto money in deflation because it will be more valuable later.
The overall effect of this is that nobody will be spending at the moment and the economy will suffer even more from decreased demand. This leads to his second point which is that the money that debtors owe will increase with time and the decreased aggregate demand will deter creditors away from spending their money. The final problem that deflation causes is in the area of wages. Workers are very unwilling to accept wage cuts immediately and this leaves companies with the simple choice of laying off some workers, which will raise unemployment.
Despite all of these arguments against low inflation, the European Central Bank is planning to keep the inflation rate below the target of 2 percent. The average inflation rate for the ECB in 2013 was 1.4 percent, and the rate this past December was a meager .9 percent.
The president of the ECB, Mario Draghi, addressed the situation by saying that “We are not seeing any deflation at present…but we must take care that we don’t have inflation stuck permanently below 1 percent and thereby slip into the danger zone.”
Germany is the strongest economy in the Eurozone and they are intellectually opposed to an increase in any sort of inflation of the Euro, but the only problem with this position is that the inflation rate of the Euro is locked in across all the Eurozone economies.
This means that a low deflation rate in Germany may be acceptable, but that same rate could have severe effects in countries such as Italy and Greece where the economies are still very weak.
A version of this article appeared in the Tuesday, Jan. 28 print edition.
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