Home' Trinidad and Tobago Guardian : October 30th 2014 Contents OCTOBER 2014 • WEEK FIVE www.guardian.co.tt BUSINESS GUARDIAN
THE ECONOMIST | BG29
The world economy is not in good shape. The
news from America and Britain has been rea-
sonably positive, but Japan s economy is strug-
gling and China s growth is now slower than
at any time since 2009. Unpredictable dangers
abound, particularly from the Ebola epidemic,
which has killed thousands in West Africa and jangled nerves
The biggest economic threat by far, however, comes from
Now that German growth has stumbled, the euro area is on
the verge of tipping into its third recession in six years. Its
leaders have squandered two years of respite, granted by the
pledge of Mario Draghi, the European Central Bank s president,
to do "whatever it takes" to save the single currency.
The French and the Italians have dodged structural reforms,
while the Germans have insisted on too much austerity. Prices
are falling in eight European countries. The zone s overall
inflation rate has slipped to 0.3 per cent and may well go into
outright decline next year. A region that makes up almost a
fifth of world output is marching toward stagnation and defla-
Optimists, both inside and outside Europe, often cite the
example of Japan. It fell into deflation in the late 1990s, with
unpleasant---but not apocalyptic---consequences for both itself
and the world economy.
The euro zone poses far greater risks, though. Unlike Japan,
the euro zone is not an isolated case: From China to America
inflation is worryingly low, and slipping. Unlike Japan, which
has a homogenous, stoic society, the euro area cannot hang
together through years of economic sclerosis and falling prices.
As debt burdens soar from Greece to Italy, investors will take
fright, populist politicians will gain ground and, sooner rather
than later, the euro will collapse.
Although many Europeans, especially the Germans, have
been brought up to fear inflation, deflation can be still more
savage. If people and companies expect prices to fall, they stop
spending and, as demand sinks, loan defaults rise. That was
what happened in the Great Depression, with especially dire
consequences for Germany in the early 1930s.
It therefore is worrying that, of the 46 countries whose
central banks target inflation, 30 are below their target. Some
price falls are welcome---tumbling oil prices, in particular, have
given consumers incomes a boost---but slowing prices and
stagnant wages owe more to weak demand in the economy
and roughly 45 million workers are jobless in the rich Organisation
for Economic Cooperation and Development countries.
Investors are starting to expect lower inflation even in
economies, such as America s, that are growing at reasonable
rates. Worse, short-term interest rates are close to zero in many
economies, so central banks cannot cut them to boost spending.
The only ammunition comes from quantitative easing and
other forms of printing money.
The global "lowflation" threat is a good reason for most
central banks to keep monetary policy loose. It is also, in the
longer term, a prompt to look at revising inflation targets a
The immediate problem, however, is the euro area. Continental
Europe s economy has plenty of big underlying weaknesses,
from poor demography to heavy debt and sclerotic labor markets,
but it also has made enormous policy mistakes.
France, Germany and Italy all have eschewed growth-enhanc-
ing structural reforms. The euro zone is particularly vulnerable
to deflation because of Germany s insistence on too much fiscal
austerity and the European Central Bank s timidity. Even now,
with economies contracting, Germany is still obsessed with
deficit reduction for all governments, while its opposition to
monetary easing has meant that the ECB, to the obvious despair
of Draghi, has done far less than other big central banks in
terms of quantitative easing, notwithstanding this week s move
to start buying "covered bonds."
If there was ever logic to this incrementalism, it has run out.
As budgets shrink and the ECB struggles to convince people
that it can stop prices from slipping, a descent into deflation
seems all too probable. Signs of stress are beginning to appear
in both the markets and politics. Bond yields in Greece have
risen sharply, as support for the left-wing Syriza party has
surged. France and Germany are trading rhetorical blows over
a new budget proposal coming out of Paris.
If Europe is to stop its economy from getting worse, it will
have to stop its self-destructive behavior. The ECB needs to
start buying sovereign bonds. Chancellor Angela Merkel of
Germany should allow France and Italy to slow the pace of
their fiscal cuts. In return, those countries should accelerate
structural reforms. Germany, which can borrow money at neg-
ative real interest rates, could spend more building infrastructure
That would help, but not be enough. It is a bit like the early
years of the euro debacle, before Draghi s whatever-it-takes
pledge, when half-solutions only fed the crisis. Something
radical is needed.
The hitch is that European law bans many textbook solutions,
such as ECB purchases of newly issued government bonds.
The best legal option is to couple a dramatic increase in infra-
structure spending with bond-buying by the ECB. Thus the
European Investment Bank could launch a big---say $350 bil-
lion---expansion in investments such as faster cross-border rail
links to more integrated electricity grids, and raise the money
by issuing bonds, which the ECB could buy in the secondary
Another possibility would be to redefine the EU s deficit
rules to exclude investment spending, which would allow gov-
ernments to run bigger deficits, again with the ECB providing
Behind all this sits a problem of political will. Merkel and
the Germans seem prepared to take action only when the single
currency is on the verge of catastrophe. Throughout Europe
people are hurting: In Italy and Spain youth unemployment
is above 40 per cent. Voters vented their fury with the established
order in the EU s parliamentary elections earlier this summer,
and got little change. Another descent into the abyss will test
Once deflation has an economy in its jaws, it is hard to shake
off. Europe s leaders are running out of time.
@2014 The Economist Newspaper Ltd. Distributed by the New
York Times Syndicate
World's biggest economic problem
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