When the euro declined vs. the US dollar, the ECB was happy that inflation would inch back up. The fear now is that falling oil prices will take away the alleged gain of a falling euro.
With that backdrop, credit the Financial Times for the absurd headline of the week: Eurozone Fails to Benefit from Weak Currency as Oil Price Slides.
Pity the policy makers given the job of rescuing the eurozone from deflation.
The unorthodox steps the European Central Bank has taken since June – including a programme of private-sector asset purchases – have caused a steep fall in the euro. The single currency is down 8.4 per cent against the dollar and 4.75 per cent on a trade-weighted basis from its peaks this year.
The weaker exchange rate will ease pressure on the ECB in its fight to raise inflation back to its target of just below 2 per cent. Mario Draghi, the central bank’s president, has said the currency’s earlier strength explains 0.4 percentage points of the fall in inflation since 2012. In that year, prices were growing 2.7 per cent a year.
But just as this depreciation is starting to fuel inflation, the ECB must contend with a fall in oil prices that all but wipes out the effect of a sliding currency. A weaker euro should swiftly raise the cost of imported energy. Instead, Brent crude has fallen 9 per cent in euro terms this month alone. This is the main reason why eurozone inflation fell again in September to 0.3 per cent, a five-year low – a figure confirmed by data on Thursday.
“The drop in oil prices is a problem for the ECB,” says Marco Valli, an economist at UniCredit, adding, however, that the situation would have been far worse without the single currency’s fall.
“The impact on inflation is already visible and significant – if you still had the euro at 1.40 to the dollar, eurozone inflation would probably be zero.”
Pity the Keynesian Fools
Financial Times writers Delphine Strauss and Claire Jones say “pity the policy makers.” I say pity the fools who believe the thesis of their article.
There is absolutely no benefit to rising consumer prices. Things are even worse if prices rise but wages don’t.
The very essence of rising standard of living is more goods at lower prices thanks to innovation and rising productivity. And there is no reason to believe wages will rise (or keep up with prices) if prices do rise.
Challenge to Keynesians
I challenge Strauss and Jones (or anyone else but especially Keynesians and Monetarists) to prove rising prices provide an overall economic benefit.
Sure, those with first access to money benefit (the banks, the already wealthy, and government bodies via taxation). But that is at the expense of everyone else.
The absurd underlying notion behind the battle cry for inflation is that if prices fall people will stop buying things and the economy will collapse.
Reality Check Questions
- If price of food drops will people stop eating?
- If the price of gasoline drops will people stop driving?
- If price of airline tickets drop will people stop flying?
- If the handle on your frying pan falls off or your blow-dryer breaks, will you delay making another purchase because you can get it cheaper next month?
- If computers, printers, TVs, and other electronic devices will be cheaper next year, then cheaper again the following year, will people delay purchasing electronic devices as long as prices decline?
- If your coat is worn out, are you inclined to wait another year if there are discounts now, but you expect even bigger discounts a year from now?
- Will people delay medical procedures in expectation of falling prices?
- If deflation theory is accurate, why are there huge lines at stores when prices drop the most?
If falling prices stop people from buying things, how are any computers, flat screen TVs, monitors, etc., ever sold, in light of the fact that quality improves and prices decline every year?
Deflationary Spiral Nonsense
I have discussed this many times before, most recently in Deflationary Spiral Nonsense; Keynesian Theory vs. Practice; Eurozone Policymakers Concerned About Falling Prices
The idea that falling prices are bad for the economy is ridiculous. Taking out insurance against falling prices is even more absurd.
Ask any consumer if he wants lower gas prices, lower food prices, lower hotel prices, lower computer prices, or lower prices on any consumer items and the answer will be yes.
Keynesian Theory vs. Practice
Keynesian theory says consumers will delay purchases if prices are falling. In practice, all things being equal, it’s precisely the opposite.
If consumers think prices are too high, they will wait for bargains. It happens every year at Christmas and all year long on discretionary items not in immediate need.
Asset Deflation vs. Consumer Price Deflation
What central bankers should fear is falling asset prices, more specifically, loans made on assets in an asset bubble.
The irony is central banks create asset inflation by fighting something everyone on the planet should welcome.
Mike “Mish” Shedlock