This is the chart that eurozone policymakers are most afraid of. It shows Euro Area inflation is falling precipitously over the past three years leaving the region perilously close to falling into deflation — an outcome they are desperate to avoid.
Why is this important? Inflation is normally a dirty word. But a little bit of inflation is good for economic growth because it encourages people to spend today rather than save for later. Economic growth across large chunks of Europe is declining toward 0%. It’s teetering on the brink, essentially. The ECB actually needs some inflation, for once, to get things rolling again.
The European Central Bank (ECB), which has a mandate to achieve an average 2% inflation rate, is meeting tomorrow to set interest rates for the Euro Area. Yet with interest rates already right down against the zero lower bound, and the deposit rate (the interest rates the central bank pays on its own savings accounts) having dropped into negative territory (-0.1%) in June, there are few options open to the central bank to stimulate economic activity and try to push up inflation by lowering interest rates. The rates can’t go any lower.
Mario Draghi, the president of the ECB, has promised to do “whatever it takes” to resolve the region’s problems and is now openly discussing the potential of launching a European asset purchase programme similar to the quantitative easing programmes in the U.S. and U.K. But the question for many is whether he has promised too much and will now struggle to deliver.
The problem facing Draghi is that, while countries like Greece and Italy are in great need of increased spending to help restart their sluggish economies. But one of the key the mechanisms by which central bank policy is transmitted to the real economy — bank lending — is broken.
Lending is collapsing all over the place, basically.
What it suggests is that even if the ECB does act tomorrow, central bank action alone will struggle to alleviate the problems in the areas where they are most apparent.
His lack of firepower may well be the reason why Draghi used his speech at Kansas City Fed’s annual conference at Jackson Hole to raise the prospect of loosening the “overall stance of [fiscal] policy” — that is, to pull back on some of the budget tightening measures European Union leaders have been pushing for over recent years.
There’s just one problem: The Germans. There is little sign that Europe’s largest economy is listening. Germany wants balanced budgets above everything. Germany’s finance minister Wolfgang Schäuble even implied Draghi’s speech was all just a misunderstanding that had been “overinterpreted.“
Few believe that, but convincing the Germans of the need to reverse spending cuts is a big ask — and it may be a necessary one.