It is often said that one picture is worth a thousand words. This could not be truer of a Wall Street Journal chart copied above that shows relative inflation and unemployment developments across the world’s most advanced country blocs. For that chart can leave little doubt that Europe is now at a much greater risk than is the United States of a prolonged period of Japanese-style price deflation.
Among the more striking features of the chart is Europe’s very poor employment performance in the post-2008 Lehman crisis period. In the United States, unemployment did increase from around 5% before the Lehman crisis to 10% at its peak by end-2009. However, since that time it has steadily declined to its present level of 7.2%. By contrast, European unemployment rose from less than 8% in 2008 to a little over 10% by end-2009. It then increased steadily further to 12.2% by October 2013. It did so as Europe experienced a double dip economic recession, which turned out to be its longest post-war economic recession.
Economic theory would suggest that broad dis-inflation movements are driven by the existence of large gaps in the labor and product markets. With unemployment as high as it is in Europe, it should have come as no surprise that over the past year European consumer price inflation would decelerate sharply from 2.6% to 0.7%. It should also have come as no surprise that those countries in the European periphery, where the labor and output market gaps are very much larger than the European average, would be driven to deflation or very close to deflation.
Looking ahead, it is difficult to see how the lackluster economic recovery in prospect for Europe will materially bring down Europe’s unemployment rate from 12% to a more acceptable level. For that reason one should not be surprised if by end 2014 Europe as a whole flirts with deflation and if the countries in the European periphery lapse into outright deflation. One has to hope that the European Central bank is paying attention since it would seem that the ECB is already way behind the policy curve and that a heavily indebted European periphery is in no position to withstand a prolonged period of price deflation.