- At the IMF meeting this weekend, deflation still seems to be on the minds of many.
- European Central Bank chief even alludes to creating negative interest rates.
- What if the economic problems are structural, aggregate demand efforts will not resolve them.
The International Monetary Fund cannot get its mind off of deflation.
"The world's top financial officials stepped up warnings about low inflation during weekend meetings of the International Monetary Fund, calling for action to combat downward price pressure that threaten consumption and stymie debt reduction."
Brian and Blackstone and Ian Talley continue in the Wall Street Journal, "The IMF's policy committee highlighted stubbornly weak price increases as a key drag on the global recovery, which is approaching the end of its fifth year."
Annual inflation for the eurozone is around 0.5 percent, below the target of the European Central Bank, which is around 2.0 percent.
The concern among these officials is about a cumulative decline in economic activity because of low inflation or even worse…deflation. One reason is that low inflation goes with low growth. But, countries find it harder to regain their competitiveness in periods when there is low inflation.
A third factor is that low inflation makes it harder for those in debt to reduce their debt levels. Of course, deflation actually results in the real value of the debt to rise, thereby, increasing the burden of the debt.
This concern is sufficiently great that the president of the European Central Bank, Mario Draghi seems ready to push interest rates below zero. The concern arises, according to Claire Jones and Chris Giles in the Financial Times, comes about because of the strength of the euro.
"The single currency has risen 6 percent against the dollar and 9 percent against the yen in the past year and remains close to multiyear highs…even though the ECB gave its strongest hint yet this month that it could embark on mass purchases of government bonds..."
Draghi stated that he will not stand by and watch any more increases in the euro that would continue to weaken exports from the eurozone and put even more downward pressure on inflation.
The real fear is that Europe will suffer an experience something like Japan has gone through over the last decade or so. Thus, the emphasis is more of this and more of that…anything to get aggregate demand rising. But, the emphasis is all on demand…pure Keynesianism.
Maybe, just maybe, the problem is a structural one and something that more demand cannot solve right now. The idea that countries cannot "regain their competitiveness in periods when there is low inflation" is just a vocalization of the dogma of a certain way of thinking.
Many of the countries in Europe -- especially the southern fringe -- need to reform their labor markets, their labor practices, and their social practices.
It is remarkable to me all of the new studies coming out that are pointing to the changes in the labor markets, both in the United States as well as in Europe. There are major structural problems in the labor markets and in quite a few cases, particularly in Europe, reviving aggregate demand is not going to put many of these people back to work.
And, that is the essence of the Keynesian approach to unemployment. Stimulate the economy with monetary policy or government spending and put those unemployed people back into the jobs that they used to have.
This may work the first time you try and do it…and the second time…and the third time…and so on…but there comes a point when the world has moved on and you cannot just continue to pump up demand and put people back to work. Businesses…the world…has moved on.
Furthermore, business practices have changed. In the 1990s and into the 2000s, businesses "hoarded" workers. Because of the ups and downs in the economy and the fact that the labor market was pretty well stretched, businesses would not lay off people during a downturn. They did this to not have to try and rehire the people once the economy rebounded. This kept unemployment down but it also meant people were kept on the payrolls for the wrong reason.
Several of the recent studies I have seen point to the fact that because people were kept under these circumstances, very often human resources practices went slack…why do a real thorough review of an employee when you know that employee will be kept on anyway…and the ability of some firms to distinguish between highly productive people and less productive people became a grey area. As a consequence, employers treated both equally…and productivity dropped.
With the Great Recession these practices began to change. Hiring slacked off and people, who were let go, were not rehired. And, they couldn't find work elsewhere. What they had been trained for …well…it wasn't there anymore.
Countries that have dealt with these structure problems have fared much better in the economic recovery. Germany is, of course, given as the prime example of a country that took care of quite a few of these problems and has benefited greatly from the effort.
Just recently, it looks as if Great Britain has benefited from following this path. There were numerous articles in the papers and journals last week about how George Osborne, the British Chancellor of the Exchequer was going to present England's case before the IMF meetings.
England's economic recovery is well on its way…the fastest growing economy in the economic union. Many at the IMF, including the Chief Economist of the fund, Oliver Blanchard, to put it mildly, criticized the austerity path it took. The discussing in the press was over how much Osborne's speech included the phrase, the IMF was wrong, but he didn't go so far as to wiggle his nose at the IMF officials and tell them "I told you so."
In addition, we have Greece getting back on its feet after the austerity measures it faced. It's primary government surplus has been forecast by the European Commission to reach 2.7 percent of GDP this year and to rise to 4.1 percent in 2015. The Greek current account has just achieved its first surplus, reducing the need for more foreign investment. And, the Greek economy is poised to begin its economic recovery.
Given these factors and what else is going on in Europe, investors gave Greece a real vote of confidence as it they over-bid the new issue of Greek sovereign debt. The spread of the 10-year Greek bond over the yield on the 10-year German bund is the lowest it has been for years.
If the major problems being faced by the countries of the eurozone are structural, efforts to stimulate the economy, either by further efforts of the monetary authority will only postpone all of the adjustments that need to be made and will keep most of the continent uncompetitive in world markets. Europe's people will continue to pay for past efforts to keep them their old jobs because the restructuring that is needed, will just be kicked, once again, down the road further.
Remember, too, that the performance of exchange rates depends upon what others do. Europe doesn't want to start an exchange rate war.