It’s straight out of the textbook that low inflation – and above all deflation – has negative effects on economic growth that we all know about. That’s the main reason why ECB President Mario Draghi implemented an ambitious set of monetary expansion measures in March, with the aim of boosting prices to a level more suitable for economic growth, namely 2%.
Of course it’s very early yet to evaluate the result of these measures. The dangers of deflation, aggravated by low oil and raw materials’ prices, a global demand which has yet to pick up and the economic slowdown in China, recently flagged by the IMF, are not exclusive to Europe. But what is a fact is that prices in Europe, both in the EU and the Eurozone, are just on the brink of deflation.
In March, eurozone inflation was 0%, better than the -0.2% recorded in February, but worse than January’s 0.3%. Despite the fact the average was 0%, most of the countries in the area registered clearly negative inflation in March: -1.0% in Spain, -0.1% in France, -0.2% in Italy, -0.4% in Poland or -0.7% in Greece. A few countries bucked the trend, particularly the UK where the CPI (Consumer Price Index) rose 0.5% in March. Consumer prices rose 0.1% in Germany and 0.5% in Portugal. But these were exceptions.
The situation is a bit better in the US, but it’s nothing to shout home about. The CPI rose only 0.9% in the last 12 months, a level of inflation which is also obviously insufficient given that the target is 2%. Against this backdrop of low prices, it’s likely that the Fed will be very cautious with respect to possible new rate hikes. And also because GDP growth has slowed in the last few quarters. It was 1.9% in the fourth quarter compared with 2.1% in the third, 2.4% in the second and 2.6% in the first: so there has been a clear slowdown.
In Spain, funnily enough, it doesn’t look as if the low inflation levels are affecting our economy’s growth. Despite inflation having been below 1% in the past months (in annual terms), growth remains fairly strong. And it has been expanding annually: 2.7% in the first quarter of 2015, 3.2% in the second, 3.4% in the third and 3.5% in the fourth. Furthermore, domestic demand contributed 4.1 percentage points to GDP and investment grew 6.4%.
Apart from the fact that low inflation and deflation have negative effects, we musn’t forget that in Spain there has been a concerted effort towards competitive devaluation, meaning lower prices. So in light of the measures undertaken, and the fact that Spain’s labour reform has led to a stagnation in labour costs, it’s not surprising that prices are falling.
And the truth is that businessmen in Spain don’t appear to be very alarmed, can we say, by the dangers of deflation. This is mainly because most of them consider this situation as more of an opportunity than a risk. The economy’s lower costs, ranging from oil prices and raw materials to bank financing, and including wage cuts, have improved Spain’s competitiveness abroad. There are also many who believe that this is very helpful for cleaning up company’s balance sheets, paying down debt and taking on new projects.