It's a reflex. On Friday, when the Federal Statistical Office announces that consumer prices in Germany have fallen for the second time in a row, there'll be a commotion all over again.
Advocates of an extremely relaxed monetary policy will bring up concerns about deflation again and think their beliefs have been confirmed. They'll say there's no way around the European Central Bank's bond-buying program which starts in March. But the inflation rate was already negative in January, at -0.4 percent here in Germany and at -0.6 percent in the euro zone as a whole.
How problematic are these figures? Is there really a danger of a spiral of sinking prices and falling demand? Many economists think so but I believe these fears are exaggerated.
The central task of the ECB is to ensure price stability. According to the bank's own definition, this stability is achieved when the inflation rate is just under 2 percent.
Even if this target is currently being clearly missed, the fears of deflation are unfounded.
It is true that deflation constitutes one of the most unpleasant economic problems. It is wrong, however, to interpret every failure to achieve the inflation target as a sign of a slide into deflation. Deflation as a serious aberration only happens when prices decline as a result of pronounced consumer restraint, as was the case in the 1930s in the global economic depression. Only then is there the danger that consumers can feel compelled to put off their purchases.
The economy is picking up in most euro zone countries.
None of these scenarios is currently the case. First of all, dramatically dropping oil prices are primarily responsible for the fall in consumer prices. Products based on crude-oil account for a good 12 percent of the statisticians’ typical consumer basket.
Secondly, the economy is picking up in most euro zone countries. And third, as recent studies show, supply-related price reductions – even if they are lasting – in no way lead to permanent consumer restraint in anticipation of a further declines.
There are more signs these days that industrialized countries are entering a new phase of development: A phase that is characterized by very flat price developments, moderate growth rates, but still perceptible increases in real income. Other characteristics of this new phase are the digitalization of many production and distribution processes, boosts of productivity and a flood of inexpensive new product and service innovations.
That puts pressure on the prices of many goods, meaning prices are less likely to increase. The impact of these key 21st-century technologies has surpassed all known technological leaps of the past, comparable only to the introduction of the steam engine or use of electricity. Few industries will not be fundamentally affected by digitalization. This will lead to sustained pressure on the prices of most goods and services.
Downloaded music costs much less than a CD, while getting legal advice online is cheaper than visiting an attorney. In addition, the many new app-based business models circumvent the prices of traditional vendors.
Uber is stirring things up in the market for taxis. Auxmoney is facilitating private loans and challenging banks in their core business. BlaBlaCar is offering car-sharing possibilities across Europe in competition with the trains and buses. Consumers can access a new level of transparency thanks to free price comparison portals such as check24 or HRS, increasing the price pressure on almost all traded goods and services.
Small price increases or even dropping prices aren't necessarily a sign that something is wrong. They're the result of growing consumer sovereignty and smarter companies, who are finding ways to use new technologies.
If this thesis is correct, then extremely relaxed monetary policies risk failing to achieve their goals. Instead of meeting a self-imposed inflation target by stimulating the real economy, the result would be rapidly rising asset prices with all the familiar risks of financial crises and subsequent recessions.
The current inflation target should be reviewed. There is much that suggests it is too high.
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