Last month I wrote about the risk of deflation in the eurozone. This has far from abated, however, looking at this issue in further detail may provide some much needed colour to this picture.
Firstly, it is important to note that when speaking about inflation we are referring to the Harmonised Index of Consumer Prices (HICP) in the eurozone.
Looking back almost two decades, the average core HICP has been 1.5 per cent per annum. Currently this rate is at around 0.24 per cent which is well below the average.
We need to note that in the recent past all the countries in the eurozone have contributed less to this core inflation rate. However, the biggest declines have come from Italy, Greece, Portugal, Ireland, Spain and Cyprus.
All of these countries, with the exception of Italy, have actually contributed negatively to core inflation indicating that a very small degree of deflation is already present. It is also important to note that, just a few years ago, these same countries were among the highest contributors to the inflation index and hence this inflation measure is even more sensitive to the economics of these areas.
Secondly, there are other countries in the eurozone which are still experiencing inflation, albeit lower than previous years.
This is no surprise and in line with the generic macro-economic scenario of each respective country. Therefore, inflation/deflation is currently very patchy and uneven in the eurozone making it very difficult for the European Central Bank (ECB) to adopt a Europe wide monetary strategy. Surely this is no surprise – this is a direct result of monetary union – so if this was not a problem in the past why is it problematic now?
Mario Draghi is having to deal with the challenges of monetary union in a way no other president has had to do
In the first place, the question is not correct. Monetary union has always been the achilles heel of the eurozone. One of the issues monetary union brings about is that it does not allow the economies in the eurozone to operate as efficiently as possible for a prolonged period of time.
The reason for this is precisely the Europe-wide monetary easing or tightening imposed on all member countries irrespective of the individual national economic story being experienced. When inefficiency is experienced during periods of growth this is more acceptable than during periods of contraction.
This is because contraction is a problem especially when this is experienced by a number of eurozone members simultaneously.
Therefore when one speaks about quantitative easing in a European context, this may not necessarily be the ideal solution for the eurozone, given that the various states within this area are performing differently. What we need is to have the ECB conduct geographically-customised intervention via its central balance sheet in Frankfurt. I can already hear the eurosceptics in choir shouting this is impossible – but have we not already seen the ECB doing what was deemed to be impossible? Mario Draghi is having to deal with the challenges of monetary union in a way no other president has had to do.
The irony is that, the point at which the ECB is about to become the principal supranational banking regulator for the eurozone (thereby reducing the powers of the national central banks and centralising these powers within Frankfurt) may coincide with the need for the ECB to turn onto the various national central banks to execute a monetary programme which is customised to the specific needs of the various member countries.
Whichever option the ECB decides to adopt is unlikely to have Germany’s official blessing.
However, Germany is more likely to accept an unorthodox course of action now rather than deal with greater inflation throughout the eurozone in the not too distant future.
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This article is the objective and independent opinion of the author. The information contained in the article is based on public information.
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Karl Micallef is an executive director at Curmi and Partners Ltd.