The next phase of economic stagnation

The disastrous consequences of Keynesian thinking never seems to subside, the next catastrophe being the introduction of Quantitative Easing by the ECB. The following is an exchange of views under the heading, Eurozone prepares for QE. Bootle is your Keynesian, and when it comes down to it, can only think in terms of aggregate demand. The Europeans, like the Americans and the Japanese, and I guess pretty well everyone else, generally cannot think outside of macro aggregates. They seem to have no understanding of how a market economy slowly, but ever-so surely, knits itself back together, if the government would only stop messing with the parameters under which businesses must operate. The following is a bit long-winded, but since we are heading into the next phase of economic stagnation, it is worth understanding the kind of macro thinking behind it.

The ECB is preparing to announce a huge stimulus programme. We hear diverging views from the chief economist at one of Germany’s largest banks Commerzbank Joerg Kraemer and leading British economist Roger Bootle.

KRAEMER: I think that deflation is one of the most abused terms in economic policy discussions. Because there is no real threat from deflation. The Bank for International Settlement made it clear over a study of 150 years that a mild decline in prices is no problem for real GDP growth, and especially in the eurozone. The only reason why we have a negative inflation rate is the decline in oil price, but the decline in oil price is good for the economy. And if you strip out oil and look at the underlying core inflation at 0.8% is also low, but this is primarily caused by the fact that in some peripheral countries such as Spain, Portugal and Ireland, firms have cut their unit labour costs, they regained their price competitiveness and now they pass on a part of the cost reduction onto their customers in the form of slightly falling consumer prices, but again this is GOOD deflation because it goes hand-in-hand with an increase in profit margins and this is nothing to worry about, but nevertheless the negative inflation rate is used by the doves on the ECB council as an argument to go for QE which – in the end – will not change the picture of low inflation and low growth, but will primarily help the finance ministers of the highly indebted countries and their banks, which had bought a lot of government bonds, for example Spanish banks have bought roughly one-third of the outstanding volumes of Spanish government bonds.

BOOTLE: I think this is a dramatic misjudgment and it’s one that people coming from Germany are rather inclined to make with German history behind them because of course, the great fear in Germany – understandably – is inflation. Other countries have suffered significantly from deflation. As to the idea that the BIS concluded that over the last 150 years, deflation has been a good thing, well I wonder where they’ve been all that time. I mean, it all depends quite frankly on what the circumstances are.

Now, when you’ve got an economy that isn’t that heavily indebted, that isn’t super-sensitive to every little jot and tittle of the latest CPI figures, that isn’t very financially sophisticated, then yes, probably falling prices no one notices frankly and even know what’s going on. But when you move to the sort of economy we’ve got in today, where you have very heavy levels of debt, both government and private sector, we’ve got the markets all agog to see what’s happening to the CPI, I think is potentially quite dangerous to have a situation where prices are falling and are likely to fall year after year. Now we are not quite there yet really because at the moment all I think that’s happened in Europe is really the effect of a one-off drop in oil prices, which isn’t really if you like genuine deflation. But the danger is we might move to that.

KRAEMER: The Bank for International Settlements also showed that the slight decline in the Japanese consumer price index over the past 14 years did not change the picture that per capita GDP in Japan has grown roughly by the same amount than per capita GDP in the U.S. As long as consumer prices decline only mildly, this is not a big problem. We had this, for example, in the second half of the 19th century, during the gold standard, we had several periods of mild deflation, which had no negative impact on real GDP. I think the point is when you try to fight, when you try to avoid the inevitable, low inflation, low growth environment, after the burst of a debt bubble, then you only fuel asset price inflation.

BOOTLE: Let me be clear. I am not the greatest fan of quantitative easing in the sense that I don’t think it’s going to cure the European malaise, much of which has real rather than monetary foundations. It’s not the answer to a maiden’s prayers. It’s not a magic wand and moreover, the evidence of its effectiveness in other countries is not settled. In Japan it didn’t do very much good for a long time. In the United States and the UK it appears to have done some good quite how much we don’t know. The point is there is not much else in the locker. There is not much else you can do. If you’re in a situation where aggregate demand is very weak and that’s a position I think the eurozone is in and you are in danger of slipping into the sort of deflation which I at least and some other judges think is pretty damaging, then this is a mechanism for fending that danger off. And I have to say, I don’t think that there will be much impact from quantitative easing within the Eurozone, apart from through the exchange rate. In driving the exchange rate lower that’s going to help to boost eurozone net exports. It will boost aggregate demand. It will tend to keep up the price level. On balance I think those are pretty good things to be aiming at.

No one ever mentions markets, profits or entrepreneurs in any discussion of the economy. Economic theory has become junk science.