Saturday, December 20, 2014

20/12/2014: ECB, Inflation Expectations and Oil

There is much hype about the ECB not actively gunning for re-inflating the economy around. Which is understandable... as the fears of deflation are real. But it is also partially misplaced, as deflationary causes are a bit more complex and changing over time.

The main cause of the longer-term deflation is stagnant demand. This provides support for low level inflation base off which any negative shock to prices risks triggering a deflation. Here, in my opinion, ECB can do some helping, but not much.

The second cause, the shock to the downside, is oil price. And here ECB should do absolutely nothing, simply because lower cost of energy is neither caused by the monetary drivers, nor is hugely detrimental to the economy. If anything, lower cost of energy helps business margins and household budget, partially offsetting the stagnant demand.

Here's the link between Euro area inflation expectations and oil prices, courtesy of @ReutersJamie:

Yes, ECB is way off-target on its monetary policy: although the above begs a question if we really do want to see ECB balancesheet expanding so dramatically once again. Yes, ECB off-target on inflation. But no, ECB balancesheet growing is not a solution to the core problem holding European demand under water. Debt is, followed by lack of investment. And ECB can't help much with either. At least it cannot help by expanding it balancesheet.

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