Why ECB's Draghi is Wrong About Deflation

We have seen a parade of deflation headlines in the European financial press during the past few years, even as the European Central Bank implemented unprecedented monetary stimulus.

Type "deflation Europe" into Google's search bar and you'll see for yourself.

Even so, on December 8, ECB President Mario Draghi said this (WSJ):

"The risk of deflation has largely disappeared."

But, in our view, such an assertion flies in the face of the evidence.

Let's start with a few headlines from just the past two months that we shared with you in a recent posting on these pages:

  • Italy October EU-harmonised consumer prices confirmed in deflation territory (Reuters, Nov. 14)
  • Bulgaria annual CPI records 0.6% deflation in October (The Sofia Globe, Nov. 14)
  • Romania's deflation deepens to 0.6% y/y in September (, Oct. 11)

Granted, Italy, Bulgaria and Romania are just a fraction of the entire European Union. Still, these headlines might prompt an objective observer to at least question Draghi's statement.

Furthermore, a review of Germany, the EU's largest economy, would raise even more doubts about the claim that the risk of deflation has mainly disappeared.

EWI's September 2016 European Financial Forecast showed this chart and said:

Germany's Economic Performance Over the Past Decade

German GDP has so far failed to return to its old high, as the top graph shows. The second graph [shows] stagnating consumer prices. The third graph provides a unique look at how broad the economic slowdown has become. Bloomberg's Indicator of Real-Time Activity combines five surveys from three sources, giving an up-to-date look at Germany's economic direction. After reversing from its 2007 all-time peak and hitting a lower peak in February 2011, the index has been dawdling for five years and counting. … The Ifo Pan German Business Climate Index (fourth graph) also confirms a critical slackening in Europe's largest economy, as does the bottom chart of German new-car registrations.

New-car registrations may indicate economic turns because consumers usually get loans to buy new cars. Hence, auto sales often reflect changes in available credit. Also, a new car is usually an optional purchase, so auto sales often take a disproportionate hit as the economy weakens. With these factors in mind, German new-car registrations declined 3.9%, their fastest pace in a year, according to the September European Financial Forecast.

Looking at another big European economy, the September issue also mentioned that in August, Britain's service sector contracted at its fastest pace since the bear market that ended in 2009.

In the meantime, ECB economists predict inflation will pick up across the Continent in 2017 and 2018 (WSJ, Dec. 8). They might be correct. Then again, the massive bond-buying program that the central bank launched in March 2015 has largely proved ineffective to boost inflation, so far.

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