German Prices Fall, Europe is Deflating

The economic policies of the conservative German government of Angela Merkel have been wrong from the beginning of the global financial crisis. However, Germany has escaped from the folly thus far because the Greeks, Spaniards, Portuguese, Italians and Irish have born the financial pain. Since Germany depends heavily on exports and because its markets are wallowing in recession or worse the chickens have come home to roost. Prices in Germany are falling, and the nation has imported deflation. The European Central Bank will be hard put to fix things if Dr. Merkel and company don’t change their tune.

Reuters reports, “Preliminary data on Thursday showed consumer prices in Europe’s largest economy, harmonised to compare with other European countries, dropped by 0.5 percent on the year in January after rising by 0.1 percent in December. That undershot the consensus forecast in a Reuters poll for a 0.2 percent fall. It also falls far short of the European Central Bank’s target for close to but just under 2 percent over the medium term in the euro zone.”

The wire service also stated, “Preliminary inflation data for the 19-nation euro zone is due on Friday and economists polled by Reuters before the German data was released expected it to show the cost of living in the single currency bloc dropping by 0.5 percent in January after falling by 0.2 percent in December – its first drop since 2009.

“But Marco Wagner, economist at Commerzbank, said the German data suggested the euro zone rate could slip to -0.6 percent. He added that the ECB could significantly increase the volume of government debt it buys per month in the second half of the year because inflation and growth are likely to remain weak until then.”

Energy prices account for much of the decline, owing to the precipitous drop in oil prices. At the same time, cheaper food prices also helped bring prices lower. This is going to spread to other parts of the economy because every sector is affected by lower energy prices.

The ECB can buy bonds to pump liquidity into the system, but monetary policy is limited in what it can achieve. At this point, it is close to pushing on a rope. What is required in Germany and in Europe as a whole is fiscal action. The one nation that avoided the effects of the Great Recession is South Korea, and its government spent like a drunken sailor to ensure that aggregate demand did not plummet as it did in every economy that tried austerity.

Of course, vast spending offends the sensibilities of the right. Dr. Merkel has been as parsimonious as any cartoon hausfrau when it comes to government spending. Yet as a scientist, she should understand that when spending by business and by consumers drops, spending cuts by the government won’t increase overall spending (that is, GDP) — it shrinks things further. Her insistence on austerity throughout Europe has brought the EU to this sorry pass.

She should consider a little of her own nation’s history. Germany’s creditors did not saddle the Bundesrepublik with the entirety of Nazi debt. Germany’s debt burden was halved. Then, there was a rule that repayment would only occur through export earnings, not government funds (that is, the German taxpayer was not on the hook). Further, the D-mark was deliberately undervalued to encourage those exports. There was nothing austere about it. And it was called the Wirtscaftswunder, the German Economic Miracle.