Expert Commentary

ECB in Deflation Denial

Don’t mention the D word.

In last week’s bizarre public address highlighting the U.S. unemployment numbers, this was an actual quote from President Trump: "This isn't a terrible recession. I don't even mention the 'D' word. I don't talk about the 'D' word. I don't want to talk about it because every time somebody even mentions it -- I don't like the 'D' word."

The D word that Trump was referring to (I suspect, but then who knows?) is depression. On the other side of the Atlantic Ocean, another D word that is not popular is deflation.

The European Central Bank appears to be in a funk about how to address the looming price deflation. That is because a tightrope must be walked between those states in Europe that are gunning for the ECB to monetarily inflate more (Spain, Italy) and those that are more cautious (Germany, Netherlands). The assumption, which we think is loose at best, is that flooding the economy with newly created euros will cause consumer prices to surge. However, even though there is often a link between monetary inflation and price inflation, it is not mechanical. Nevertheless, the ECB seems to be paranoid about even acknowledging the threat of price deflation, in case it stokes the fears of those states opposing more stimulus.

ECB President Lagarde body-swerved a question on deflation in a recent press conference and ECB Chief Economist, Philip Lane, couldn’t bring himself to type the D word in a recent blog, stating: “Taken together, the scale of the increase in economic slack means that the net impact on inflation dynamics is assessed to be substantially negative in the staff projections, even when allowing for the pro-inflationary impact of some damage to supply capacity.”

Thus, heads are firmly buried in the sand. If consumer prices start to deflate (as we expect), perhaps the ECB will call it negative inflation, as some already call price deflation. Central banks are so focused on consumer prices as a gauge of their “success” in aiding the economy that they can’t see the forest for the trees. When all this historic money printing doesn’t end up in rampant price inflation, expect central banks’ focus on consumer prices to be ditched. Ironically, that will probably be the signal of price inflation ahead.

Germany Price Inflation Expectations Chart