FX MONETARY POLICY
protects an economy from sliding into def lation and makes it easier for a central bank to stimulate the economy. It also makes it easier for employers to reduce inf lation- adjusted wages; workers often are happier with a 1% raise when inf lation is at 2% than with a 1% wage cut when inf lation is at zero,
e c onomi s t s— exactly same.
is
even though they are—to the
These days when a def lation scenario
d is c us s e d Japan is very often used as a
That easily
template. is
understandable, having seen recent economic history.
In
the European case there is even one more fu n d ame n t al reason to believe def lation
is
a possibility for
Zone: the Euro demographics. Ageing
populations create a propensity to def lation. Old people borrow less and consume less. And nowhere outside of Japan are there bigger proportions of old people
than
in Europe. The average Italian or German isn’t much younger than the average Japanese.
44 FX TRADER MAGAZINE January - March 2014
- for example due to tighter monetary policy - can reduce the price level. Economists normally call productivity increases and falling oil prices a positive supply shock. They are unilaterally positive as a positive supply shock overall increases prosperity. That’s the good def lation. Conversely a
These days when a deflation scenario is discussed Japan is very often used as a model
GOOD AND BAD DEFLATION
The overall price level in the economy may fall for two reasons. First, productivity increases may cause prices to fall. As will falling input prices - for example lower oil prices. Second, a general contraction in aggregate demand
general decline in prices, which is a result of weak aggregate demand - a negative demand shock - is purely negative as it usually leads to higher unemployment and lower capacity utilization in the economy. That’s the bad def lation.
In general the economic development
in Europe in the last has
five years been
cha rac t e r i zed by very weak d e m a n d development. It has created clear d e f l a t ion a r y trends in several E u rop e a n e c o n o m i e s . That certainly has not been good.
It has
been a bad d e f l a t ion . However, the recent decline we have seen in
inf lation
European is
p ri m a ri l y a result of falling
oil
prices - that is a good def lation, which shouldn’t be worrying. The paradox is that these recent (positive) def lationary trends in the European economy seem to have caused the European Central Bank to wake up and reduce interest rates. and it is now being speculated that the ECB will
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