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MONETARY POLICY


undertake further action to ease monetary policy.


According to the monetary policy textbook central banks should not respond to ‘good def lation’. This obviously could give reason to question the fact that the ECB is now finally moving


to


ease monetary policy. But the truth is that the ECB in the past five years have failed to s u f f i c i e n t l y a g g r e s s iv el y ease monetary policy to avoid bad def lation.


O b v i o u s l y they have been short in easing action not for inattentiveness and, I assume, not


for lack of economic structures and cycles.


The argument for the ‘good’ camp


is that falling periphery


price levels are a necessary evil, needed to restore competitiveness and growth. The argument for the ‘bad’ camp is that def lation


FX


competitiveness without falling price levels.


The difference between the two camps lies in who the periphery is supposed to regain competitiveness against. The ‘good’ def lation camp wants to preserve competitiveness in northern Europe low


via overall


i n f l a t ion , fo r ci n g p er i p h er y countries into def lation. This line of thinking aims to restore p er i p h er y competitiveness relative to the rest


of the


world (and of course


relative


understanding of the basic principles of the modern central bank textbook. There are in fact many ways to slice the good versus bad def lation debate. A recent paper from Goldman Sachs (Global Markets Daily: ‘Good’ or ‘Bad’ Def lation in the Euro area – November 22nd) has been quite helpful in explaining the dilemma policy makers are facing in a monetary union of nations with diverse


According to the monetary policy textbook central banks should not respond to ‘good deflation’


in the periphery may exacerbate some of the underlying fiscal problems and is not actually needed to restore competitiveness, which would ask merely for lower inf lation relative to Germany. This line of thinking argues that Germany and the smaller current account surplus countries need to accept higher


inf lation, so that periphery countries can regain


to Germany), w h i l e preserving the competitiveness of the overall Euro


area


(read northern Europe) relative


to the rest of the world. Ireland’s 5% drop in core prices can be seen as a template for this line of thinking.


The ‘bad’ def lation camp thinks the periphery should regain competitiveness principally vis-à-vis Germany, with higher German inf lation eroding some of


its own competitiveness gains FX TRADER MAGAZINE January - March 2014 45


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