Some of you might be wondering why the ECB is going to such great lengths to meet its price stability objective (2 percent inflation). Aren’t we better off when inflation is low? That is, when goods are becoming cheaper? That was one of the questions raised by ECB President Mario Draghi during his recent speech at the New York stock exchange. Not that anyone was given the opportunity to give an answer; after Draghi raised a question, he would immediately answer it himself.
His answer? ‘Certainly, in the short run, a fall in inflation benefits consumers. But if inflation stays too low for too long a period, it actually harms them.’ Subsequently, he gave a couple of reasons why consumers would be harmed if inflation were to stay too low, for too long. For example, he claimed that low inflation would complicate the adjustment process of an economy, resulting in high unemployment. It would also be tough for countries to improve their competitive position and debts would weigh more heavily, complicating the economic recovery.
And with all due respect, but I applaud Draghi for being able to put so much nonsense and factual inaccuracies in one single speech.
Let's examine the negative effects he proposed. His first suggestion, that low inflation causes high unemployment, goes against all of the available scientific literature, economic literature you would expect the ECB president to be knowledgeable of. It was shown long ago that aiming for more inflation in order to lower unemployment doesn’t work; it is a myth that they are related in this way. For an economic, still believing in this relation is the same as believing the earth is flat. You’d only need to make a list of the average annual inflation and unemployment in Western countries, for the past decades, to see that unemployment is low in countries that have a history of low inflation, and generally high in countries that have a high inflation on average.
With regards to Draghi’s assertion that low inflation would hamper a country’s competitive position: you’d have to ask yourself why countries such as Germany or the Netherlands, who have a long tradition of low inflation, also have had a strong competitive position for a long time. And why is the competitive situation of Greece and Italy so dire? After all, given their traditionally high average inflation, shouldn’t these countries have a rock-solid competitive position?
And finally, he argued that lower inflation would raise the existing debt burden (in real terms), which would dampen the economic recovery. Perhaps it is because I did not grow up in a Western country, but when people claim the economic recovery doesn’t take off because the debts weigh heavier during times of low inflation, I cannot help but asking whether the problem lies with low inflation, or simply with these high debts?! Low inflation, without towering debts, is a blessing for an economy. Eliminating that enormous advantage, only because of surmounting debts, is as if you were to advocate to prohibit all vehicles because they cause accidents every year.
You know what Draghi did not do in his speech? He did not give a real-world example, using a country with a continuously low inflation that has fallen into trouble. And that is not because there are no countries with a tradition of low inflation, because there are plenty. Draghi didn’t use an example, because the actual reality of those countries wouldn’t quite match his rubbish story.
To remind you, Draghi said ‘But if inflation stays too low for too long it actually harms them [the consumers]’. If the consumer is harmed by something, so is the economy. We don’t have to go for from home, speaking in terms of both geography and time, to give one recent example with which we can show Draghi’s nonsense. (For those who would want to go back in time; Germany and the Netherlands provide illuminating examples.) What country am I talking about? Switzerland!
Since the euro’s introduction in 1999, total inflation in Switzerland has been about 9 percent. Or in other words, prices haven’t even risen by more than a half percent each year. That’s a figure I feel we could fairly call low. As of 2008, there were three years in which prices declined, one year in which they remained unchanged, and three years of a slightly positive price change (above 0 percent).
Despite everything mentioned above, nothing shows that the Swiss economy suffers: it hasn’t collapsed, consumer spending hasn’t declined, nor does Switzerland suffer high unemployment. Actually, in contrast: consumption is increasing and unemployment is very low (below 5 percent, which is low in comparison with the average of 12 percent in the Euro area). Moreover, Swiss companies are able to handle the international competition just fine.
If Draghi’s story had been true, we’d have a refugee crisis in the EU years ago. That is, we would have had thousands of Swiss people crossing the border over the Alps in order to reach their rich neighboring euro countries! There would have been fences all around Switzerland for years! That is, if his story were true, of course.
Yet the most astonishing of all is that Draghi has been proclaiming this nonsense for quite some time now, both inside and outside the Euro area, and still keeps on getting away with. Donald Trump recently said he had amassed so much trust from his voters, that he could commit a murder on the Fifth Avenue in New York, and still wouldn’t lose a single vote. Of course, that is what Trump speculates, but not a statement he can provide evidence for. But in the case of Draghi, these are not just mere speculations; week after week he proves how much economical nonsense and factual inaccuracies – there is also another word to describe this, but I won’t use it – he can tell. Yet no matter how often he does it, he just keeps on having the full trust of European politicians and many others that he just continues to get away with it.