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Deflation posing major risk to US and Europe economies.

JEDDAH: ARAB NEWSThe risk of deflation in the US and the euro zone may require more expansionary monetary policy, such as Quantitative Easing (QE), according to the QNB Group Overall in 2014, deflation could be a serious risk for the US and Europe, it said in a report.

Continued expansionary monetary policy could therefore alleviate some of this risk as shown by the recent experience in Japan. It could also encourage capital flows to emerging markets, thus bring back some stability in global financial markets.

Lower international commodity prices and subdued domestic demand have lead to historically very low inflation rates, well below the central banks' target of 2 percent.

This calls for a continuation and possibly acceleration of unconventional monetary policy to offset the dangers that deflation could pose on an already weak recovery. The experience of Japan provides a useful historical precedent. After decades of deflation and weak growth a successful mix of policies has helped Japan exit its deflations trap.

In October 2013, inflation in Japan rose above inflation in both the US and euro zone for the first time this century. Rising Japanese inflation is a direct consequence of expansionary economic policies introduced this year, which could help the country escape from the lost decades of low growth and deflation from the real estate crash of 1989 until today.

Meanwhile, inflation in the US and euro zone has fallen to around 1.0 percent, the lowest levels since 2009 when the global recession and collapsing commodity markets dragged down prices. These low inflation rates raise the risk that the US and the euro zone could be entering their own deflation trap with lost decades of low growth and deflation ahead, like in Japan. According to QNB Group, this strengthens the case for an extension of expansionary economic policy, such as QE.

Since the 1990s, the Japanese economy has languished in a feeble state of weak growth and deflation that persisted into the 21st Century. From 2000 to May 2013, annual inflation of the consumer price index (CPI) was negative (averaging -0.3 percent), while real GDP growth was less than 1 percent over the same period.

However, in the last few months, the economy has turned around after a raft of expansionary economic policies was introduced by the current Prime Minister, Shinzo Abe, who came to power at the end of 2012. These policies, known as "Abenomics" include aggressive expansionary monetary policy, heavy spending on public infrastructure and an active policy to weaken the Japanese yen.

Growth has averaged 3.1 percent so far this year and inflation rose from -0.3 percent in the year to May 2013 to 1.1 percent in the year to October. Abenomics is likely to have contributed significantly to Japan's improving economic performance. A consequence of expansionary monetary policy, such as QE, is that it tends to devalue the exchange rate by increasing the supply of money. This can have a positive impact on the economy as it makes a country's businesses more competitive, encouraging growth. It can also push inflation higher by increasing the cost of imports.

According to economic theory, deflation fuels expectations that prices will continue to fall, encouraging consumers, businesses and government to put off purchases, thus holding back growth. It also increases the real value of outstanding domestic debt, thus making it more difficult for borrowers to repay.

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Publication:Arab News (Jeddah, Saudi Arabia)
Geographic Code:9JAPA
Date:Dec 14, 2013
Words:579
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