If we would listen to the Europeans advocating austerity measures to punish Greece and Italy in particular for their profligacy, then inflation is right around the corner, according to the Germans who fear it most. Germany’s Finance Minister Wolfgang Schaubele is the most hawkish in advocating that the Greeks won’t get the next installment of their rescue package unless they shave off 130B euros in spending cuts to bring down their some 400B euros in debt.
Herr Schaubele is the principal advocate of what Paul Krugman calls the “confidence fairy”. The confidence fairy is the myth that too much debt causes the loss of confidence in a sovereign currency, driving up interest rates and inflation, even during recessions. It is the rationalization extreme fiscal conservatives use to justify their ideology that all debt is bad (though it is their wealthy supporters who do the most lending), and so debtors must be punished for their borrowing.
That is behind Herr Schaubele’s attempts to drive Greece out of the euro by insisting on such draconian austerity measures that Greece cannot possibly fulfill. Herr Schaubele’s efforts have succeeded instead in pulling several EU countries back into recession, as prices and output are falling, which is what one would expect, because such austerity measures cause a huge drop in incomes, and so any stimulus to grow economies. Great Britain, Ireland, Italy the Netherlands, and Spain are just a few countries suffering from its effects.
“We doubt that the euro zone will be able to avoid further contraction in the first quarter and very possibly the second as well in the face of tighter credit conditions, a further tightening in fiscal policy in many countries, the ongoing pressures facing consumers (high and rising unemployment, and still squeezed purchasing power) and limited global growth,” said Howard Archer, chief European economist at IHS Global Insight, said in a Marketwatch interview.
Economists have been discussing the dangers of inflation since the beginning of economics, but don’t really spell out that there are at least 2 kinds of inflation. There is consumer inflation measured by such as the Consumer Price Index, and there are many commodity price indexes that measure asset inflation.
Graph: World Bank
Consumer price inflation was nonexistent in December at the headline and core levels. The consumer price index in December was unchanged for the second month in a row with lower energy costs playing a key role. Excluding food and energy, the core CPI decelerated to a modest 0.1 percent increase after gaining 0.2 percent in November, and is up just 2.2 percent year-over-year.
Graph: The World Bank
For the U.S., commodity prices are best measured by the U.S. Producer Price Index for producer goods, which at the producer level in December was tugged down by gasoline and food costs but the core was warmer than expected. Producer prices edged down 0.1 percent after rebounding 0.3 percent the prior month.
The two are not necessarily related, because producers cannot always pass on their costs to consumers, though economists still take sides. The so-called monetarists, or neo-classicists tend to be fiscal, small government conservatives that believe all economic activity depends on the size of the money supply. And government should not be in the business of boosting the money supply with stimulus, which only causes more inflation.
Whereas Keynesians, or neo-Keynesians, believe that there is really no danger of inflation as long as unemployment is high, which happens during recessions. That’s because consumers who power some 67 percent of aggregate demand cannot create inflationary pressures as long as personal incomes, wages and salaries and the like are stagnant.
In fact, Keynesians maintain from their Great Depression experience that the overall money supply doesn’t increase during recessions, but is hoarded, causing deflationary pressures. And deflation is the hardest to root out, as Japan found out since their bubbles burst in 1990. In fact, corporations are the largest hoarders of cash (some $2 trillion to date), so don’t expect much hiring from them.
Yet, it is really small businesses that provide 70 percent of new hires, so that is where we should look for jobs’ improvement. A good measure of small business is the National Federation of Business Optimism Index, which hasn’t yet risen above recession levels. But the jobs market is tightening, in line with U.S. overall improved employment.
“Reports of workforce reductions are at their lowest level since October 2007,” said the latest NFIB report. “Forty-one percent of owners hired or tried to hire in the past three months, but 31 percent reported few or no qualified applicants for the position(s). The increase in the percent of owners with hard to fill job openings indicates that job markets are tightening somewhere, and correctly anticipated a decline in the unemployment rate.”
So beware of the confidence fairies, says Nobelist Paul Krugman. If you believe in them, you will surely lose confidence in the very institutions that create economic growth.
Harlan Green © 2012