Deflationary ghost emerges from corona crisis

The ‘deflationary ghost‘ is back, for the first time in more than four years. This means that prices are not rising but falling. One possible consequence is that people are postponing spending, because products may be even cheaper later on. And that in turn leads to less demand and even lower prices.

As a result of the corona crisis, products in the EU have become cheaper and the cost of living has also fallen (in August minus 0.2 percent). In July prices were still rising (plus 0.4 percent).

On a broad front, the prices of products and services went down in August, as a result of the corona crisis and the lockdown.

Deflation is strongest in Cyprus (minus 2.9 percent), Greece (minus 2.1 percent), Estonia and Ireland (minus 1.2 percent). Belgium stood at minus 0.9 and Germany at minus 0.1 percent in August. Prices rose slightly in the Netherlands (plus 0.3 percent) and in France (plus 0.2 percent).

The inflation rate is often skewed by volatile energy prices, alcohol and tobacco taxes and seasonal fresh food prices. In August, for example, energy prices were 7.8 percent lower than last year. For a better and more balanced inflation picture, these price categories are removed from the inflation rate. What remains is called core inflation. The ‘cleaned’ core inflation rate for August is 0.4 percent.

Swamp

Negative inflation or deflation is a kind of ghost scenario. It is considered a swamp for the economy. In a healthy economy, prices move with supply and demand, a lot of demand and too little supply push prices up, too little demand and a lot of supply push prices down.

The fear is that if prices fall and the fridge or shoes are cheaper tomorrow than today, spending will be postponed. Demand will fall even more, while there are enough fridges and shoes and the price will drop further. For some consumer goods and services, this downward purchasing price spiral may start, but not or at most temporarily for indispensable and necessary products and services.

With its monetary policy, the European Central Bank aims at a euro zone inflation close to 2% as the most desirable price level. However, inflation has been well below that level for years, despite successive interest rate cuts. Low inflation and low interest rates seem the new normal.