Paul Krugman: Depressing Draghi


 

A correspondent directs me, despairingly, to the last part of Mario Draghi’s latest press conference — and the correspondent is right, it does give cause for despair. Draghi is, after all, as smart and flexible an ECB president as we’re likely to get for a long time; quite possibly ever, because the euro might not last. Yet what he has to say about inflation manages to be wrong on multiple levels, and this kind of thing has to be damaging to ECB policy.

So, the remarks: a questioner, presumably from Spain, asks:

I am from a country that has an unemployment rate of 27%, which is a number of a great depression, a fiscal policy that is contractionary and a monetary policy in Spain and also in other countries that is also contractionary because credit is not available to small and medium-sized companies. Are you telling the Spanish, Portuguese, Irish or even Italian people that the ECB can’t do anything else with inflation actually lower than 2%?

Draghi’s reply:

Well, I am not sure I get the point, but I think I get it. First, the fact that inflation is low is not, by itself, bad; with low inflation, you can buy more stuff. Second, we don’t see deflation and that is what we have to fear. We don’t see that yet.

He then goes on to defend austerity policies, making several other bad arguments in the process. But let’s just do this part.

First, “with low inflation, you can buy more stuff”???? Don’t we teach students in Econ 101 exactly why that’s a naive fallacy, that lower inflation also means lower growth in earnings, and that the cost of inflation has nothing to do with reduced purchasing power?

OK, but while that’s upsetting, what matters for policy is Draghi’s statement that “we don’t see deflation and that is what we have to fear.” Wow. Maybe not in Econ 101, but I thought every professional economist understood that there isn’t a red line at zero inflation, so that low inflation becomes a potential problem if and only if it crosses zero.

Look, there are two reasons to believe that inflation in advanced economies in general, and in Europe especially, is too low, and that excessively low inflation is doing harm.

The first is that we’re suffering from inadequate demand, and the zero lower bound on interest rates is an important constraint on monetary policy. Larry Ball estimates that U.S. unemployment rates in recent years would have been, on average, 2 percentage points lower if we had entered the financial crisis with 4 percent rather than 2 percent inflation. Europe has the same problem, exacerbated by the lack of fiscal integration, which has caused it to adopt overall a much tighter fiscal policy than the United States.

This isn’t a new argument, nor is it way out there; it’s been made by many people, including the chief economist of the IMF. Yet Draghi talks as if low inflation is no problem, that only deflation is an issue.

But we’re not done. The other inflation-related issue is downward nominal wage rigidity, and to some extent downward nominal price rigidity. You might think that these are issues only if we have actual deflation; but because relative prices and wages are changing all the time, the truth is that this downward rigidity starts to become a problem in a depressed economy even at low positive rates of inflation; it’s quite clear in the United States. And in the euro area, where debtor countries are expected to achieve huge “internal devaluations”, it’s a much bigger issue.

Now, I find it hard to believe that Draghi is unaware of these issues; maybe he’s just playing to the inflation hawks on his board. But even so, the fact that at this late date, with Europe very much in what amounts to a depression, the old fallacies are still being trotted out is very, well, depressing.

Depressing Draghi – NYTimes.com

This entry was posted in ECB, HomeWork, Mario Draghi, Paul Krugman. Bookmark the permalink.

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