Deflation Worries in the Eurozone and Fisher's Debt Deflation Theory
Deflation Worries
Lino Sau
Department of Economics and Statistics
“S. Cognetti de Martiis”
University of Turin
(Italy)
Prepared for a seminar on Current Crisis, University of
Torino, March 11
th
, 2015 and for PKSG (Post Keynesian
Study Group), Robinson College, Cambridge (UK)
1
•
There has recently been a
marked increase in
concern about deflation
, particularly in the
euro zone
.
•
As even both the
Financial Times
and
The
Economist
recently (2013) put it:
the ghost of
deflation is in the euro zone
!
•
Relatively few people
alive today have
experienced deflation,
but for Europeans
that
may now be changing. Indeed,
prices are
falling and inflation remains stubbornly low
.
2
3
•
Eurostat index shows that inflation
dropped to 0.9%
for the euro zone as a whole since September 2013
.
That is way under the
European Central Bank
(ECB) target which is close to 2%
.
•
Over the past months the trend has intensified
.
France, Italy, Spain, Portugal, Greece, Cyprus,
Ireland, Slovakia, Slovenia, Estonia and Latvia
have all
seen price falls
, and already have
one foot
in deflation
.
•
Much the same
is happening in
Bulgaria
,
Romania,
Hungary and the Czech Republic
.
Poland is at
zero
.
Denmark
is close, and so
is Sweden.
4
•
As we know all too well, the phenomenon of
persistent
falling
prices across the economy
blighted the lives of millions of people in the
1930s.
•
In this connection
Irving Fisher
tried to explain
this macroeconomic malady in his well known
“
Debt Deflation theory of Great Depressions
”
(Econometrica, 1933), which may be considered
the seminal work for the development of the so-
called
debt deflation school
(Keynes, 1930;
Tobin, 1980, Minsky, 1982 et al.) in political
economy.
5
Fisher’s assumed that: “at some point of time, a state
of
over-indebtedness
exists, this will tend to lead
to
liquidation
. Then we may deduce the
following chain
of consequences
in
nine
links:
•
(1)
Debt liquidation
leads
to distress selling
and to
•
(2)
Contraction of deposit currency
, as bank loans are
paid off, and to a
slowing down of velocity of
circulation
.
This contraction
of deposits and of their
velocity,
precipitated by distress selling
,
causes
•
(3)
A fall in the level of prices
, in other words, a
swelling of the dollar
. Assuming, as above stated, that
this fall of prices
is not interfered
with by
reflation
or
otherwise
, there must be.
•
(4) A
still greater fall in the net worth of business
,
precipitating
bankruptcies
and
6
•
(5) A
fall in profits
, which in a "capitalistic," that is, a
private-profit
society, leads to a
fall in aggregate
investments
•
(6)
A reduction in output
, in
trade
and in
employment
of labour
. These
losses
,
bankruptcies
, and
unemployment
, lead to:
•
(7)
Pessimism and loss of confidence
, which in turn
lead to
•
(8)
Hoarding and slowing down
still more the
velocity
of circulation
. The above
eight changes
cause
•
(9)
Complicated disturbances
in the rates of interest, in
particular,
a fall in the nominal rates
and a
rise in the
real rates of interest
.
7
Over the years the theory of
debt deflation
considered above has come in for
criticism on
various fronts.
•
1
st
. Deflation process is indeed rare, and even of
little theoretical or practical relevance.
•
But!
it is worth noting that the
persistence
effects
considered above can also come about without a
simultaneous fall
in the level of consumption good
prices and capital goods;
all that is needed, in fact, is
for the deflation process to hit the
prices of real
and/or financial assets
– a case by no means rare or
isolated in the economic history (cf.
real-estate busts
in recent time (Arestis-Karakitsos, 2003; Sau, 2013).
8
•
2
nd
.
Mainstream economists
observed that a fall in the
general level of prices
can have reasonably limited
effects
since it brings about
a simple
redistribution
in
wealth from debtors to creditors
:
But!
At this regards
Tobin (1980)
demonstrated
if the
marginal propensity to spend on the part of the
debtors (consisting mainly of entrepreneurs and
households) is,
as might reasonably be expected,
greater
than that of the creditors
, the fall in prices
may prove far from stabilising.
Furthermore if the debtors go bankrupt
the creditors
find
themselves having to bear the heavy losses in
part through credit
recovery and also due to
the state
of widespread insolvency
.
9
Then on proceeding from static to dynamic analysis,
it immediately becomes crucial to consider
the role
of expectations vis-à-vis future prices
.
•
It is quite possible that the
original price decline
will
lead to the expectation of further declines
.
•
Purchasing decisions
will be postponed
,
aggregate
demand will fall off
, and the
amount of
unemployment increased
still more.
10
•
New approaches
inside the
debt-deflation school
have taken into account the
increasing complexity
and integration
in the financial systems during the
age of globalization due to the
adoption of the
neo-
liberal
paradigm by many emerging and developed
countries
.
-
In the US
, this paradigm
stemmed on late 70’s and
was followed and embraced by many European
countries during the 80’s and 90’s: laissez-faire
principle
in
financial globalization
and the
process
of
securitization.
11
These processes has driven
the US financial system
towards an overall financial fragility
: on the part of
lending institutions
,
households
and
purchasers of
mortgage-backed securities
up
to the crisis.
(i.e lenders provided
funds to borrowers, through
subprime mortgage contracts
, only due to
a belief that
the housing value would continue to increase, but this,
in turn, promote the increase i.e. self-fulfilling
prophecy)
→
By contrast
with Fisher’s approach,
exogenous vs.
endogenous
over indebtedness and assets (real-
estates) boom and busts
as main ingredients
of the
subsequent risk of debt deflation process in the USA.
12
- the
over-lending process
by institutional
MM
(money managers) investors
,
banks
and other
financial institutions
- the
over-borrowing
by
households and firms
-
even if the latter play a
passive role in the
process (because of financial constraints link
to the increase in income inequalities)
- since
the
process was driven
by an
excessive
supply
of available funds, through the over
mentioned
deregulation
and
financial
innovations.
13
14
•
As soon
as the payment obligations increased
at
a higher rate
than the expected future cash-flow
;
the
financial institutions in US
will be driven to
hold that the new
financial structure had
deteriorated too much
↓
they deemed the
increase
in
leverage
excessive
and then pushed
for a reversal in tendency
↓
•
The worsening of the “state of credit”
lead
to a
drop in employment
and in the production
financed with loans and a fall in the value of the
collaterals
(i.e. houses, equipments and financial
assets).
15
→ when the
bubble progressively burst
, the
progression analyzed previously
for the boom
and the “over lending”
phase
must now be
reversed
↓
progressively
lending standards was raised
by
financial institutions
causing households and
businesses
de-leveraging of their positions.
16
•
At this point as the credit available to the
private sectors
was rationed
or the conditions
on
which they could get access to credit
became more onerous (i.e. credit crunch)
↓
•
households
and
distressed
firms
were forced
to liquidate
their
financial assets,
or
even
sold (no
orderly financial markets
as assumed
in the EMH)
their
real estate
in order
to meet
their obligations
.
17
•
Furthermore
through the
effect on the
general price levels,
there were
further drops
in the
internal net worths (i.e. difference
between assets and liabilities)
of households
and firms
in real terms
.
•
Such a situation had the seeds by a Fisher’s
debt-deflation
spiral.
18
•
BUT!
in the USA the fall in the general level of
prices, in the aftermath of the crisis
, was
partly
avoided, thanks
to:
•
Huge quantitative easing (QE) policies by the
FED
•
and expansive fiscal policies (DEFICIT
SPENDING) by the Government
.
19
•
The Europeans were not completely
responsible
for
the crisis
, yet they have
become
its chief victims
.
•
The origin of the current European
crisis
indeed can be
directly traced back to the US
crisis
of 2007–2009 over depicted which
spilled over
into a
sovereign debt crisis
in
several
euro area
countries
in early 2010
.
•
The
prominent
role of the inter-bank market
caused a chain reaction
and
a contagion
within
the
area
.
20
21
•
In many of these countries,
government
bailouts of banking and financial systems
contributed
to an increase in public debt
.
•
Private debt became public debt
, be it
through
banking crises
or the
burst of
housing bubbles
, leading
to the sovereign
crisis
.
•
The latter
begin with Greece
,
but
suddenly spread over
some other
countries of the
euro zone
like
Portugal
,
Ireland
,
Italy
and
Spain
.
22
•
Between
2007 and 2010
,
the debt to GDP ratio
of the euro area increased from 66.3% to
85.4%
;
•
The most dramatic increase in
public debt occurred in
Ireland
where
the country’s debt problems
can be
clearly
ascribed to the country’s banking crisis.
On
2006
the
central government financial balances as a percent
of GDP was positive
and close to
2.9%
(see OECD
Economic Outlook 89 database tab. 27). The situation
changed in
the course of the Irish banking crisis (2008)
when the Irish government, under pressure from
European governments and institutions but also from the
US government,
guaranteed most liabilities
of Irish-
owned banks.
•
Indeed,
in Ireland on 2010
the
budget deficit as a
percent of GDP was close to -32.4%
.
23
•
Like Ireland,
Spain did not have a fiscal or debt
problem before 2008
. Again,
on 2006 the
financial balances as a percent of GDP was
positive
and
close to 2.0
%.
•
Spain’s situations changed
when the global financial crisis
put
an abrupt end
to a long cycle of high growth (which
started around 1996) that had been accompanied,
like in the
US
, by a
construction and real estate boom
. When
output
contracted in 2008
, the Spanish housing bubble burst and
destabilized the banking system.
•
On 2009 and 2010 the budget deficit in Spain
raise up to -11%
(see OECD Economic outlook 89
database, tab. 27).
24
•
According to the statistics by OECD economic
outlook
quoted above,
countries like Ireland,
Spain, Portugal and Italy (where the debt level
was above 100% of GDP
prior to the crisis,
but
unlike the Greece
the
debt to GDP
ratio
fell
between the adoption of the euro
in
1999
and
2007)
showed a high degree of fiscal
responsibility
in the
six years prior to the crisis
.
•
That is,
rather than the result of government
profligacy,
the
sovereign crisis in these countries
is the result of the latest phase of a crisis caused
by a flawed financial
and
economic model
.
25
•
If it is not enough,
Europe's policy regime is
inflicting ultra-austerity
and is
aggravating
the situation further
.
•
By
mistakenly blaming
the EU crisis on
profligate states
and
by imposing
a crash diet
of
fiscal cuts on many countries
, they have
made the problem of private debt and public
even worse
.
26
•
The
policy is self-defeating
in broader
economic terms. Indeed
when income is
declining
,
fiscal positions worsened
(
tax
revenues decrease
and
transfer payments
grew larger
due to
rising unemployment
during the crisis
).
•
But the central
contradiction
of
Europe's debt
crisis strategy is link to some sort of debt
deflation bias
.
27
That is
many countries are forced to cut
wages and prices for competitiveness reasons
→
this frustrates the other objective of
controlling the debt
since
deflation increase
the debt burden
, worsening the situation.
→That is:
they are damned if they do, and
damned if they don't
. Something like a
Scilla/Cariddi dilemma.
•
As Fisher (1933, p. 344) argued: “…t
hen we
have
the great paradox
which, I submit, is the
chief secret of most if not all,
great
depressions: The more the debtors pay, the
more they owe”
.
28
•
The risks
that deflation engenders are well known
.
•
First, by creating expectations that prices will be
lower
next year it gives
consumers
incentives to
postpone
purchases.
As a result
, aggregate demand declines
putting
further downward pressure on prices.
•
Second,
since private and public debts are fixed
nominally, declining prices increase the real burden of
the debt and the real interest rate.
(Put differently,
as prices decline government and private revenues
decline
while
the service of the debt remains unchanged
. This
forces the private and public sectors
to spend an increasing
proportion of revenues to
service the debt
, forcing them
to cut
back their spending on goods and services
.
This in turn increases
the intensity of the deflationary process
)
29
30
31
•
The
second effect, the debt-deflation dynamics,
is already working.
It is important
to stres
s that
this effect does not crucially depend on inflation
being negative
. It starts operating
when inflation
is lower than the rate of inflation that was
expected when debt contracts were made.
(
Thus,
during the last ten years inflation expectations
in the euro zone have
been very
close to 2%
. Current nominal interest rates
on long-term bonds
reflect the expectation that inflation will be 2% for the next five to ten years
.
However,
inflation
in the euro zone
has been declining
since early last year
and
now stands at 0.8%.
This debt-deflation dynamics, which are of the same
nature as those analyzed
by Irving Fisher.
The
nominal debt increases with
the nominal rate of interest (which includes a 2% inflation expectation), but
the nominal income in the euro zone increases by only 0.8%.
As a result, an
increasing proportion of these revenues
must
be spent on the service of the
debt)
.
32
•
Mario Draghi
recently
has declared that the ECB “
will do
whatever it takes to avoid a crisis of the euro
” and on
January 22
nd
he
has
promoted a QE plan
for Europeans
countries to
avoid deflation
.
•
Draghi’s plan
will inject nearly $60 billion
a month
into the
euro economy to prevent deflation
,
push down the euro
and
restore confidence
in the shared currency.
•
At first glance, it appears that
Draghi fired the proverbial
big bazooka
that will
blast Europe out
of its lethargy.
The
ECB’s quantitative easing
— the flooding of financial
institutions with money to promote increased lending and
liquidity —
is not without merit
. The
$1.5 trillion monetary
stimulus
program, which will be disbursed over the next
two years,
is bigger than anyone had imagined.
33
•
Unfortunately
this is a necessary
but
not sufficient
condition
to sort out the euro-zone from deflation
….
and
to avoid a Great Depression.
•
Part of the plan
is to
push down the value
of the euro,
thus making
European exports
more attractive abroad.
•
The initial reaction
was a surge in stock markets
across
the continent
and the further decline of the euro,
to
1.12
per U.S. dollar.
•
But investment
is the foremost goal, and
interest rates
are already
at an all-time low
. The problem
is that
businesses are not investing
because there
is a
pervasive fear
that
they won’t be able
to
pay back
their loans
,
regardless of the interest rate
.
34
Recent concerns about deflation in the eurozone have led to discussions about the potential impacts on the economy. This article explores the Eurostat index data showing a significant drop in inflation levels across several European countries. It also delves into Irving Fisher's Debt Deflation theory, which describes the chain of events that can occur when over-indebtedness leads to distress selling, price falls, and economic distress. The historical context of deflation and its potential implications are discussed in relation to the current economic situation.
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Deflation Worries Lino Sau Department of Economics and Statistics S. Cognetti de Martiis University of Turin (Italy) Prepared for a seminar on Current Crisis, University of Torino, March 11th, 2015 and for PKSG (Post Keynesian Study Group), Robinson College, Cambridge (UK) 1
There has recently been a marked increase in concern about deflation, particularly in the euro zone. As even both the Financial Times and The Economist recently (2013) put it: the ghost of deflation is in the euro zone! Relatively few people alive today have experienced deflation, but for Europeans that may now be changing. Indeed, prices are falling and inflation remains stubbornly low. 2
Eurostat index shows that inflation dropped to 0.9% for the euro zone as a whole since September 2013. That is way under the European Central Bank (ECB) target which is close to 2%. Over the past months the trend has intensified. France, Italy, Spain, Portugal, Greece, Cyprus, Ireland, Slovakia, Slovenia, Estonia and Latvia have all seen price falls, and already have one foot in deflation. Much the same is happening in Bulgaria, Romania, Hungary and the Czech Republic. Poland is at zero. Denmark is close, and so is Sweden. 4
As we know all too well, the phenomenon of persistent falling prices across the economy blighted the lives of millions of people in the 1930s. In this connection Irving Fisher tried to explain this macroeconomic malady in his well known Debt Deflation theory of Great Depressions (Econometrica, 1933), which may be considered the seminal work for the development of the so- called debt deflation school (Keynes, 1930; Tobin, 1980, Minsky, 1982 et al.) in political economy. 5
Fishers assumed that: at some point of time, a state of over-indebtedness exists, this will tend to lead to liquidation. Then we may deduce the following chain of consequences in nine links: (1) Debt liquidation leads to distress selling and to (2) Contraction of deposit currency, as bank loans are paid off, and to a slowing down of velocity of circulation. This contraction of deposits and of their velocity, precipitated by distress selling, causes (3) A fall in the level of prices, in other words, a swelling of the dollar. Assuming, as above stated, that this fall of prices is not interfered with by reflation or otherwise, there must be. (4) A still greater fall in the net worth of business, precipitating bankruptcies and 6
(5) A fall in profits, which in a "capitalistic," that is, a private-profit society, leads to a fall in aggregate investments (6) A reduction in output, in trade and in employment of labour. These losses, unemployment, lead to: (7) Pessimism and loss of confidence, which in turn lead to (8) Hoarding and slowing down still more the velocity of circulation. The above eight changes cause (9) Complicated disturbances in the rates of interest, in particular, a fall in the nominal rates and a rise in the real rates of interest. bankruptcies, and 7
Over the years the theory of debt deflation considered above has come in for criticism on various fronts. 1st. Deflation process is indeed rare, and even of little theoretical or practical relevance. But! it is worth noting that the persistence effects considered above can also come about without a simultaneous fall in the level of consumption good prices and capital goods; all that is needed, in fact, is for the deflation process to hit the prices of real and/or financial assets a case by no means rare or isolated in the economic history (cf. real-estate busts in recent time (Arestis-Karakitsos, 2003; Sau, 2013). 8
2nd. Mainstream economists observed that a fall in the general level of prices can have reasonably limited effects since it brings about a simple redistribution in wealth from debtors to creditors: But! At this regards Tobin (1980) demonstrated if the marginal propensity to spend on the part of the debtors (consisting mainly of entrepreneurs and households) is, as might reasonably be expected, greater than that of the creditors, the fall in prices may prove far from stabilising. Furthermore if the debtors go bankrupt the creditors find themselves having to bear the heavy losses in part through credit recovery and also due to the state of widespread insolvency. 9
Then on proceeding from static to dynamic analysis, it immediately becomes crucial to consider the role of expectations vis- -vis future prices. It is quite possible that the original price decline will lead to the expectation of further declines. Purchasing decisions will be postponed, aggregate demand will fall off, unemployment increased still more. and the amount of 10
New approaches inside the debt-deflation school have taken into account the increasing complexity and integration in the financial systems during the age of globalization due to the adoption of the neo- liberal paradigm by many emerging and developed countries. - In the US, this paradigm stemmed on late 70 s and was followed and embraced by many European countries during the 80 s and 90 s: laissez-faire principle in financial globalization and the process of securitization. 11
These processes has driven the US financial system towards an overall financial fragility: on the part of lending institutions, households and purchasers of mortgage-backed securities up to the crisis. (i.e lenders provided funds to borrowers, through subprime mortgage contracts, only due to a belief that the housing value would continue to increase, but this, in turn, promote the increase prophecy) i.e. self-fulfilling By contrast with Fisher s approach, exogenous vs. endogenous over indebtedness and assets estates) boom and busts as main ingredients of the subsequent risk of debt deflation process in the USA. (real- 12
- the over-lending process by institutional MM (money managers) investors, banks and other financial institutions - the over-borrowing by households and firms - even if the latter play a passive role in the process (because of financial constraints link to the increase in income inequalities) - since the process was driven by supply of available funds, through the over mentioned deregulation innovations. an excessive and financial 13
As soon as the payment obligations increased at a higher rate than the expected future cash-flow; the financial institutions in US will be driven to hold that the new financial structure had deteriorated too much they deemed the increase in leverage excessive and then pushed for a reversal in tendency The worsening of the state of credit lead to a drop in employment and in the production financed with loans and a fall in the value of the collaterals (i.e. houses, equipments and financial assets). 15
when the bubble progressively burst, the progression analyzed previously for the boom and the over lending phase must now be reversed progressively lending standards was raised by financial institutions causing households and businesses de-leveraging of their positions. 16
At this point as the credit available to the private sectors was rationed or the conditions on which they could get access to credit became more onerous (i.e. credit crunch) households and distressed firms were forced to liquidate their financial assets, or even sold (no orderly financial markets as assumed in the EMH) their real estate in order to meet their obligations. 17
Furthermore through the effect on the general price levels, there were further drops in the internal net worths (i.e. difference between assets and liabilities) of households and firms in real terms. Such a situation had the seeds by a Fisher s debt-deflation spiral. 18
BUT! in the USA the fall in the general level of prices, in the aftermath of the crisis, was partly avoided, thanks to: Huge quantitative easing (QE) policies by the FED and SPENDING) by the Government. expansive fiscal policies (DEFICIT 19
The responsible for the crisis, yet they have become its chief victims. Europeans were not completely The origin of the current European crisis indeed can be directly traced back to the US crisis of 2007 2009 over depicted which spilled over into a sovereign debt crisis in several euro area countries in early 2010. The prominent role of the inter-bank market caused a chain reaction and a contagion within the area. 20
In many of these countries, government bailouts of banking and financial systems contributed to an increase in public debt. Private debt became public debt, be it through banking crises or the burst of housing bubbles, leading to the sovereign crisis. The suddenly countries of the euro zone like Portugal, Ireland, Italy and Spain. latter begin spread with over Greece, some but other 22
Between 2007 and 2010, the debt to GDP ratio of the euro area increased from 66.3% to 85.4%; The most dramatic increase in public debt occurred in Ireland where the country s debt problems can be clearly ascribed to the country s banking crisis. On 2006 the central government financial balances as a percent of GDP was positive and close to 2.9% (see OECD Economic Outlook 89 database tab. 27). The situation changed in the course of the Irish banking crisis (2008) when the Irish government, under pressure from European governments and institutions but also from the US government, guaranteed most liabilities of Irish- owned banks. Indeed, in Ireland on 2010 the budget deficit as a percent of GDP was close to -32.4%. 23
Like Ireland, Spain did not have a fiscal or debt problem before 2008. Again, on 2006 the financial balances as a percent of GDP was positive and close to 2.0%. Spain s situations changed when the global financial crisis put an abrupt end to a long cycle of high growth (which started around 1996) that had been accompanied, like in the US, by a construction and real estate boom. When output contracted in 2008, the Spanish housing bubble burst and destabilized the banking system. On 2009 and 2010 the budget deficit in Spain raise up to -11% (see OECD Economic outlook 89 database, tab. 27). 24
According to the statistics by OECD economic outlook quoted above, Spain, Portugal and Italy (where the debt level was above 100% of GDP prior to the crisis, but unlike the Greece the debt to GDP ratio fell between the adoption of the euro in 1999 and 2007) showed a high responsibility in the six years prior to the crisis. That is, rather than the result of government profligacy, the sovereign crisis in these countries is the result of the latest phase of a crisis caused by a flawed financial and economic model. countries like Ireland, degree of fiscal 25
If it is not enough, Europe's policy regime is inflicting ultra-austerity and is aggravating the situation further. By mistakenly blaming the EU crisis on profligate states and by imposing a crash diet of fiscal cuts on many countries, they have made the problem of private debt and public even worse. 26
The economic terms. Indeed when income is declining, fiscal positions worsened (tax revenues decrease and transfer payments grew larger due to rising unemployment during the crisis). policy is self-defeating in broader But the central contradiction of Europe's debt crisis strategy is link to some sort of debt deflation bias. 27
That is many countries are forced to cut wages and prices for competitiveness reasons this frustrates the other objective of controlling the debt since deflation increase the debt burden, worsening the situation. That is: they are damned if they do, and damned if they don't. Scilla/Cariddi dilemma. Something like a As Fisher (1933, p. 344) argued: then we have the great paradox which, I submit, is the chief secret of most depressions: The more the debtors pay, the more they owe . 28 if not all, great
The risks that deflation engenders are well known. First, by creating expectations that prices will be lower next year it gives consumers incentives to postpone purchases. As a result, aggregate demand declines putting further downward pressure on prices. Second, since private and public debts are fixed nominally, declining prices increase the real burden of the debt and the real interest rate. (Put differently, as prices decline government and private revenues decline while the service of the debt remains unchanged. This forces the private and public sectors to spend an increasing proportion of revenues to service the debt, forcing them to cut back their spending on goods and services. This in turn increases the intensity of the deflationary process) 29
The second effect, the debt-deflation dynamics, is already working. It is important to stress that this effect does not crucially depend on inflation being negative. It starts operating when inflation is lower than the rate of inflation that was expected when debt contracts were made. (Thus, during the last ten years inflation expectations in the euro zone have been very close to 2%. Current nominal interest rates on long-term bonds reflect the expectation that inflation will be 2% for the next five to ten years. However, inflation in the euro zone has been declining since early last year and now stands at 0.8%. This debt-deflation dynamics, which are of the same nature as those analyzed by Irving Fisher. The nominal debt increases with the nominal rate of interest (which includes a 2% inflation expectation), but the nominal income in the euro zone increases by only 0.8%. As a result, an increasing proportion of these revenues must be spent on the service of the debt). 32
Mario Draghi recently has declared that the ECB will do whatever it takes to avoid a crisis of the euro and on January 22ndhe has promoted a QE plan for Europeans countries to avoid deflation. Draghi s plan will inject nearly $60 billion a month into the euro economy to prevent deflation, push down the euro and restore confidence in the shared currency. At first glance, it appears that Draghi fired the proverbial big bazooka that will blast Europe out of its lethargy. The ECB s quantitative easing the flooding of financial institutions with money to promote increased lending and liquidity is not without merit. The $1.5 trillion monetary stimulus program, which will be disbursed over the next two years, is bigger than anyone had imagined. 33
Unfortunately this is a necessary but not sufficient condition to sort out the euro-zone from deflation . andto avoid a Great Depression. Part of the plan is to push down the value of the euro, thus making European exports more attractive abroad. The initial reaction was a surge in stock markets across the continent and the further decline of the euro, to 1.12 per U.S. dollar. But investment is the foremost goal, and interest rates are already at an all-time low. The problem is that businesses are not investing because there is a pervasive fear that they won t be able to pay back their loans, regardless of the interest rate. 34
