Austerity is not working in the EU........the fear is deflation.
I.M.F. Warns of ‘Sizable Risk’ of Deflation in Euro Zone
By JACK EWING
Published: July 18, 2012
FRANKFURT — The International Monetary Fund, warning of “a sizable risk” that some euro zone countries could suffer a debilitating decline in prices, called on Wednesday for the European Central Bank to pump money into the region’s economy by buying huge volumes of government bonds.
Such bond buying, which the Federal Reserve has undertaken in recent years to stimulate the United States economy, is a move the central bank has resisted, one that would probably outrage the fiscal disciplinarians of Germany.
And it is unclear whether the I.M.F.’s public push for big spending by the central bank will make it more or less likely for the bank’s president, Mario Draghi, to act. He, like any central banker, wants to appear immune to outside pressure.
But the I.M.F. is well respected, and its warning of deflation, a destructive plunge in prices, could help give the central bank the economic rationale to use the stimulus of buying billions of euros in government bonds.
In a report critical of euro zone policy, the I.M.F. said that there was a 25 percent risk of consumer price deflation before 2014 and that the danger was greatest in countries, like Italy, where growth was slow and the government was counting on tax increases to reduce its huge debt.
“A deeper euro area crisis would have substantial global implications,” the I.M.F. said in its report, which also warned of other possible shocks to the euro currency bloc, including the failure of a big bank.
The central bank did not comment on the fund’s report.
Deflation is typically a feature of severe economic decline and soaring joblessness that far outweighs any benefit to consumers from falling prices. A downward price spiral would make it harder for countries like Greece, Italy and Spain to control government debt, the fund said, because falling prices and wages would further depress tax receipts.
Prime Minister Mario Monti of Italy has been a leading proponent of government bond buying by the central bank. Spanish leaders have been pleading with the bank to buy their bonds and hold down borrowing costs.
The central bank has spent 212 billion euros, or $260 billion, at the current exchange rate, buying government bonds since 2010, but has resisted calls for it to mimic the much larger purchases by the Federal Reserve and the Bank of England.
Since the financial crisis of 2008, the Fed has made two rounds of purchases, totaling hundreds of billions of dollars. Many economists say this quantitative easing is a reason the United States economy recovered from the crisis faster than most of its European counterparts.
Richard Barwell, an economist at the Royal Bank of Scotland, doubted that the central bank would follow the monetary fund’s advice without evidence of deflation throughout the euro zone. “I think they would view it as being counterproductive,” he said. “It would be alleviating all pressure on policy makers to solve the underlying cause of the problem.”
But fund officials framed their call for big bond purchases as a way for the central bank to maintain its control over interest rates and contain borrowing costs for troubled countries.
“It is an essential part of the E.C.B. fulfilling its mandate,” Helge Berger, an adviser in the fund’s European department, said during a conference call Wednesday with reporters.
Quantitative easing is how central banks stimulate the economy when they have already pushed interest rates as low as they can go. This month, the central bank cut its benchmark interest rate below 1 percent for the first time, to 0.75 percent. But quantitative easing is opposed by Germany, the biggest contributor to the bank, because it would amount to the use of the central bank to finance governments. And German sentiment carries weight with the bank, which is reluctant to further divide the euro zone.
Mr. Draghi has given no clear signals that the bank is seriously considering quantitative easing or other measures. But on Tuesday, at a meeting here with Michael Noonan, the Irish finance minister, Mr. Draghi tentatively addressed a widespread concern that central bank bond buying hurts more than it helps. For instance, it could make the central bank a senior creditor over other bond buyers, who would then be at greater risk if a government defaulted on its bonds.
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