Posted by: Dirk | June 25, 2009

Fighting deflation – the ECB at work?

This month’s ECB monthly bulletin discusses deflation and concludes (p.6):

Against this background, it is again important to stress that the indicators of inflation expectations over the medium to longer term remain firmly anchored in line with the Governing Council’s aim of keeping inflation rates below, but close to, 2% over the medium term.

The question is: how does the ECB stop deflation? In normal times, you would expect the ECB to lower the interest rate. But we are not in normal times, we are in the liquidity and also investment trap, so that today the interest rate is already quite low without investment going up. But if investment is not going up, how is monetary policy supposed to work? Where will the extra demand come from that results in more inflation? The global outlook is bleak, and unemployment in the eurozone is about to jump up after the first round of fiscal stimulus runs out during the summer. Also, banks will have to write off further capital losses later this year and the transmission is still not working, even though the ECB is really trying.

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