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Real World Shows Economics Has a Deflation Problem

Mark Gilbert is a Bloomberg View columnist and writes editorials on economics, finance and politics. He was London bureau chief for Bloomberg News and is the author of “Complicit: How Greed and Collusion Made the Credit Crisis Unstoppable.”
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Jacob Rothschild, the billionaire scion of arguably Europe's greatest banking dynasty says we're living through "the greatest experiment in monetary policy in the history of the world." There's a major flaw in the experiment, though: the real world isn't responding to policy in the way that the textbooks say it should. Moreover, it seems increasingly evident that the fears that led to zero interest rates and quantitative easing were at best overblown, if not entirely unjustified.

The economic quandary is easy to parse. Central banks almost everywhere have sanctioned a 2 percent inflation target as signifying financial Nirvana. But, as the table below shows, consumer prices in the world's major economies are rising much slower than that arbitrary ideal:

Spain has emerged as the poster child for deflation. Prices fell by 0.6 percent in July, the country's 12th consecutive month with no increase in inflation. The textbooks suggest that when there's a prolonged period of falling prices -- the definition of deflation -- the economy can quickly find itself in a tailspin. Businesses and consumers will defer purchases in the expectation that goods and services will be even cheaper in the future.

So if Spain has had an average inflation rate of -0.4 percent since the end of 2013, and has seen lower prices in 23 of the past 30 months, consumers will have responded by shunning the shops and curtailing their spending, right? Wrong:

The average annual gain in Spanish retail sales in the past three years is 1.7 percent. Spending climbed by 5.8 percent in June, even as prices were dropping by 0.8 percent. So the prospect of cheaper goods in the future doesn't seem to be inhibiting Spaniards from indulging in a little (or quite a lot of) retail therapy.

So is there something else going on in the Spanish economy that might explain this cavalier attitude to falling prices? (Apart, I mean, from what might seem to be an obvious truth -- well, obvious to non-economists -- that most people welcome lower prices as an opportunity to buy more stuff.)

Well, one big success has been a drop in the unemployment rate. While June's 19.9 percent jobless figure is still horrendously high, it's dropped steadily from a peak of more than 26 percent at the start of 2013:

And if you compare that drop in Spanish unemployment with the Organization for Economic Cooperation and Development's measure of domestic consumption, an interesting trend is apparent:

Moving from the specific to the general is always risky. What's happening in Spain's economy may be particular to its singular circumstances, and may not be applicable to a different country. But the economic evidence in Spain makes you wonder whether concern about deflation -- and the unprecedented global scramble to avoid that price phenomenon -- will turn out to have been much ado about not much.

This column does not necessarily reflect the opinion of the editorial board or Bloomberg LP and its owners.

To contact the author of this story:
Mark Gilbert at magilbert@bloomberg.net

To contact the editor responsible for this story:
James Greiff at jgreiff@bloomberg.net