October 31, 2020

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Deflationary spirit arises due to the corona crisis

Deflationary spirit arises due to the corona crisis

The “deflationary spirit” is back for the first time in over four years. This means that prices do not rise but fall. One possible consequence is that people postpone spending because products can be even cheaper later. And that in turn leads to less demand and even lower prices.

The corona crisis has made products cheaper in the EU and the cost of living has also fallen (minus 0.2 percent in August). Prices rose in July (plus 0.4 percent).

Across the board, prices for products and services fell in August as a result of the corona crisis and lockdown.

Deflation is greatest in Cyprus (minus 2.9 percent), Greece (minus 2.1 percent), Estonia and Ireland (minus 1.2 percent). Belgium was down 0.9 percent and Germany was down 0.1 percent in August. In the Netherlands the prices rose slightly (plus 0.3 percent) and in France plus 0.2 percent.

The rate of inflation is often skewed by volatile energy prices, alcohol and tobacco taxes, and seasonal fresh food prices. Energy prices in August were 7.8 percent below the previous year’s figure. For a better and more balanced inflation picture, these price categories are then taken from the inflation figure. What is left is called core inflation. “Adjusted” core inflation for August is 0.4 percent.

swamp

Negative inflation or deflation is kind of a ghost. It is considered a swamp for the economy. In a healthy economy, prices move with supply and demand, high demand and insufficient supply, while too little demand and supply push prices down.

The fear is that if prices fall and the fridge or shoes are cheaper tomorrow than they are today, spending will be postponed. Demand then drops even more while there are enough refrigerators and shoes and the price continues to drop. For some goods and services for consumers, this downward spiral in purchase prices can continue, but not or at most temporarily for essential and necessary products and services.

With its monetary policy, the European Central Bank is aiming for inflation in the eurozone of almost 2 percent as the most desirable price level. However, despite successive interest rate cuts, inflation has been well below this for years. Low inflation and low interest rates seem to be the new normal.