Prices in October are 0,3% lower compared to a year earlier, according to figures from the European statistical office (Eurostat). This makes October the third consecutive month of negative inflation. That minus creates heated discussions in the financial world.
The fact that we can just have to deal with falling prices terrifies many economists and almost all central bankers. Consumers postpone purchases, with the result that after a few months everything becomes even cheaper. At the same time, the same consumer is also an employee and with falling prices and declining demand, companies see turnover and profits fall. Sooner or later there will be layoffs, unemployment will rise and there will be more competition in the labor market. This means that wage increases level off and wages can even fall. The end result: low growth, recession and mass unemployment.
Japan is often cited as an example. The problem is that Japan has no mass unemployment, the unemployment rate is just over 2%. Consumption has also increased in the country, despite very low inflation or deflation in recent decades.
History lesson
However, economic history teaches us something quite different about deflation. Prices fell during the half of the Golden Age. In the more than 3 decades after the Industrial Revolution, around 1880, prices fell sharply as a result of technological progress and globalization. This structural deflation led to an enormous increase in prosperity, according to figures from the International Monetary Fund. This history proves that deflation is undesirable only if it is caused by a slump in demand for goods and services. If deflation occurs because supply exceeds demand, it is not only a logical consequence from an economic point of view (the law of supply and demand), but also increases prosperity.
Fear of inflation
In 2020, central bankers are terrified of deflation and no measure is shunned to prevent prices from falling. This is partly because for many economists economic history was not exactly a frequent subject during their studies. Modern economics faculties would much rather have economic models that are less able to predict the future than a blind fortune teller looking at the tarot cards.
Central bankers usually know the history. And yet they are more willing to cut out the market forces, buy whatever is loose, and print unlimited money, than allow prices to fall. The reason for this is apparent from a recent publication, by the International Institute of Finance, entitled 'Attack of the debt tsunami'. Total global debt is about $277.000 billion, or $40.000 per person. This debt burden is the result of the economic thinking of the past 50 years. The desire to keep the economy growing required ever-increasing debt. As a result, the most logical economic scenario, deflation, must be avoided at all costs. In fact, maintaining the debt-driven economic model requires high inflation, even if it is disastrous for real prosperity and social stability.
Low interest rates remain
In practice, this means that we have to take into account official interest rates of 0 percent in the eurozone and the US until at least 2024. It also means that long-term interest rates will remain low for the time being, because the central banks with every conceivable – and unlimited – means want to keep. There is one but: the influence of the central banks on long-term interest rates is large, but not 1% and not forever. In other words: think twice before you write off the fixed interest rate as an option for a loan. The longer the term, the more that option deserves serious consideration.