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Economic Deflation in the Euro Zone Report


Introduction

Between 2009 and 2011, the entire world experienced a global recession that decreased the purchasing power of most people. The trend mostly affected the US; an idea borrowed from the initial crisis experienced in Europe. Notably, the number of people who spent on luxurious goods and services was minimal.

Most statisticians establish that the cause of the great recession, which the society felt a little later in 2008 was because many banks issued loans to clients enabling them to flood the real estate business. Mortgages became affordable in East Asia, the US, and the Euro zone. Most investors constructed houses whose occupants they are less likely to establish even today.

When the world overcame the global financial crisis (GFC) in 2011, most banks including the European Central Bank (ECB) decided to lower its loan interests in order to accommodate the rising needs of borrowers within the euro zone (Ferrero 2014). In turn, the bank that largely depends on taxation, lending, and borrowing fails to achieve its objective in the society.

The paper intends to explain how reduction in the prices of goods and services after the GFC is likely to cause a major deflation, and efforts underway to avoid the trend at the microeconomic and macroeconomic level.

Deflation

Economists equate deflation to a period in which the demand for goods and services grows because of a decrease in prices. They associate deflation with a falling aggregate demand (AD) and an increase in the aggregate supply (AS) (Gnos and Rochon 2011, p. 103). It results in an increase in the potential GDP over the actual GDP of a country.

It means that a market experiencing high rates of deflation have high supply of commodities, which emanates from an increase in the purchasing power because of decreased prices. The following illustrations explain how a decrease in the prices of goods and services influences the purchase decisions, which results in an increase in supply.

Causes of deflation are assumptions made by different economists because it occurs differently across diverse regions. Two possible causes are a fall in aggregate demand and an increase in aggregate supply (The autumn statement: ‘Tis not the season 2014). The illustration summarises the fact that when manufacturers increase the production of different products and services, they should match the same with consumer demand.

At the microeconomic level, consumers find economic stimulus in price, place, product, and promotion (Jones 2014). The four elements of marketing are very important in determining consumer decision, but the price strategy is an obvious catch when marketers seek to increase the demand levels. After the 2008 to 2011 GFC, manufacturers believed that increasing the supply of products and services would increase the demand.

Breaking such economic rules might cause the European Central Bank a great deflation. Most European countries are capable of borrowing from the central bank with an almost negative interest rate, in order to increase the number of people interested in national bonds and other credit facilities for the development of the Euro zone.

This followed decrease in demand for credit facilities after the GFC. The intention was to reduce loan acquisition austerity implemented by most governments after the GFC (Burda and Wyplosz 2013, p. 19). Deflation is not only a problem of the European Central Bank (ECB), but for various manufacturers. In a normal price sensitive market, customers will always wait for a period in which the prices are very low.

Delays in purchases reduce the value of the products in the market. When ECB decided to increase credit finance for the people of Europe, it meant that the euro zone would later subject itself to debt increment. The euro zone has many debt problems within the private sector and the government (Mayes and Viren 2004, p. 17).

Through bureaucratic principles, the euro zone survives the bouts of the deflation even though fears continue to increase over the economic stability of the region in the next few decades.

Economic Deflation in the Euro Zone

A decrease in aggregate demand and an increase in aggregate supply are results of both benign and malign deflation. The 2008 increase in interest rates and prices of commodities was evident because of the increased intake of loans in 2001 and 2007. Benign deflation occurred between 2001 and 2007 determined by a higher supply or productivity and a low demand for loans (Langdana 2009, p. 95).

Such levels of excess result in an increase in production capacity that exceeds the demand, and it causes a financial slump. In 2008, the demand for credit facility acquisition reduced because of the increase in the rate of interest on various loans. The IMF (International Monetary Fund) and the World Bank among other fiscal, but non-profit oriented institutions played limited role in reducing the risks associated with the deflation rates.

The real estate bubble, low consumption power, and high productivity rates created an environment of confusion since the supply extremely exceeded the demand. Benign deflation signified most parts of the 19thcentury especially in relation to the GFC of the 1930s (Basci, Togan, and Hagen 2007, p. 144). A repeat was obvious in 2008 when the world was in the process of experiencing another GFC. Malign deflation occurred past the 19th century, and most European countries experience the effects of the economic concern.

Arguably, there is no demand for the manufactured products and services. Manufacturers and credit firms are very many and the competition is very stiff. Much concern is on the value and the security of a product or a bank offering the loan instead of the interest rates or the product quality. Malign deflation mostly results in organisational layoffs in order for companies to pay the employees.

The exchequer also suffers because it has to collect taxes from the taxpayers who do not display the willingness to pay taxes. The negative multiplier scenario becomes evident because the country or the entire euro zone lacks a platform for increase in income, but has to spend on paying workers and outsourcing in order to increase supply of products and services (December 2014 euro system staff macroeconomic projections for the euro area 2014, p. 5). In essence, the productivity levels of countries increase, but there is no demand for the finished products and services. In return, the society fails to account for the needs of employees across diverse industries.

Euro zone’s below target inflation

While the US had the Federal Reserve respond to its GFC, the euro zone had to seek the intervention of the ECB. Between 2009 and 2010, Europe experienced the worst case of inflation that made the population refrain from home or business ownership. The FOMC Federal Open Market Committee began creating an appealing environment for mortgage acquisition by august 2010, and the ECB had to create an assurance for the security of investment in most banks within the euro zone.

Characterised by the benign deflation, most credit facility acquirers relied on security and value. Price sensitivity became an issue mostly sought after by the societal minorities. In the US, the Federal Reserve (FDR) took a bold step in making credit facilities attractive to the populace between August and December in 2010 (Mankiw 2007, p. 112).

Like a security bond or an initial public offer, the FOMC created an opportunity for LSAP (Large Scale Asset Purchases) within the euro zone. The intention was to create an environment of economic stability or stimulus in order to encourage an increase in credit acquisition within the euro zone. In the US, the Federal Reserve ensured that by the end of the year 2010, it recovered fiscal investments while empowering the public to continue accessing credit facilities for mortgage acquisition.

Many questions arise concerning euro zone’s preparation for low inflation by following in the footsteps of the FDR. According to the EIB (European Investment Bank), the euro faces the risk of depreciation. Arguably, the euro zone is in the process of transforming into a new Japan. Before the GFC in 2008, the region’s economy was 2% less than its current state, and the same seems to be the trend to date (Bentley 2008, p. 31).

EIB mentions that the euro continues to weaken, while the Southern states continue to gain prowess for their efforts geared at stabilising the troubled economies. For instance, in Germany, industrial production reduced immensely one year after the euro zone experienced the GFC.

The following graph illustrates the way recession affected the euro zone between August and December 2009.

The way recession affected the euro zone

From the graph, the month of August 2009 presented a period in which many countries within the euro zone faced deflation. In most cases, supply increased while the purchasing power decreased. The reason was that few people took interest in loan acquisition in order to get mortgage or real estate services in an already flooded market.

Germany is yet to recover with a steady rising GDP of about 0.2% annually. Russia, Belgium, France, and Britain are in the process of increasing consumption power by producing quality and security driven products and services instead of concentrating on the price strategy.

Russia, Greece, and Turkey experienced conflicts with the IMF as they had to respond to fiscal sanctions put in place after the countries became incapable of repaying their debts (Fertekligil 2001, p. 49).

Euro zone’s concerns and risks associated with the deflation

The 2009 global credit crunch resulted in an increase in the cost of energy and basic commodities. Consumers refrained from increased purchases and loan acquisition in order to spend on basic commodities. Houses became very expensive because real estate businesses owners who initially gained from the deflation in 2008 increased the prices of houses in order to earn high profit margins.

The rationale was also to repay the increased loan interest rates, which they would raise from the houses. Even though the ECB reduced the loan interest rates in 2011 in order to attract consumers into loan acquisition, few people displayed interest in loans. Most businesses used capitalist means to set prices for their commodities instead of depending on government controls or other avenues of consumer watch.

Banks also resisted loans from the ECB, and in 2009, they only acquired only 0.19% of the offer. Out of the 42 billion Euros offered by the ECB, only 82 million Euros facilitated banks in the euro zone. Other associated risks include improvement of other continents, both household and national debt increase, and reduced expenditure (Minerd 2014). The central bank and domestic banks face the risk of losing clients to microfinance institutions that offer less secured, but prompt loans (Wolfson 2014)

Mitigation measures

The euro zone strived to find long term solutions to the problem of inflation by reducing the cost of product and service acquisition. It resulted in an increase in supply based on low costs of production, and decrease in demand. Most economics sceptics feel that the reduction in interest rates might be a risky step for the euro zone.

The ECB governing council should be completely in support of the process, but few members feel that the deflation awaiting the region will be irreconcilable in the future. Besides reduction in loan interest rates, the ECB promoted the bond worth 10.5 billion Euros, whose response remains low.

Initially, the inflation rate within the region was 0.2%, but today it is 0.4% meaning that the euro zone has to continue increasing interest in ECB credit facilities. With a low inflation rate displayed by a 2% annual decrease, chances are that the euro zone could end up with the greatest rate of deflation in the world history (Mankiw 2007, p. 128).

In France, the central bank decided to issue out a 10-year bond period with an annual 2% reduction in inflation rate since 2006. By 2010, the euro dropped to $1.2437 affecting parts of Portugal, Spain, Scotland, Ireland, and Austria. ECB critics mention that the euro zone should strive at reflating the economy in order to reclaim the rightful fiscal position of the region in the world.

Other mitigation measures include the introduction of prolonged loan repayment periods in order make loan repayment manageable for most credit facility acquirers. Continued efforts geared at increasing cash flow within the euro one create losses for the ECB (Herman n.d., p. 92). The effects of the malign inflation increase the rates of unemployment because the excessively low consumer demand translates into low rate of tax collection. On the other hand, the government has to fulfil the needs of the growing labour market while the rate of unemployment increases.

Macroeconomic variables

Macroeconomics represents fiscal discussions involving an entire country. It encompasses the makeup of microeconomic debates resulting from household expenditure and its effects on the national expenditure. Variables at the macroeconomic level include economic input and economic output.

The euro zone assesses such measure within the private and the public sector with much emphasis on the economic equilibrium, economic sustainability, and rates of employment.

Economic Output

Experts always measures economic output based on the amount that the society effectively contributes towards the growth of the Gross Domestic Product (Gertler and Rogoff, 2004, p. 13). By 2010, the amount of imports exceeded imports in Scotland, and it meant that the UK GDP slightly reduced by about 1.8% from 2008 to 2009. The measure of economic output results from the rate of unemployment, inflation rate, and interest rates among other factors.

Unemployment rates

The rate of unemployment in the UK is twice the rate of unemployment in the US today. About 16% of the entire employable population lacks the capability to work in an initially unemployed environment. Unemployment refers to the ratio of the population that has stable job opportunities over the population that lacks placement in a stable institution in which they earn income (Banerjee, Marcellino, and Masten 2005, p. 31).

Through employment, people pay taxes, which earn the government revenue through the UK revenue authority. The UK over the past decade strives at creating an environment of a zero unemployment rate, which is extremely difficult to achieve if not impossible. The International Labour Law (ILO) uses the claimant count to measure the rate of employment and unemployment in the UK.

According to the claimant count measure, only counts the potential population of workers who have requisite qualifications, but lack placement in the proper job positions (Armstrong, Caselli, Chadha, and Haan 2014). It also establishes the rate of unemployment based on the population of workers who are seriously looking for employment and the benefits that accompany such positions without success. Self-employed people who do not earn social security benefits do not qualify for the unemployed in the UK, because they have sources of income from the private sector.

The following graph explains the rate of unemployment in the UK from the 1980s to 2001, which market the beginning of the global benign deflation. The rate of unemployment increased when the purchase power of the UK residents reduced in 2009. The society made little contributions through taxations, which reduced the rate of human resource acquisition and retention within the public sector.

The rate of unemployment in the UK 1989 to 2001

As many people lack jobs, they do not contribute towards the economic development through tax contribution. In addition, the self-employed individuals in the private sector only get enough resources to fulfil basic needs. Most of them operate in non-regulated industries based on freelance engagement meaning that the government cannot ensure tax compliance.

Without tax contribution or a society defined by tax evasion faces the risk of economic underdevelopment. It happens because the exchequer lacks enough resources to pay employees in the public sector (Ller 2013, p. 47).

Recession and interest rates

Consumer indices determine the level of inflation in different countries. In the UK, the society determines an increase in inflation rates when the consumer index reduces. It means that the people cannot afford basic commodities because of an obvious increase in the prices. When the retail price index (RPI) increases, it means that the rate of inflation is equally on the increase (Minerd 2014, p. 2).

Most statisticians use the existing interest rates to determine the level of inflation in the banking sector. Today, for a country within the UK to acquire credit facilities, it should follow the due procedures set by the central bank. When the interest rates in the central bank increased, most banks feared getting loans, and business people equally feared seeking similar services from the local banking institutions.

When the trend continues, the UK begins worrying about its macroeconomic position. High interest rates mean that the euro weakens against the dollar and investors are likely to shift gear towards continents that perform well. Nobody would face a high risk of credit acquisition in a bank or country with very high interest rates.

When interest rates increased in 2009, most people in the UK shifted towards sustenance of their businesses instead of acquisition of homes, luxuries, and mortgage facilities (Main Macroeconomic Indicators n.d.). The UK reduced the interest rates in order to avoid the real estate bubble that affected the euro zone and the US after the GFC. The UK believes in the creation of a stable macroeconomic environment by maintaining stable prices of commodities even in the face of a GFC, but the mitigation plan remains unachievable (Bentley 2008, p. 34).

When inflation occurs, the cost of production increases, and only the companies dealing in consumables have the assurance of making profits. Non consumable products especially in the luxury sector face the risk of immobility in an inflated market. Concerns include the possibility of a global deflation already signified by a reduction in the aggregate demand for goods and services.

The price strategy remains very relevant in the determination of quality assurance for goods and services in the market. When consumers fail to create a link between product benefits and prices then the purchasing power automatically reduces.

Economic input

Economic input signified by what the exchequer and the banks do to avoid inflation remains very important in microeconomics discussions. The variables under investigation include the economic equilibrium, equality, and fiscal sustainability.

Economic sustainability

The UK measures economic sustainability through its actual and potential GDP. The actual GDP represents that the real measure of economic growth annually after eliminating the aspects of recession that affected the potential GDP (Akers 2014). A steady growth in the GDP signified by the 2% growth rate of the UK for the past 8 years means that the region has the potential of creating a sustainable employment environment.

In 2009, the growth rate was reverse as the economy of the UK indicated a 0.2% growth rate, which resulted in low rates of full employment. Underemployment became a concern as most companies lay off workers in order to cater for the needs of a section of employees. In 2011, the economic stimulus process adopted and the labour law adopted by the employers in the UK resulted in the absorption of many unemployed people.

Equality and equilibrium

The UK has a huge number of immigrants, but it still strives at creating an environment in which its citizens are capable of enjoying the resources without any form of discrimination. In order to provide an excellent environment of growth while still sustaining its Foreign Direct Investment, the UK has to imitate Japan.

Currently, Japan leads in the production of surplus commodities even when the demand dies not match the supply (Fall in euro zone inflation rate fuels deflation concerns 2014). At the macroeconomic level, surplus production attracts interest from investors and foreigners who are likely to acquire the affordable products and services (Objectives of government macroeconomic policy 2014, p. 2).

When FDI fails to solve the problem of recession in a country, high probabilities include the possibility of countries running into financial deficits as indicated in the graph.

UK trade balance

The graph gives credit to Japan that has a sustainable growth rate in the GDP enabling many people to get equal employment opportunities even in the face of a GFC. Establishment of a state of equilibrium remains a high priority for most countries including the UK. The UK displays interest in creating demand for the supplied products and services contrary to initial marketing strategies in which the supply responded to the prevailing demand.

The World Trade Organisation (WTO) qualifies a steady economic growth and the market equilibrium as elements of macroeconomic growth (Riley 2012, p. 4). The WTO mentions that competition between countries creates an environment of sanity because countries have to understand that consumer satisfaction at the microeconomic level has a direct impact on growth at the macroeconomic level.

As such, competition between Japan and the UK should continue until the UK is capable of surplus production. Maintenance of equilibrium between demand and supply is the only solution to inflation because the RPI will also reduce automatically. In summary, at the macroeconomic level, countries have to assess the economic outputs and inputs that are relative depending on the type of market involved in the discussion.

Most countries within the euro zone have relatively close GDPs except for the few facing financial sanctions by the IMF. At the macroeconomic level, politics, technology, and socio-environmental factors have a direct impact on the economics of a country (Wickens 2011, p. 36).

Conclusion

The GFC affected different parts of the world; the responses towards the economic crisis were different. The euro zone might face a worst economic deflation in an attempt to lower the risks of the 2008 recession. The mitigation measures adopted by the euro zone are short term, but the most appropriate for the season.

However, the changing economic environment that calls for increase FDI efforts makes it impossible to have unique ways of dealing with global financial crises that affect everyone in the world.

References

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