Today, Italian media published the news that prices in January were 0.6% lower than a year ago, calling such deflation a disease, a contagion. The fact that a component of deflation is the falling price of oil should be good news for an oil-importing country such as Italy. But no! National TV (RAI) insists that deflation is a nightmare, and other media wish for inflation to come back thanks to Draghi’s QE.
Some call deflation a national emergency and yet, they seem to have a hard time explaining why prices getting lower is such bad news. Indeed, it seems that they can’t explain it, at least not until they no longer confuse the symptom for the disease.
One explanation they give is that deflation means lower GDP at current prices, and this makes the Debt/GDP ratio look bad. This should speak for how foolish the Debt/GDP rule is, rather than be a real cause for concern. To me, bad news is any economic indicator that tells me something bad is happening to the real standard of living of people. Unemployment at 13.4%, and youth unemployment at 43.9%: Let’s talk about this nightmare (not to speak of Greece’s nightmare squared).
Another explanation is truly peculiar (but well known to economists who are familiar with the expectations hypothesis). In such a view, deflation is bad because consumers expecting falling prices postpone their spending and cause the current prolonged stagnation. Well, actually, if Italy’s deflation were caused only by falling oil prices, there would be reason to celebrate, and no reason why the ECB should want to take us back to 2%, except another foolish rule. If the VAT were cut by 50%, deflation would get even bigger, at least for a one-time adjustment. Yet, consumers would be much better off.
Deflation is a symptom
When domestic prices fall because imports like oil get cheaper, deflation is a (good) signal of better terms of trade. No nightmare, no contagion. Italy’s current deflation partly reflects this positive (to Italy) opportunity.
Current Italian deflation is a problem because it reflects the fact that wages are stagnant, and wages are stagnant because demand is stagnant, and demand is stagnant because private debt is not capable of funding investment, and public debt is prevented (by the Debt/GDP rule discussed above) from doing so.