The European Central Bank Worries As The Euro Area Suffers From Stagflation

by Stephan Smith on October 12, 2014

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Stagflation seems to be afflicting the Euro Area. The President of the European Central Bank, Mario Draghi, announced in his statement at the thirtieth meeting of the International Monetary and Financial Committee, which occurred on October 10th 2014 in Washington D.C., that the Euro Area is suffering from both a high unemployment rate and low inflation.

Such conditions has Mario Draghi and the European Central Bank (ECB) on alert and ready to take additional conventional and unconventional actions in order to move inflation closer to its target of under but close to 2%. Whatever measures are taken will result in the ECB utilizing even more expansionary monetary policies. Though no specific actions were disclosed during Mario Draghi’s statement, there is widespread belief that the ECB will utilize the same tool the Federal Reserve is currently using, quantitative easing.

According to the EuroStat news release on September 30th, 2014, the August 2014 unemployment rate in the Euro Area reached 11.5% and 10.1% in all of the European Union. High levels of unemployment will wane on the economic activity of a region and cause price instability which is contrary to the European Central Bank’s mandate. During 2007 through 2008, the Euro Area and the European Union’s unemployment rate was below 8%, significantly lower than the most recent statistics.

The Euro Area’s unemployment rate for August 2014 is down by 0.5 percentage points when compared to August 2013, a modestly good sign. Though there is some improvement in the Euro Area’s labor market, the rate at which jobs are being added is much to slow for price stability to be maintained. Prolonged high unemployment rates will lead to softer GDP growth and economic hardships.

A chart displaying the unemployment rate of the Euro Area and the European Union.

A chart displaying the unemployment rate of the Euro Area and the European Union.

See the Euro Area Unemployment Rate for August 2014 Report.

Inflation also has the Euro Area in a corner. The September 2014 annual inflation rate for the Euro Area is 0.3% according to the EuroStat news release. That’s only 0.4 percentage points from deflation. Deflation is a highly undesirable situation for central banks and they’ll do almost anything to prevent it. Executing additional expansionary monetary policies like quantitative easing or lowering interest rates can help tackle this problem of low inflation and high unemployment.

The European Central Bank’s interest rate (Main Refinancing Operations Rate) is currently at 0.05%, which is extremely low. The ECB already has a very loose policy in this regard, but due to poor economic data, the ECB may need to implement a negative interest rate. To what degree implementing a negative interest rate affects the inflation rate is yet to be seen, but I can’t help but think that it will move it higher.

To wrap things up, the European Central Bank is on the cusp of executing additional policies that will further accommodate economic growth and spending. I see the euro remaining depressed in valuation due to anticipation of further loosing of policies by the ECB.

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