Economist Sees Global Deflation Fears as Overblown

In contrast to an economically strengthening U.S., Levy describes Europe’s weak economy as at a much earlier stage of recovery where weak aggregate demand is the key concern. Eurozone GDP rose an estimated 1% last year, up from just 0.7% the previous year. “Europe’s risks of deflation are nontrivial,” he writes.

Still, the economist does not recommend the ECB putting its foot on the easy-money accelerator, arguing that doing so risks encouraging Europe’s economic policymakers to further postpone reform of policies that got Europe into its present troubles.

Specifically, policies that have promoted uncompetitive wages need to adjust to economic realities, and as such “even temporary deflation along the road to recovery may be the best – albeit painful – path of adjustment from earlier excesses.”

Japan’s situation is even more distinct from the U.S. than that of Europe, having lived with deflation for two decades and finally emerged only recently to a low level of economic growth. Today nominal GDP is barely above its level in 1991 and 7% below Japan’s previous peak.

This prolonged bout of insufficient aggregate demand has stemmed from misguided monetary and economic policies, growth-suppressing regulation, and a shrinking and aging population and work force that have curtailed household and business spending, Levy says.

While Abenomics has to some extent lifted Japan out of this malaise, “it’s far too early to claim success,” Levy writes. He says that a weaker yen, stronger Nikkei, rising wages and increased confidence are likely to push core inflation above 1% but likely fall short of the Shinzo Abe administration’s 2% goal.

“Critics are correct,” Levy writes, “that failure to implement economic, regulatory and immigration reforms constrain long-run potential growth and drain confidence.”

Because of these widely varying stories, aggressive stimulus of the sort recommended by deflationistas may benefit Japan, but would be inappropriate for a Europe still in need of adjustment to downward price and wage pressures.

And a U.S. where economic expansion is gaining traction — personal income is growing faster than inflation and household net worth is at an all-time high, he says — worries over deflation are altogether misplaced.

“It is unclear why U.S. policymakers and commentators fear disinflation that stems from innovation-based price reductions amid accelerating aggregate demand,” the Bank of America economist concludes.