The world economy is not in good shape. The news from America and Britain has been reasonably positive, but Japan's economy is struggling and China's growth is now slower than at any time since 2009. Unpredictable dangers abound, particularly from the Ebola epidemic, which has killed thousands in West Africa and jangled nerves far beyond. But the biggest economic threat, by far, comes from continental Europe.
Now that German growth has stumbled, the euro area is on the verge of tipping into its third recession in six years. Its leaders have squandered two years of respite, granted by the pledge of Mario Draghi, the European Central Bank's president, to do "whatever it takes" to save the single currency. The French and Italians have dodged structural reforms, while the Germans have insisted on too much austerity. Prices are falling in eight European countries.
The zone's overall inflation rate has slipped to 0.3 percent and may well go into outright decline next year. A region that makes up almost a fifth of world output is marching toward stagnation and deflation.
Optimists often cite the example of Japan. It fell into deflation in the late-1990s, with unpleasant but not apocalyptic consequences for both itself and the world economy. But the eurozone poses far greater risks. Unlike Japan, the eurozone is not an isolated case: From China to America, inflation is worryingly low, and slipping. And, unlike Japan, which has a homogenous, stoic society, the euro area cannot hang together through years of economic sclerosis and falling prices. As debt burdens soar from Italy to Greece, investors will become fearful, populist politicians will gain ground, and — sooner rather than later — the euro will collapse.
Although many Europeans, especially the Germans, have been brought up to fear inflation, deflation can be still more savage. If people and firms expect prices to fall, they stop spending, and as demand sinks, loan defaults rise. That was what happened in the Great Depression.
So it is worrying that, of the 46 countries whose central banks target inflation, 30 are below their target. Some price falls are welcome. Tumbling oil prices, in particular, have given consumers' incomes a boost. But slowing prices and stagnant wages owe more to weak demand in the economy and roughly 45 million workers are jobless in the rich OECD countries. Investors are starting to expect lower inflation even in economies, such as America's, that are growing at reasonable rates. Worse, short-term interest rates are close to zero in many economies, so central banks cannot cut them to boost spending. The only ammunition comes from quantitative easing and other forms of printing money.
The global lowflation threat is a good reason for most central banks to keep monetary policy loose. It is also, in the longer term, a prompt to look at revising inflation targets a shade upward. But the immediate problem is the euro area.
Continental Europe's economy has plenty of big underlying weaknesses, from poor demography to heavy debt and sclerotic labor markets. But it has also made enormous policy mistakes. France, Italy and Germany have all eschewed growth-enhancing structural reforms. The eurozone is particularly vulnerable to deflation because of Germany's insistence on too much fiscal austerity and the ECB's timidity. Even now, with economies contracting, Germany is still obsessed with deficit reduction for all governments, while its opposition to monetary easing has meant that the ECB, to the obvious despair of Draghi, has done far less than other big central banks in terms of quantitative easing.
