The world’s next credit crunch could make 2008 look like a hiccup

Is this why central bankers are so scared of raising interest rates?

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Interest rates are supposed to reflect credit-worthiness of a country, thus investors should require financially weak countries to pay higher interest rates to compensate for risk.

That makes it difficult to explain why a 10-year government bond in the United States yields 2.05 percent, while 10-year bonds in France, Italy and Spain yield 0.53 percent, 1.25 percent and 1.23 percent, respectively.

And some bond rates are negative in Germany, Switzerland and Sweden.

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Feb 8 (Reuters) – If Greece is forced out of the euro zone, other countries will inevitably follow and the currency bloc will collapse, Greek Finance Minister Yanis Varoufakis said on Sunday.

Greece’s new leftist government is trying to re-negotiate its debt repayments and has begun to roll back austerity policies agreed with its international creditors.

In an interview with Italian state television network RAI, Varoufakis said Greece’s debt problems must be solved as part of a rejection of austerity policies for the euro zone as a whole. He called for a massive “new deal” investment programme funded by the European Investment Bank.

“The euro is fragile, it’s like building a castle of cards, if you take out the Greek card the others will collapse.” Varoufakis said according to an Italian transcript of the interview released by RAI ahead of broadcast.

The euro zone faces a risk of fragmentation and “de-construction” unless it faces up to the fact that Greece, and not only Greece, is unable to pay back its debt under the current terms, Varoufakis said.

“I would warn anyone who is considering strategically amputating Greece from Europe because this is very dangerous,” he said. “Who will be next after us? Portugal? What will happen when Italy discovers it is impossible to remain inside the straitjacket of austerity?”

Varoufakis and his Prime Minister Alexis Tsipras received friendly words but no support for debt re-negotiation from their Italian counterparts when they visited Rome last week. But Varoufakis said things were different behind the scenes.

“Italian officials, I can’t tell you from which big institution, approached me to tell me they backed us but they can’t tell the truth because Italy also risks bankruptcy and they are afraid of the reaction from Germany,” he said.

“Let’s face it, Italy’s debt situation is unsustainable,” he added.

Italy’s public debt is the largest in the euro zone after Greece’s and Italian bond yields surged in 2011 at the height of the euro zone crisis. They have since fallen steeply and have so far come under little pressure from the renewed tensions in Greece.

Varoufakis said his government would propose a “new deal” for Europe like the one enacted in the United States in the 1930s. This would involve the European Investment Bank investing ten times as much as it has so far, Varoufakis said.

If Europe continues to pursue counterproductive austerity policies the only people who will benefit will be “those who hate European democracy,” he said, citing the Golden Dawn party in Greece, the National Front in France and the United Kingdon Independence Party in Britain.

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So, the governor of the Bank of England, Mark Carney, is filling his fountain pen, and looking for a stamp.

Now that inflation has fallen to 0.5% on the Consumer Prices Index (CPI) measure, he’s got to write a letter to the chancellor, explaining why inflation has missed the Bank’s target of 2% by more than one percentage point.

But why on earth should he be writing to George Osborne to apologise, when low inflation looks so attractive?

For example, falling oil prices will probably mean that the average British motorist will save around £140 this year. What he or she doesn’t spend on petrol – perhaps £4bn in total – is likely to be spent elsewhere, so boosting the economy in other ways.

So if falling prices are good for individuals and the economy, how can inflation also be beneficial?

How does inflation stimulate the economy?

In the example of falling oil prices, the motorist probably doesn’t have much choice as to whether to buy petrol or not. But imagine if the price of the car itself were to start falling. Instead of buying yourself a new car this year, why not buy it next year, when it might be hundreds of pounds cheaper? A little inflation encourages you to buy sooner – and that boosts economic growth.

Why should borrowers love inflation?

Anyone with a mortgage or a loan benefits from inflation, as it has the effect of eroding debt. In the 1960s my father bought a house for £11,000. But with inflation peaking at around 13% in the late 70s, his wages were rising fast too – meaning the mortgage repayments were taking an ever smaller share of his income. By contrast, deflation – or falling prices – increases the real value of debts. Not a good place to be.

What effect does inflation have on wages?

Rising prices make it easier for companies to put up wages. They also give employers the flexibility not to increase wages by as much as inflation, but still offer their staff some sort of rise. In a world of zero inflation some companies might be forced to cut wages.

That would not be good for morale, recruitment or productivity. For most of the last five years inflation has been running ahead of wage rises, but thanks to inflation, wages have also been rising, even if the money doesn’t go as far.

Why does the government like inflation?

The government has a huge debt, which is getting bigger thanks to a deficit of £90bn. It would dearly love to see that eroded by inflation, which in turn would see its own income rising. As long as there’s a good dose of inflation in the system, tax revenue should go up, even if the economy is stagnant.

But why is too much inflation bad?

When inflation is too high of course, it is not good for the economy or individuals. Inflation will always reduce the value of money, unless interest rates are higher than inflation. Indeed if inflation falls below 0.5% in the UK, savers will actually get a positive return on their money, and they will be less inclined to spend it.

High inflation – as Gordon Brown used to remind us when he was chancellor – is also a cause of boom and bust in the economy. It therefore produces low growth and higher unemployment.

If inflation in the UK exceeds that of other countries, it can also erode competitiveness.

So what inflation rate is good?

Most central banks favour an inflation target that is in the region of 2% to 2.5%. The Bank of England’s target of 2% under the CPI measure is fairly typical. Some economists argue there should be a higher target in times of recession, such as 3%. This can promote higher growth, by keeping interest rates lower for longer.

But whatever the precise level, most do agree that a little dose of inflation is absolutely essential.

“The most important thing to remember is that inflation is not an act of God, that inflation is not a catastrophe of the elements or a disease that comes like the plague,” said the Austrian philosopher and economist Ludwig von Mises.

“Inflation is a policy.”

( Sources : http://www.bbc.com/news/business-30778491 )

Read also : https://www.currencyfundgroup.com/2015/01/10/why-is-deflation-bad/

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A number of readers have asked me to explain why deflation is a bad thing; and the truth is that while I’ve alluded to the issue a number of times, I’m not sure if I’ve ever laid out the whole case. So here goes.

There are actually three different reasons to worry about deflation, two on the demand side and one on the supply side.

So first of all: when people expect falling prices, they become less willing to spend, and in particular less willing to borrow. After all, when prices are falling, just sitting on cash becomes an investment with a positive real yield – Japanese bank deposits are a really good deal compared with those in America — and anyone considering borrowing, even for a productive investment, has to take account of the fact that the loan will have to repaid in dollars that are worth more than the dollars you borrowed. If the economy is doing well, all this can be offset by just keeping interest rates low; but if the economy isn’t doing well, even a zero rate may not be low enough to achieve full employment.

And when that happens, the economy may stay depressed because people expect deflation, and deflation may continue because the economy remains depressed. That’s the deflationary trap we keep worrying about.

A second effect: even aside from expectations of future deflation, falling prices worsen the position of debtors, by increasing the real burden of their debts. Now, you might think this is a zero-sum affair, since creditors experience a corresponding gain. But as Irving Fisher pointed out long ago (pdf), debtors are likely to be forced to cut their spending when their debt burden rises, while creditors aren’t likely to increase their spending by the same amount. So deflation exerts a depressing effect on spending by raising debt burdens – which, as Fisher also points out, can lead to another kind of vicious circle, in which depressed spending because of rising real debt leads to further deflation.

Finally, in a deflationary economy, wages as well as prices often have to fall – and it’s a fact of life that it’s very hard to cut nominal wages — there’s downward nominal wage rigidity. What this means is that in general economies don’t manage to have falling wages unless they also have mass unemployment, so that workers are desperate enough to accept those wage declines. See Estonia and Latvia, cases of.

Now, alert readers will have noticed that none of these arguments abruptly kicks in when the inflation rate goes from +0.1% to -0.1%. Even with low but positive inflation the zero lower bound may be binding; inflation that comes in lower than borrowers expected leaves them with a worse debt burden than they were counting on, even if the inflation is positive; and since relative wages are shifting around all the time, some nominal wages will have to fall even if the overall rate of inflation is a bit above zero. So the argument that deflation is a bad thing is also an argument saying that some economic problems get worse as inflation falls, and that too low an inflation rate may actually be economically damaging. That’s why the fact that inflation, while still positive, is below the Fed’s target is bad news; and it’s why respectable people like Olivier Blanchard(pdf) have suggested that a higher target, something like 4 percent inflation, might make sense.

And no, 4 percent inflation wouldn’t turn us into Zimbabwe. I remember when we had stable inflation of around 4 percent – and it was morning in America.

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Until the summer of 2013, positively nobody was talking about “secular stagnation.” But over the past year or so, interest in the subject has boomed to the extent that we already have economics writers complaining that other writers are misusing the term and scholars making formal models to show how it’s possible. Google Trends shows that discourse around the idea is surging.

What is secular stagnation?

Would the Depression have ended without the war? (Ingfbruno)

For starters, it has nothing to do with secular versus religious. Instead, the term comes to us from a 1939 presentation given by Alvin Hansen titled “Economic Progress and Declining Population Growth.” In these tailing days of the Great Depression, Hansen was trying to draw a contrast between a cyclical period of slow growth and a structural transformation of the economy. Hansen believed that the world was not experiencing a down period during an up-and-down series of fluctuations. Instead, he said, “we are passing, so to speak, over a divide which separates the great era of growth and expansion of the nineteenth century” from a new era of much slower growth.

The Depression, in other words, was not a passing phenomenon but rather something that might last indefinitely. Instead what happened is that Nazi Germany launched a war that ended up intersecting with an already-ongoing military conflict between Japan and China. This battle lasted for years and involved nearly the entire planet. During its course, global output surged — though production was mostly dedicated to killing people and blowing things up rather than increasing living standards. But after the war, the economies of Western Europe and North America boomed. Secular stagnation was largely forgotten. But with growth consistently disappointing in recent years, interest in Hansen’s ideas has rebounded.

Importantly, although the rapid return of growth led to a collapse of interest in the secular stagnation hypothesis it didn’t exactly debunk it. Hansen’s argument was that the American economy lacked the kind of self-correcting forces that would restore an adequate level of demand and end the Depression. The outbreak of a giant world war is definitely not the same thing as an economy self-correcting — it was an enormous external source of stimulus.

Why are people talking about secular stagnation now?

http://www.vox.com/2014/10/28/7078167/secular-stagnation

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