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Incipient deflation investing

Автор: Tygogor | Рубрика: Synchrony financial number of employees | Октябрь 2, 2012

incipient deflation investing

n most countries, investors are free to decide whether they believe deflation or inflation For all the Bank of Japan's worrying about incipient bubbles. investors anticipate. We see upside risks to inflation in the short-term, but to us inflation is a process, not an event. Although we see incipient shifts. prolonged deflation in advanced economies, often The incipient recovery from its own fi- invest in domestic production facilities for strategi-. SNOWFLAKE IPO STOCKS Another idea is a very conscientious use of Apache advertise products frequently how the dispenser в this is. The low gear free encyclopedia. At this point.

The deterioration of financial institutions' balance sheets caused by falling collateral values is minimized as productivity increases lift the expectations for current and future earnings, which tends to preserve or improve the value of collateral. These offsets may not be complete across all sectors of the economy, and the tendency of deflation to favor lenders over borrowers may still cause some redistribution of income. Conceptually, deflation generated by a positive supply shock could be prevented by an increase in the money supply sufficient to accelerate nominal spending and exert an offsetting degree of upward pressure on the price level.

In the 19 th century, under the gold standard, a relatively fixed supply of gold often constrained countries from expanding their money supplies to counteract deflation. In and , the U. Despite the severity of the contraction of economic activity, an exacerbating deflationary spiral was avoided at that time. However, the economic recovery that began in mid has been slow paced and has not erased concerns about deflation.

Several indicators can be used to assess the risk of deflation: 1 measures of aggregate price behavior, 2 measures of the output gap, 3 measures of asset market prices, 4 measures of credit and monetary conditions, 5 the path of the exchange rate, 6 the proximity of nominal interest rates to the zero bound, and 7 estimates of investor expectations for future movement of the price level.

Consider the recent behavior of each class of indicator. A steady fall of the aggregate price level as evidenced by downward movement in the Consumer Price Index CPI or the Producer Price Index PPI is the clearest and most direct indicator of disinflationary pressure in the economy. However, prior to an outright fall of the price index, there is likely to be a prolonged deceleration in the measured rate of inflation.

Also, the CPI and other aggregate price indexes are for a number of reasons likely to have an average annual upward bias in the range of 0. Reflecting the severity of the recent recession, the price level, as measured by the CPI, declined about 2. With economic recovery, which began in mid- , the price level stabilized and began to rise again, up about 1. However, as the pace of economic growth slowed over much of , the CPI's rate of increase also slowed, with a succession of monthly increases in the CPI of near zero.

This deceleration of inflation renewed concern that the risk of deflation had increased. In recent years, the CPI has typically increased at an annual rate of around 2. The recent deceleration of these indexes represents a break from that pattern and, given the index's upward bias, could be evidence of incipient deflation; but this behavior has occurred for too short a time period for a definitive conclusion to be drawn.

The Congressional Budget Office CBO estimates that when the economy bottomed out in mid, the output gap the difference between the level of output produced if the economy's resources were fully employed and the actual level of GDP was 8. On the other hand, the estimated current output gap is much smaller than what accompanied the deflation during the Great Depression.

The economic recovery that has occurred since then has narrowed the output gap to an estimated 7. However, an output gap of that size after nearly 30 months of economic recovery suggests that a substantial degree of economic slack remains, and it may continue to exert sizable downward pressure on the price level. Moreover, it will continue to do so if weak near-term economic growth leads to little or no narrowing of the output gap.

Because deflation reduces the value of collateral held by lenders and raises the real cost of borrowing faced by borrowers, the demand and, in turn, the price of many classes of assets may fall along with goods prices. Most asset prices fell sharply during the economic collapse of and House prices fell particularly sharply and house prices are still falling, continuing to have an adverse effect on the balance sheets of households and banks, and dampening the recovery of aggregate spending. In contrast, the stock and bond prices have rebounded.

With house prices likely to remain weak, repairing household balance sheets will probably require a large diversion of current income from consumption spending to debt reduction for several more years, tending to weaken aggregate demand and slow economic growth.

An appreciating dollar will decrease the domestic price of imported goods and services and exert downward pressure on the price level in the process. The trade-weighted dollar exchange rate had generally been on a downward path since early ; however, as the financial crisis and recession intensified during the last half of and the first quarter of , the dollar appreciated as foreign investors increased their demand for relatively safe dollar-denominated assets, particularly U.

Treasury securities. As the crisis subsided and the global economy seemed to be staging an economic recovery, the increased demand for dollar assets abated and the dollar depreciated during the remainder of Over the first six months of , the dollar changed direction and appreciated about 5.

Whether because of the sovereign debt problems in the euro area that emerged at this time or out of concern for the sustainability of the slow-paced global economic recovery, the demand for low-risk dollar assets strengthened again, exerting upward pressure on the dollar. Given the normal lags, this appreciation is not likely to have exerted much downward pressure on U. However, should a global "flight to quality" keep the demand for U. Treasury securities strong, the deflationary impact of an appreciating dollar on the level of prices in the United States may become more evident.

In an economic crisis, with weakening balance sheets and rising uncertainty about the economic future, households will hold larger cash balances rather than spend and financial institutions will attempt to increase liquidity and accumulate excess reserves rather than lend. This shift in behavior tends to decrease the money supply and exert more downward pressure on economic activity and prices. During the Great Depression, the Federal Reserve the Fed passively allowed the money supply to contract as a result of households' and businesses' actions to increase liquidity.

As the money supply fell, so did the price level, intensifying the economic collapse already underway. Beginning in mid, the Fed took aggressive steps to keep the money supply from contracting by boosting currency and bank reserves. Measures of the money stock increased substantially over the next year. For the 12 months ending in June , the money stock measure M2 increased 9. However, for the 12 months ending in June , M2 increased only 1.

This slower rate of growth in M2 could be the result of higher demand for cash balances by households and a diminished willingness of banks to use reserves for lending to businesses and households. Bank lending is the principal way the economy creates money. The persistence of such a low rate of money supply growth could have been deflationary.

Concern about slow economic growth and the rising risk of deflation, prompted the Fed to again accelerate the growth of the money supply. If nominal interest rates are at or near zero, deflation will increase real interest rates and dampen interest-sensitive spending which adds to the deflationary momentum.

Also, at this point, the Fed's normal means of countering weak aggregate spending, namely adjusting nominal interest rates downward, is not operational. Although being at the zero bound itself does not raise the risk of deflation, it creates an economic environment in which the negative effects of deflation on economic activity can be sharply amplified. An estimate of whether investors in long-term securities are expecting inflation or deflation can usually be gleaned from the relationship between Treasury securities and inflation-indexed bonds.

The yield on the latter has sometimes been used as a proxy for the real interest rate. Therefore, if the nominal rate on the Treasury security is higher than the inflation-indexed rate, investors are thought to be expecting inflation as measured by the premium of the nominal rate over the inflation-indexed rate. On the other hand, if the nominal rate is below the inflation-indexed rate, then investors are expecting deflation. In January , the nominal yield on a five-year Treasury bond was about 2.

In December , the nominal yield on the five-year Treasury bond had fallen to about 0. By this indicator, the bond market's expectation of future inflation has fallen about 0. Collectively, these several indicators suggest a continuing risk of deflation, but they do not give conclusive evidence that the price level is currently falling. Of particular significance for elevating the risk of deflation is the persistence of a large output gap, the nominal federal funds rate being at the zero bound, and long-term inflation expectations falling closer to zero.

So far, however, broad-based price indexes show a deceleration of inflation but do not reveal the presence of deflation. Over the last year, growth of the money supply has accelerated substantially. How can economic policy contain or mitigate the potentially large negative economy-wide effects of a deflation caused by a negative demand shock?

The simple answer is that the government can take actions to support current aggregate spending. Increased current spending that exerts upward pressure on the price level is a counterforce to a negative demand shock. If these policies also induce economic agents to expect future prices to be higher than current prices, they are likely to shift their spending toward current goods and away from future goods.

There are two general classes of policy responses to be applied, separately or in combination, as the severity of the deflation problem warrants. The first class of policies comprises the standard macroeconomic policy tools of monetary and fiscal policy. The second class is greater use of the Fed's traditional role of "lender of last resort. Arguably those policy measures, in addition to supporting economic activity, forestalled deflationary momentum during this period of economic contraction.

Monetary policy is the Fed's standard and most frequently used tool to exert broad-based influence on credit conditions, economic activity, and the price level. The targeting of the federal funds rate is accomplished with open market operations whereby the Fed buys or sells Treasury securities for cash to increase or decrease liquidity in the financial markets, which influences real borrowing costs and may subsequently influence credit-sensitive spending by households and businesses.

To fight deflation, the Fed could exert upward pressure on the price level by applying a stimulative monetary policy. The Fed achieves this stimulus by entering the federal funds market and making open-market purchases of Treasury securities from banks in exchange for cash.

The infusion of cash increases the reserves liquidity of the banking system, exerting downward pressure on interest rates. The effect on interest rates is likely to be reflected quickly and most fully on short-term interest rates and possibly spread to longer-term interest rates.

Beginning in September , in response to continuing evidence that disruptions in financial markets could have adverse effects on the wider economy, the Fed aggressively applied successive injections of monetary stimulus, as it purchased securities for cash and pushed down the federal funds rate from 5.

The federal funds rate has effectively remained at the zero bound through The stimulative effects of a much lower federal funds rate to the wider economy can be substantially muted in a time of economic crisis when the demand for liquidity increases sharply. This lack of a stimulative effect occurs because banks, wary of elevated risk of loan default, prefer to increase their reserves and liquidity, rather than increasing their lending activity and keeping credit liquidity moving to support spending in the non-financial sectors.

The phrase often used to describe monetary stimulus's lack of effect on real economic activity in times of financial crisis is that monetary policy is "unable to get traction. Also, if the nominal federal funds rate has fallen all the way to the "zero bound," as it currently has, the Fed is prevented from using normal operating procedures of targeting interest rates to apply the degree of monetary stimulus needed to increase aggregate spending and counter deflation. However, there are alternative strategies that the Fed could employ to provide stimulus in this situation.

The current interest rate on long-term assets depends on the entire expected future path of short-term interest rates, including the zero rate for the federal funds rate. If the central bank can persuade the public that it will hold down the short-term rate to near zero for longer than had been expected, interest rates across the whole term structure should also fall, stimulating spending.

Such an outcome would hinge on whether the Fed's policy commitments are taken as credible by the public. In this circumstance, however, some economists argue that it is also possible for economic agents to see a policy of keeping short-term nominal interest rates near zero for an extended period not as stimulative, but alternatively as a commitment to a passive policy response, and they come to expect the persistence of deflation and no decrease of nominal long-term interest rates.

A likely example of this tactic was the Fed's August 10, , policy statement in which it said that economic conditions warrant keeping the federal funds rate near zero for an extended period. This statement was a turnabout from a few months earlier when the Fed was discussing when and how it might gradually raise interest rates as the economic recovery proceeded.

Second, the Fed could alter the composition of its balance sheet , shifting from liquid short-term, low-risk assets toward less liquid long-term assets or other riskier assets. This policy is sometimes called "qualitative easing. If the Fed shifts the composition of its balance sheet toward long-term assets by selling short-term treasuries and buying long-term treasuries or other long-term assets, such as asset-backed securities, it could possibly lower long-term yields to provide stimulus to economic activity.

Prior to , the Fed actively managed the yields on government debt, including long-term bond yields. This earlier ability may give credence to the efficacy of this alternative procedure for conducting monetary policy. A third option for implementing monetary policy at the zero bound is to expand the size of the Fed ' s balance sheet , by increasing its monetary liabilities.

This policy is often called "quantitative easing. The policy focus, however, is shifted from the price of reserves interest rates to the quantity of reserves. To bolster the liquidity of the financial system and stimulate the economy, during and the Federal Reserve aggressively applied conventional monetary stimulus by lowering the federal funds rate to near zero and boldly expanding its "lender of last resort" role, creating new lending programs to better channel needed liquidity to the financial system and induce greater confidence among lenders.

Following the worsening of the financial crisis in September , the Fed grew its balance sheet by lending to the financial system. By the beginning of , demand for loans from the Fed was falling as financial conditions normalized. Had the Fed done nothing to offset the fall in lending, the balance sheet would have shrunk by a commensurate amount, and the stimulus that it had added to the economy would have been withdrawn.

In the spring of , the Fed judged that the economy, which remained in a recession, still needed stimulus. The Fed's planned purchases of Treasury securities were completed by the fall of and planned Agency purchases were completed by the spring of This expansion of the fed's balance sheet is often called "quantitative easing 1" or QE1.

When at the zero bound for nominal interest rates and faced with a sharp economy-wide demand for liquidity, combating weak aggregate spending and incipient deflation may also require the Fed to shift its operating procedure for conducting monetary policy from targeting interest rates to targeting the inflation rate.

With inflation targeting, the Fed announces a target path for the price level. For a policy of inflation targeting to be successful, the Fed must convince the markets that it is credible by vigorously and transparently pursuing policies that are consistent with reaching the inflation target. In effect, the cure for deflation is a credible promise of future inflation. The minutes of an early meeting of the Fed's Open Market Committee indicate that the Fed would begin to make available to the public the committee's long-term projections for important macroeconomic variables, including the rate of inflation.

The Fed has been doing this now, and in January decided to publish forward interest rate projections to further help guide expectations. These action could be interpreted as the Fed initiating a policy of inflation targeting.

Nevertheless, operation of monetary policy at the zero bound for the federal funds rate is a passage through poorly charted waters. There remains substantial uncertainty about how well the alternative operating procedures worked during the recent crisis and recession. However, the Great Depression gives support to the belief that monetary policy can be an effective counterforce to deflation even when the demand for liquidity is high and nominal interest rates are at the zero bound.

In , President Franklin Roosevelt temporarily took the United States off the gold standard and freed the Fed from having to maintain high interest rates to maintain the dollar's fixed parity to gold. This monetary expansion, however, was implemented by the U.

Treasury, not by the Federal Reserve. Under the gold standard, the Treasury was allowed to issue gold certificates, in proportion to the gold stock, that were interchangeable with Federal Reserve notes. The devaluation directly increased the nominal value of the existing U. In addition, the devaluation induced a large inflow of gold through its effects on the trade balance and the attractiveness of dollar assets.

Rising political tensions in Europe would also contribute to the attractiveness of dollar assets. The Treasury issued gold certificates equal to the rising value of the gold stock and deposited them with the Fed. As the government spent them, they were converted into Federal Reserve notes, increasing the monetary base.

Despite nominal interest rates being at the zero bound, credit became more readily available and real interest rates were reduced, stimulating interest-rate-sensitive components of aggregate spending. In addition, the large monetary expansion arguably changed expectations from deflation to inflation, making prospective borrowers more confident that their debt service burden would not be increasing.

In response, the economy grew strongly and brought a relatively quick end to deflation. In the role of "lender of last resort," the Fed offers credit to solvent but temporarily illiquid financial institutions. With this action the Fed is engaging in another form of qualitative easing, changing the composition of its balance sheet, in this case shifting its holdings from less risky assets toward more risky assets, but the primary aim of such operations is to ensure the smooth functioning of financial intermediation in the economy.

The borrowers are financial institutions with assets exceeding liabilities; however, because their debts tend to be short-term and liquid while their assets are long-term and illiquid, they need the ability to raise short-term funds to meet short-term debt obligations. The expectation is that with reliable access to short-term liquidity, financial institutions will be more willing and able to lend to each other and to the non-financial sectors of the economy.

The Fed's "discount window" is its facility for making loans to financial institutions with short-term liquidity problems; the "discount rate" is the interest rate charged for these loans. Financial institutions are often reluctant to use the discount window out of concern that financial market participants will draw a negative inference about their financial condition if their borrowing from the Fed becomes known.

In response to the recent financial crisis and recession, the Fed greatly expanded its lender-of-last-resort role, creating new lending programs to better channel needed liquidity to the financial system and induce greater confidence among lenders. These actions were a means to restore credit flows to the wider economy.

One of the reasons for the severity of the economic collapse and deflation from to was the Fed's failure to aggressively undertake lender-of-last-resort actions, allowing thousands of banks to fail and causing a contraction of the money supply. The Fed's current ability to pursue further large lender-of-last-resort activities to counter deflation may be constrained by the changing risk profile of the central bank's balance sheet.

Its recent lender-of-last-resort initiatives have meant that the Fed has exchanged a sizeable portion of its holdings of low-risk Treasury securities for high-risk collateral. Although the Fed is able to hedge some of this risk, the average level of risk carried in the Fed's total asset holdings has increased. Fiscal policy can support aggregate spending and exert upward pressure on the price level through an increase in the budget deficit.

A policy of fiscal stimulus would involve tax cuts or spending increases or some combination of the two. Unlike monetary policy, which transmits its impact to economic activity indirectly through financial markets, fiscal policy has a relatively direct impact on economic activity. Increased government spending is a direct addition to aggregate demand. In addition to its effect on aggregate spending, fiscal stimulus may have an indirect positive effect on the condition of financial institutions' balance sheets as the salutary effect on economic activity also exerts upward pressure on asset prices.

To be most effective, fiscal policy initiatives would occur in conjunction with a stimulative monetary policy and any other measures needed to relieve a restricted flow of credit. Fiscal stimulus was not used to counter the deflation and collapse the U. Fiscal policy became more stimulative from onward, but the degree of fiscal stimulus was modest relative to the economy's massive output gap.

The output gap for the U. In response to the financial crisis and recession, several fiscal measures were enacted. Presently, there is a policy debate over whether added short-term fiscal stimulus should be used to assure sustained economic recovery and to counter any incipient deflation. Proponents argue that if the pace of private spending proves insufficient to keep the economy expanding and the price level from falling, further stimulus by monetary and fiscal policies may be warranted. On the other hand, opponents maintain that the associated government borrowing would add to an already large accumulation of government debt, with the consequence of slower future economic growth.

It is true that for an economy operating close to potential output, government borrowing to finance budget deficits will in theory draw down the pool of national saving, crowding out private capital investment and slowing long-term growth. However, the U. Chart 3 shows the share of HICP items experiencing price falls, year on year.

This share has increased recently but it remains not so distant from the average of the last decade. The share of items with negative inflation is subject to significant volatility, partly owing to seasonal factors, such as sales in the shops at certain times of the year. This makes the measure more difficult to interpret. However, it is possible to take account of these factors by comparing the proportion of items with negative inflation rates in any given month with the historical average for the same month.

As you can see from chart 4, the share of items with negative inflation rates excluding energy and food in the year to May was only a touch higher than the historical average, further confirming that there have been no widespread price cuts so far. Let me dwell on this point. Chart 5 shows the distribution of the annual rates of change in all the items included in the HICP basket, weighted by their expenditure share. This also suggests that price cuts are not generalised, but are concentrated on few items.

The items with negative inflation rates are those such as clothes or electronic devices, which undergo constant quality improvements. A few items, mainly related to oil, recorded very strong price cuts. To check whether price cuts are generalised beyond food and energy, we could look at measures that exclude such items. These — the so-called measures of exclusion-based underlying inflation — can be constructed in several ways. This range is shown as the shaded area of Chart 6, together with the headline inflation rate.

The range has come down from the peak and is at or below 1. International organisations, private forecasters and indeed the ECB expect this spell of negative inflation to be reversed, as suggested by inflation forecasts for and This can be seen, for example, from slide 7. It plots the latest HICP inflation forecasts from the Euro Zone Barometer — a publication that produces macroeconomic and financial forecasts every month from a number of major economic forecasters in Europe.

Looking at the range of individual responses which is shown as a shaded area , there is some disagreement between the highest and lowest forecast. But even in the lowest forecast, the period with negative inflation rate is expected to last no more than two quarters. Furthermore, according to the same survey, inflation projections for have been gradually revised downwards since January as economic conditions have deteriorated.

This phenomenon is illustrated in slide 8, as a month-to-month shift to the left of the inflation forecasts. So, if there is no evidence of a generalised and persistent fall in the price level in the latest inflation outturns, what is underpinning current deflationary fears?

As I see it, when people think about deflation, they have in mind two possible scenarios. The first is that the accumulation of economic slack due to the recession may exacerbate downside risks to price developments, which in turn may lead to outright deflation as monetary policy loses traction in stabilising output.

The second scenario is that a spell of negative headline inflation rates — perhaps due to the temporary impact of energy and food prices — might dislodge inflation expectations. Let me discuss these scenarios in turn. The Phillips curve provides a useful framework for assessing the impact of growing economic slack and inflation expectations on price developments. In its most basic form, this theory posits that the inflation rate depends positively on the expected rate of inflation and negatively on the degree of slack in the economy, as measured, for example, by the difference between the supply potential of the economy and aggregate output, in other words the output gap.

With euro area GDP falling at an annual rate of 4. This should exert downward pressure on prices. But how strong is this downward pressure, and can it determine deflationary risks for the euro area? Precise estimates of the Phillips curve for the euro area are subject to controversy. They vary depending on the specification, the precise measures of the output gap and expectations used, and the time frame considered.

However, the general indication from the existing studies is that, on average, relatively large and persistent changes in the output gap are needed to affect euro area inflation. A simple plot slide 9 of the evolution of various measures of the output gap against that of inflation for the euro area confirms that movements in various measures of economic slack have played a fairly modest role in the inflation process in the euro area in recent years.

The same Phillips curve analysis suggests that changes in inflation expectations play a major role in shaping inflation developments, anchoring inflation and potentially mitigating the harmful outcomes resulting from temporary shocks. In such a setting, expectations pin down the level of inflation in the long run, while changes in the output gap lead to short-run accelerations or decelerations of inflation around that level.

There are many caveats to using a Phillips curve framework to relate inflation developments to economic slack — for instance, measures of both inflation expectations and the output gap are subject to considerable uncertainty, non-linearities may arise, and the relationship may change over time. Moreover, the actual impact of slowing real economic activity on inflation depends crucially on the nature of the economic downturn, the types of shock hitting the economy, their magnitude and duration.

Wage and price rigidities may also contribute to help to moderate inflationary responses to changing economic conditions in the short run. Overall, the current weakness in real economic activity would be expected to dampen inflationary pressures in the euro area but not to lead to outright deflation. The approach underscores that while economic slack may contribute to movements of inflation in the short run, well-anchored inflation expectations are a crucial determinant in the inflation process.

Inflation expectations cannot be observed directly, but approximate measures can be derived indirectly in three different ways: asking a sample of consumers, surveying professional forecasters and extracting information from financial markets. Let me elaborate. These two measures are plotted in Chart 10, together with actual inflation. Most respondents thought that prices would either remain unchanged or fall in the next 12 months.

But this is not really the same as expecting deflation. It suggests that most respondents regard deflation as unlikely. In the second quarter of , none of the 50 participants reported a negative point estimate for , and two participants reported a point estimate below zero for Together with point estimates, participants are also asked to assess the likelihood of future inflation falling within given ranges.

Averaging the individual responses provides a summary of their assessment. Participants are also asked to provide their projections about inflation five years ahead, which can be taken as a measure of medium-term inflation expectations and hence of the credibility of the central bank.

These have remained firmly anchored, as the next chart indicates slide All survey-based measures of longer-term inflation expectations stood at 1. They also contain information about inflation risks, since investors not only demand compensation for the level of expected inflation but also for bearing the risk associated with the inflation outlook. In practice, yields on inflation-linked bonds are used as a basis to derive indicators of inflation expectations. Thus, it is useful to complement this measure with expectations extracted from inflation derivatives.

In particular, inflation-linked swap rates provide a measure of the expected inflation rates at short horizons one and two years ahead, for example. One-year inflation swap rates fell sharply in the second half of slide 13 , following the decline in oil prices and the worsened macroeconomic outlook, and remained between 0. The chart also displays market uncertainty about the future inflation outcomes in the euro area, represented by the coloured areas.

Unsurprisingly, uncertainty has increased since October Furthermore, in line with developments in point expectations, the probability associated with negative inflation readings within a month horizon increased in the months following October , as indicated by the shaded areas below the zero line, but has declined somewhat in recent months. The evolution of the term structure of inflation expectations suggests a similar pattern of gradual adjustment at slightly longer horizons slide Two-year-ahead inflation expectations have moved in tandem with shorter inflation expectations.

It should be kept in mind that the liquidity of shorter-term inflation swaps is somewhat inferior to longer-horizon contracts, and the readings should thus be interpreted with appropriate care. In contrast to developments in short-term inflation expectations, long-term euro area inflation expectations and the associated risks have remained relatively stable slide For example, the five-year forward break-even inflation rate BEIR five years ahead has fluctuated between 2.

Moreover, a decomposition of BEIRs into inflation expectations and related premia suggests nonetheless that the term structure of inflation risk premia in the euro area is upward sloping and its fluctuations are the main driver of fluctuations in BEIRs, with long-term inflation expectations anchored at levels consistent with price stability. Recent research has also shown that there are substantial differences in the determinants of short and long-term inflation expectations derived from BEIRs in the euro area.

Thus, the expected brief spell of negative overall inflation in the coming months does not seem to have no noticeable impact on longer-term BEIRs, thereby supporting the idea of well-anchored expectations in the euro area. At least so far. Overall, the evidence suggests that the euro area is a long way from generalised, persistent and expected deflation. The severity of the recession points to inflation remaining low in the next two years or so, but this is not expected to lead to the emergence of outright deflation.

The overall assessment is supported by a number of other indicators, in particular by developments in the labour market. In early , wage growth remained fairly robust, although this may partly reflect hysteresis slide In particular, the annual growth rate of compensation per employee fell to 1.

For instance, since the beginning of oil prices have more than doubled even when measured in euro. While economic analyses already provide a clear indication of the short to medium-term risks of a deflationary scenario, it might be helpful to compare them with the signals emanating from the monetary analysis.

The positive and often almost one-to-one relationship between inflation and monetary growth over longer horizons is perhaps one of the best documented results in economics and has been confirmed in a variety of empirical studies, both across time and across countries. As regards monetary analysis, this boils down to whether it is possible to separate in real time the important signal for future inflation embedded in the trends of monetary developments from the inevitable noise in the actual monetary data.

At the ECB, many measures of monetary liquidity are investigated and assessed for the implied risks to price stability. It is worth mentioning in this context that the various measures should not be regarded as mutually exclusive but rather as providing an encompassing view. An obvious measure characterising the rate of monetary expansion consists of the annual growth rate of the broad monetary aggregate M3, a measure that tends to attract most attention in the public debate.

As we can see in Chart 17, annual M3 growth decelerated further in the first quarter of compared with previous quarters. Together with the parallel deceleration in loan growth, this points to a lower pace of underlying monetary dynamics and thus moderate inflationary pressures. However, in times of financial turmoil and economic uncertainties, the behaviour of money holders, borrowers and lenders may give rise to sudden changes in money and credit dynamics, and the backward-looking nature of annual growth rates may then not immediately provide a reliable signal for current dynamics.

Looking forward, a complementary perspective, however, would focus less on the analysis of growth rates and more on the level of excess money accumulated in the past. The level of excess monetary liquidity that may have built up during a boom phase can be reabsorbed through a de-leveraging process. More precisely, over the medium term, the deceleration in the pace of money growth may lead to a direct unwinding of accumulated monetary liquidity i.

However, a protracted destruction of monetary liquidity would most likely have adverse effects on the real economy and increase the risk of deflation.

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