Mario Draghi, President of the European Central Bank is desperate about bringing the inflation back when the 18 country euro zone is drifting into deflation.
First he decided to lend the 400 bln euros to the banks and hoped that this will help. He borrowed this concept from the UK. Bank of England did that and the money went into building real estate bubble.
Second he decided to make interest rates negative on deposits held by banks. Denmark did that a while ago but has since reversed its policy.
Third the euro zone interest rates are at the lower bound and cannot fall further. If the inflation does not come back, what are their choices? Hardly any except to do quantitative easing. This involves buying the debts of companies and countries and releasing the equivalent liquidity in the market. But at the present moment the quantitative easing can only exist on paper as there are not that many asset backed papers to buy. Besides there are also disputes among the euro zone countries as to what kinds of assets should they be buying. In the meanwhile, the demand for loans and supply of credit are falling at the same time. Many companies are shrinking their balance sheet by paying off their debts. No matter how great the incentives are the banks don’t want to borrow.
Currently the projections are that the inflation in the euro zone countries is unlikely to come back for at least next 2 to 3 years. They know if the euro zone enters into a deflation they have no tools to get out. They look to Japan for their experience in dealing with deflation and their abenomics is not working either.
Efficiency and productivity have reduced the need for more workers and consumers fearing loss of jobs have gone back to the basics. Thomas Piketty in his new book has written elaborately about the consequences of income inequality and widening disparities.
There is an important lesson for India. The non-performing assets of the Indian banks could increase substantially due to the possible real estate bubble burst. For these banks they will require large amounts of money to bail them out. In theory, India cannot have a deflation and where is the assurance that it will not happen? For the time being we sit and watch as to how our government will play its cards and believe me we are standing on the most uncertain grounds. This is a call for strong leadership with vision. Do our leaders have it? Let us see.