Deflation in the eurozone is over – as shown by tentative estimations made by Eurostat, consumption prices in April were at the same level as the year before. However, this does not mean that European economies will enter the path of quick economic growth. Not so long ago, in the 70’s, developed countries were in a so-called stagflation, high inflation coupled with stagnation. Currently the risk-increasing factor is not the growing crude oil prices, but a decreasing tempo of the improvement of productiveness and unfavourable demographic tendencies. This applies to Poland as well.
Last week were a time of significant upheaval on financial markets, as demonstrated by a strong increase in the yield of European government bonds. The unprecedented drop in that regard, which has been in in place until recently, is most likely over now.
Fig 1. Yield of 10 year bonds of the German government
Source: stooq.pl. Logarithm scale.
Historically, the yield of long-term bonds of developed countries is still at a very low level, so we are now in an initial stage of the normalization of the situation on the markets. However, further yield growth will be slowed down by the QE program (loosening the monetary policy), conducted by European Central Bank. On the one hand it aims to stimulate price growth in the Eurozone, on the other to stop the bond yield growth, which in normal conditions is a result of a higher inflation expected by investors. The main beneficiaries of the bond acquisition program (QE) are the euroland governments with big debts, but this is at the expense of significant deformations on the financial markets, which makes it hard to make rational investment decisions. This also applies to the so-called real sphere, as entrepreneurs often use market interest rates to valuate investment projects.
In a long-term perspective, the decisive GDP growth factor is the quality of investment decisions made by companies (investments in fixed assets and others), households (human resource investment, such as i.e. spending on education) as well as productive public investments. Non-standard practices of central banks (such as the QE program) surely interfere with the process of effective resource allocation, as they decrease the informative role of markets.
From employers’ and entrepreneurs perspective the worst case scenario is still possible: the bond acquisition program will facilitate the end of deflation, but European politicians will still be reluctant to undertake key structural reforms and at the same time look to exploit every opportunity to restrict fiscal discipline. Thus, ECB interventions will in fact finance programs increasing public spending, imposing direct and indirect costs on the private sector.
Though Poland’s current monetary policy is very different than that of the EBC, these remarks may be seen as counterarguments to maintaining too low interest rates in the future. Data on the productiveness of developed countries (USA, UK, but Poland as well) indicate a slowdown in growth, which may result from weakening the natural market selection of companies and investment projects. In addition to a loose monetary policy, a strong fiscal expansion (including European funds) may restrict the growth of productiveness by maintaining ineffective companies on the market and inflating the prices of some goods and services.
Fig. 2. CPI inflation and M3 money supply in Poland (year to year dynamics, %)
Source: Own elaboration based on NBP figures.
NBP prognoses on the end of deflation in the fourth quarter of 2015 should not be a cause for excessive optimism, as falling prices – in accordance with what experts of Employers of Poland reiterated many times – did not have a negative impact on Polish economy. The increased purchasing power of households and relatively high investment dynamics will be conducive to an increase in inflation in the coming quarters. The M3 money supply dynamics also reinforces the prognoses of growth for the CPI inflation index in 2015.
A long-term, sustainable increase in GDP growth dynamics requires formulating much higher expectations (as well as pro-reform pressure from European societies) towards European governments and the European Commission and not towards central banks. The latter – apart from the short-term perspective – cannot effect a lasting increase in GDP growth without triggering negative phenomena such as inflation, speculation bubbles and failed investments.
Damian Olko, expert of the Research and Analysis Centre of Employers of Poland