Saturday, May 29, 2010

Why internal deflation won’t work

An excellent comment in an otherwise stupid post by Edward Hugh (a Barcelona-based economist and master of cross-posting his articles to a bazillion different blogs):    

Perplexed in Montreal Says:

Regarding the insanity of internal devaluation policies, I'd like to point out that these policies never worked anywhere. Deflation within the Gold standard, the closer historical similarity to this strange experiment called Euro, was a disaster when it was carried out, in UK in the 1920s, in Germany in the early 30s, in France in the mid-30s.

I also would suggest to have a look at Ireland. Ireland was hit quite early by the financial crisis and has dutifully applied the internal deflation recipe since. It has been a success, in the slightly surreal Brussels definition of a success: the patient has taken the pill and hasn’t died.

Well, success it is not. Ireland deficit is still way above 10% and doesn’t show signs that it will decrease rapidly below the 3% magic limit. Meanwhile the collapse in nominal GDP has mechanically made the relative debt higher.

Note that Ireland had been an early and enthusiastic adopter of the so-called ‘labor market reform’ policies. They work very well, especially in books written by economists.

The quest for deflation is a dangerous folly. It has never worked. Why expect that it will this time? ‘This time is different’, anyone?

UK exited its 1920s’ deflation by a huge devaluation of the pound, in fact exporting its problems towards its neighbours. I believe they decided it was a success, so they applied the same solution this time. France had political troubles that ended with the Front Populaire government and serious divisions that let the country totally unprepared to deal with the German response to deflation, which was quite different, and slightly more unpleasant, than that of UK or of France.

The proponents of economic suicide by deflation might want to consider the political consequences.

The really sad thing is that any graph shows that the economy of Spain is clearly recovering. Europe jumping into a suicidal austerity binge is probably one of the few things that would derail the recovery.


trevor said...

I wonder how any alternative would be financed, but there's a strange perverse delight to be had entering the world of the Flagellants, who I believe the Inquisition burnt for a while until the Vatican binned the Inquisition and John Paul II bought a whip.

santcugat said...

My feelings are that we are on the road to recovery as long as we don't fuck it up now by imposing austerity programs.