In his speech on the occasion of the ECB Annual Report 2014, Mario Draghi warns against recurring deflation. One will hold on to measures taken so far, but he sees further need for action.

In this and in the coming year, Europe's economy is supposed to be on the road to recovery. Growth rates of 2 percent (2016) and 2.1 Percent (2017) shall give the impression that the serious financial crisis of 2008 will soon be a thing of the past. However, once again, an unemployment rate of 9.2 percent EU-wide (in some European countries, such as Spain, Italy or Portugal, it is even in double figures) and an at-risk-of-poverty rate of 24.5 percent (122.6 million people) clearly show that economic success cannot be measured on growth alone. Hence, the President of the ECB, Mario Draghi, is also concerned about other problems. During his speech on the occasion of the plenary debate on the ECB Annual Report for 2014, he explained that the risk of deflation (decrease in the general price level of goods and services) is not yet of the table and that this might have far-reaching consequences for the moderate road to recovery of the EU economy.

Measures of the ECB and their effects

From the point of view of Mario Draghi, the measures, which were taken by the ECB in 2014, had been effective in averting the danger of deflation over the past two years. One of these actions had been the reduction of key ECB interest rates, which had been put in place to enable banks to lend money at an even lower rate; the other was the enormous purchase of bonds by banks and funds to provide them with the option of giving more loans to businesses and private persons at low interest rates. It is difficult to verify at this moment whether this form of monetary policy will be successful in the long run. Having said that, one can expect that the low interest rates will have a negative impact on savings and pension funds. However, the current inflation rate of 1 percent for 2016 also shows that the desired effect has not yet been achieved. Whether deflation will happen or not, is very much dependent on external effects. Draghi also mentions in his speech that because of the low oil price further measures will be needed to promote a slight inflation.

New risks for employees

The President of the ECB also comments: “A moderate recovery of the euro area economy is under way, driven mainly by domestic demand”. However, demand threatens to fall, which also has an impact on growth if on the one hand the low oil price results in deflation and wages continue to stagnate on the other. Falling prices combined with stagnating wages lead to uncertainties, thereby postponing any consumption decisions. In order to counteract this trend, additional measures have to be taken to increase demand. Draghi proposes to give financial markets and banks access to more capital and that public spending should take place in full compliance with the requirements of the Stability and Growth Pact. However, one should consider that interest rates are already at a very low level and that employees will not take out loans in times of uncertainty. That is why more priority should be given to ensure that the income and job prospects of employees are secured, that working conditions are improved and that real economy investments will be made in order to increase demand in the longer term.

Further Information:

Speech by Draghi before the European Parliament

Growth prognosis 2016

End of the European Welfare State