Essay on Capitalism, Crisis, and Class: The United States Economy after the 2008

Theory confirmed by practice says that in a healthy economy prices must rise – thus, consumers will have a permanent incentive not to postpone the purchase of durable goods, and manufacturers – the investments in hardware upgrades. Experience has shown that the optimal inflation rate is less than 2 percent a year. So there is nothing surprising in the fact that in a situation when inflation in Germany, Europe’s largest economy, dropped to 0.8%, the average figure in the eurozone fell to 0.3%, and in Spain the price growth made minus 0.5%, the ECB rang the alarm.

However, it is not only the eurozone countries that are facing the fall in the general price level. Moreover, the situation that has emerged in the European market could trigger house of cards effect in all partner countries. We believe that today we should mark the growing danger of further reduction of inflation or deflation rise worldwide in the next two tears.

Analyzing the risk of emerging deflation

Describing current economic variables, it should be marked that the greatest concern is the fact that the growth of consumer prices in the euro area fell to 0.3% in September from 0.4% in August and July, from 0.5% in June and May and 0.7% in April. In September, in Italy there was a decline in prices of 0.2% for the second month in a row, while the Spanish economy in recent months has already slipped into deflation (National Institute Economic Review, 2014; Figure 1). Many other factors are also showing a decrease in economic growth in the world, in particular (basing on studies by National Institute Economic Review, 2014; Dufour & Orhangazi, 2014; Pesek, 2014):

• Export from Germany, Europe’s largest economy, in August 2014 fell sharply against the falling demand in the world, which has caused concern that the euro zone economy may slip into recession for the third time in the last six years.
• In China, the high level of corporate debt, unstable real estate market and excessive production capacity indicate that Beijing may not achieve the target growth rate of 7.5%.
• Japan’s economy in recent years has not managed to come out of stagnation with the government raising sales tax this year, and the growth of consumption and industrial production declining.
• Developing countries, such as South Africa and Brazil, have also begun to experience economic difficulties, mainly related to the decrease in the purchasing power of partners.
• Inflation in India and Iran has declined sharply.

  The situation is complicated by the fact that in the face of the falling inflation, consumers postpone major purchases and manufacturers – investments, based on the expectations that the required goods will eventually fall in price even more. The drop in demand leads to the reduction of production of these goods, and the extra workers are laid off. Rising unemployment in turn leads to a further drop in demand and prices, which reinforces the restraint of consumers and investors (Krugman, 2009). It is extremely difficult to get out of this spiral, much more difficult than to get out of an inflationary spiral. After all, the verified means of combating inflation is increasing the interest rates by the central bank. The more expensive the loans and the higher the rates on bank deposits, the less money is thrown into the economy: manufacturers postpone investments, and consumers prefer to increase savings rather than spend them in stores. And theoretically, the central bank can raise the basic rate endlessly, but it cannot reduce the basic rate below zero (Meltzer, 2009). By now, the central banks have lowered interest rates to a record low level making nominal 0.15%, as well as offered commercial banks the target long-term refinancing operations (TLTRO) and confirmed their intention of large-scale purchases of government bonds to recover from the financial crisis of 2008-2009 (Dufour & Orhangazi, 2014). As a result, the politicians now have less tools to stimulate sustainable growth of the world economy.

  In addition, low inflation cannot be fully explained by temporary factors such as the Ukrainian crisis, sanctions against Russia, and the Middle East events. On the contrary, it reflects the profound weakness of the economy with low demand, significant decline in production, high unemployment and debt burden, as well as weak economic growth prospects. Here, we should agree with Pesek (2014) that the declined banks’ balance sheets, falling asset prices, unfavorable demographic situation and the lack of decisive action by the regulator in many developed economies today also allow comparing this situation with Japan of 1991.

  Thus, assuming that deflation eventually comes and continues for some time, this could lead to its further deepening. This, in turn, will complicate getting out of the price decline due to the dynamics of real interest rates, growth in the real debt burden, expectations of further fall in prices for businesses and consumers, deferred expenses, new fall in asset prices and increase in the number of loan defaults (Meltzer, 2009). Following this “shocking” scenario, inflation rate in the euro area could fall to -1% in 2015 and 2016, and then be able to rise to 0% (consumer price inflation in Japan has been 0% since 1995 (Pesek, 2014)). GDP growth will drop to 0% in 2015 and 2016, and later grow to around 1% (in Japan, it averaged 0.9% over the 1995-2013 period (Pesek, 2014)). Unemployment will rise to 12%. Interest rates will remain unchanged and record low, and the yield on 10-year bonds will be at the level of 1%. We can also expect a fall in asset prices and collateral values.

  Conclusion

  The recent volatility in financial markets, slow rates of world economic growth, decline in consumer prices and other factors only increase the concern that the risk of deflation in the global economy rises. If the prices drop low enough and hold at this level long enough, the economy could slip into recession around the world following the crisis already covering the strongest economies in the Eurozone (Krugman, 2009).

  In general, over the next year the economy of the entire planet will likely be determined by external factors, and if the ECB starts to pour in liquidity, we will see positive changes on the horizon of 6-12 months. If everything narrows to half-measures, the timing of economic recovery will delay, inflation rates in the euro area may fall to -1% in 2015 and 2016, and provoke setting of threshold values in a number of partner countries (National Institute Economic Review, 2014). The today’s risk of deflation is a risk of a significant slowdown in the business activity with a consequent reduction in GDP growth down to zero marks or even lower.

Do you like this essay?

Our writers can write a paper like this for you!

Order your paper here.

(No Ratings Yet)

Loading...