A James Alexander post
While still waiting for the 1Q16 official Eurostat NGDP figure for the Euro Area of 19 countries it has been interesting to have a look at the implied deflators for the currency bloc and its constituents. (Ireland, Slovakia, Cyprus and Luxemburg are all hopelessly late delivering GDP figures, and the first two don’t even seem to do it to Eurostat standards for calendar-adjusted data.)
Why look at the implied GDP deflators? They are perhaps the nearest thing we can get to an accurate measure of inflation. They are the difference between the growth rate of two very large numbers, RGDP and NGDP, and therefore theoretically perfect as measures of inflation – you just have to assume that RGDP and NGDP are measured accurately. No small assumption, especially for RGDP.
The various CPI indices by contrast, like the Euro Area HICP, merely measure price changes for baskets of goods and services, not inflation. Paradoxically, the ECB targets the HICP when it should be targeting a GDP deflator, at the very least. It really should be targeting growth in NGDP.
Two things stand out.
Euro Area inflation is nothing like as bad as the headline HICP that the ECB frets about. It is closer to HICP ex-energy, but slightly healthier, and showing an improving trend in inflation. It is not adequate, being still well below the average for the 2002-2007 period, and so not enough to drive a healthy level of NGDP growth, but it is not quite as disastrous as the 0% seen in the headline HICP.
As things stand, we see the ECB striving to ignite “inflation” but to a frustratingly low and self-defeating “less than 2%” target, but against the better target they aren’t doing too badly.
The GDP deflators also shows a much more interesting picture of Germany vs the Euro Area average. Just looking at HICP, it seems like there is price inflation harmony between Germany and the Euro Area.
But when you look at the GDP deflators a much more interesting picture emerges. We see the Euro Area average growing almost twice as fast as Germany during the 2000’s, although nothing like a rate to scare any inflation hawks. The non-German Euro Area countries consequently enjoyed high levels of RGDP growth versus Germany, although still to the benefit of “the sick man of Europe”, as Germany struggled to overcome the burden of reunification. We see that rather stealthily Germany became more competitive – even independently of the much vaunted 2004 labour reforms.
In the crisis we see a massive switch as both the GDP deflators and nominal growth collapse for the Euro Area as a whole. However, newly competitive Germany is able to take advantage of the nominal growth chaos in the rest of the Euro Area, having got used to much lower trend growth. In 2011, therefore, Germany was blithely happy with the monetary tightening at the massive expense of the rest of the Euro Area.
Over the last four years, since Draghi assumed the Presidency of the ECB, the central bank has managed to wrest monetary policy away from being solely for the benefit of Germany and we now see a gradual loss of competitiveness in Germany versus the Euro Area average. If we had taken the Euro Area ex-Germany, the contrast would have been even more stark.
Some in Germany may be alarmed to see themselves losing competitiveness against the Euro Area average. But they shouldn’t be despondent. It is not an absolute loss, just a relative one. And a relative loss is just part of the price of being good Europeans. Long may it continue.
Update This morning Eurostat did finally release an official figure for Euro Area NGDP growth. First quarter 2016 YoY growth was 3.0%, down slightly from upwardly revised figure of 3.1% in 4Q15. The figure is in line with the 20 year average NGDP growth rate but well below the 4% trend prior to the 2008 crisis. During the seven years 2007-14 NGDP growth averaged just 1%, nearly a decade of misery.