Still No Inflation in Europe

Europe is still dreaming of inflation. The EU Observer explains:

The eurozone edged out of a four-month period of deflation in April, according to the EU’s statistical agency. An estimate by Eurostat released on Thursday (30 April) found that consumer prices were flat in April 2015, up from -0.1% in March. Prices had fallen for four consecutive months since December.

Inflation data can be confusing. To make it simple yet still accurate, let us compare two “views” of inflation. They both report the so called Harmonized Index of Consumer Prices; the first looks at changes month to month, as reported in Figure 1:

Figure 1

Eurozone inflation mtm

According to this measurement, consumer prices are actually rising in the euro zone, by more than one percent in April.

However, inflation is not measured as month-to-month changes in a price index. It is measured on an annual basis. The measurement can be either calendar year or annual comparisons month by month. In the latter case the usual procedure is to remove seasonal variations from the data in order to obtain a smoother curve reflecting long-term changes in prices.

This method is dubious as it places a filter between the observer and the reality he is trying to understand. I avoid seasonally adjusted data in general as much as ever possible, and inflation data is no exception.

On the contrary, sometimes the seasonally un-adjusted data can reveal anomalies in trends that help explain current events. The following inflation data, based on the same index numbers as Figure 1, is a good example:

Figure 2

Eurozone inflation Myty

When reported on an annual basis, inflation in the euro zone suddenly looks quite different. The downward trend is unmistakably bound for deflation territory (and the trend line here is a third-degree polynomial function, so if there were any changes in the trend we would see them). Reasonably, prices do not plunge into deflation as fast as they do through the inflation part of the chart; once inflation hits zero the down bound trend will weaken drastically, even vanish altogether. However, not only is this a somewhat uncertain prediction – the knowledge among economists about deflation is very limited compared to their knowledge about inflation – but it is also important to keep in mind that even if prices stop plunging there is no reason to believe they will start rising again.

But what about that little uptick at the end of the curve? What about the observed positive price change for April as reported by the EU Observer above?

Here is where we have the true advantage of looking at “real” numbers, not seasonally adjusted ones. Because the data we analyze has not been smoothened out by seasonal adjustments, we have access to all the real-world kinks and crooks in the inflation curve.

Let us  compare the period leading up to the little uptick in March of 2015 to the period January to June 2013:

Figure 3


The 2013 excerpt ends with June and an inflation rate of 1.75 percent. For July that year inflation was 1.72 percent, in other words basically the same.

After that, the rate started declining again.

For 2014/15, April is the first month beyond the excerpt. In accordance with the events of the first half of 2013, it is logical that inflation has not yet turned downward again. But it would be rather surprising if there was some sort of rebound in prices back into inflation territory at this point. There simply are no macroeconomic reasons for a rebound to happen.

And at the end of the day, that is where you find the meat and potatoes of this issue. Traditional macroeconomic analysis centers in on GDP growth, consumer spending, private-sector job creation, business investments… If there is no upward movement in those variables, it is very difficult to find any reason why there would be inflation in the economy, especially over time.

There is one exception: pure monetary inflation. The kind they have in Venezuela and Argentina.

Surely nobody in the euro zone would want that? Thought so. Which brings us back to the point just made: there will be no sustained trend of inflation in Europe until the real sector picks up and starts growing again.