Europe, Breaking Keynesian Rules: Deflation But No Recession?

On the Wall Street Journal, we read:

The European Central Bank has the option of engaging in large-scale asset purchases, known as quantitative easing, but such a policy is not needed at present after the bank unveiled extraordinary measures to fight too-low inflation last week, a top ECB official said Friday.

“It’s in the toolbox. It’s not needed now, let me be very clear. It’s not needed now because we don’t see deflation in the euro zone and we have a deep sense that the measures we decided last week are appropriate to face the prospects of low inflation,” ECB executive board member Benoit Coeure told reporters during a conference held by Croatia’s central bank.

The media continues to report heavily on the prediction and/or expectation of monetary expansion in Europe. The ECB has repeatedly declared a commitment to opposing price deflation. They are toeing the Keynesian party line and have made this clear numerous times.

However, this is one of those cases where the announcements should be verified against the facts. Looking at the data uncovers something interesting: For the past two years, the ECB has been pursuing monetary base deflation. We can see this in the chart below, which depicts the total monetary base in the Eurozone. It is obvious what has happened over the past 2 years, starting in 2012.We never hear about this in the media. In fact, I have never heard it discussed in the media. But the data doesn’t lie:




We can see that with little variance, the monetary base has undergone true deflation. This isn’t some natural phenomenon. The ECB has actively been deflating the monetary base. Even still, the M1 has continued to rise. Nearly 6%:



Meanwhile, European banks have curtailed loans to corporations and households:




To Keynesian Economists, this is a recipe for disaster: monetary deflation and lowered commercial loan rates. According to them, Europe should be exploding any second now. But that’s not the case. There has been growth, nearly 2% per year in general:



Here’s what we can take away from this: Europe is showing us a way out of monetary inflation without provoking recession. The contracting monetary base yet growing M1 supply, falling commercial loan rate, and economic growth are supposedly all contradictory; but it is surely so. Europe may still find itself in recession soon. I can’t make any guarantees. But the Keynesian Establishment derides any possibility of deflation as leading to instant recession. Well, the Eurozone is deflating, but the supposedly inevitable recession has yet to arrive.

What does this mean for the United States? It means that the Federal Reserve’s program of Quantitative Easing is unnecessary. The economy can sustain itself without monetary base expansion. If they ended Quantitative Easing (QE) and monetary base expansion today, there is no guarantee of an instant recession, despite what the Keynesian Establishment wants everyone to believe. The possibility of recession is there, but it’s not guaranteed.

The thing to realize is this: monetary base expansion matters very little now. QE is being used to goose up the stock markets. That’s why we’re seeing all-time highs in the stock markets, most recently hitting a record DOW 17,000 on July 1st.  But QE is not what is sustaining the economy. It is sustaining the boom in stocks. The Federal Reserve inflates approx. $55 billion per month. If this were eliminated tomorrow, the Stock Markets would probably crash; but there is no guarantee that the economy would fall into recession. The key factor that determines whether or not the USA falls into recession now lies in excess reserves. I have explained the nature of excess reserves here. If the Federal Reserve were to end QE, the major factor that would determine whether or not the US faces another recession lies in what bankers choose to do with excess reserves.

The ECB has shown us that monetary base expansion can be halted without a guaranteed plunging of the economy into recession. The Federal Reserve should be taking a leaf out of the European Central Bank’s book.




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