Is France being let down?

Is France going into a deflationary spiral? Some economists — a minority, admittedly, but a growing one — fear it might be. If so, the consequences for France, for the eurozone and ultimately for the UK, would be serious indeed.

In 2013, inflation in France averaged just 0.9%. For January 2014, the estimate is lower still, just 0.7%. As the respected French columnist Christine Kerdellant said recently, ‘If this isn’t deflation, then it’s certainly disinflation.’

Things are heading the same way across Europe. In January, UK inflation dipped below the Bank of England’s 2% target for the first time in years, despite the supposedly “strong” economic recovery, which would normally be expected to add to inflationary pressure.

Few people, I think realise, how serious deflation is. Falling prices sound nice, but they’re never good news for long. Just ask Japan, which took two decades to recover from the deflation of the early 1990s. Even a small bit of deflation can be catastrophic, especially in a modern economy where reaction times are faster, panic spreads quicker, sacking people is as easy as pie, and everyone’s up to their eyeballs in debt.

Once prices start to fall, people stop buying. Why shell out for that new computer or holiday when it will be cheaper next week or next month? People stop investing. Why buy that expensive piece of kit when it might well be cheaper next year, and when the price you get for whatever you’re making or doing is falling. People stop borrowing. Why take out a loan, when the real value of the debt will get bigger not smaller?

Inflation erodes the value of debt, helping over time to make it more manageable. With deflation, this process goes into reverse, inflating the burden of mortgages and loans.

Companies, seeing the price of their products fall, may try to recoup their losses by cutting wages or laying off staff, triggering another vicious downward swing in the spiral. Confidence drains away, uncertainty takes grip. Pretty soon, everything starts to fold.

If deflation takes hold in France — or any other eurozone economy — the only way to avoid this vortex will be for the European Central Bank to effectively start printing euros (and perhaps, as Ben Bernanke suggested for the US, dropping them over Paris and Marseille from a helicopter). France desperately needs looser monetary policy to counteract the tightening of fiscal policy imposed on François Hollande by the international markets and Eurozone rules.

But with a single currency and open borders, there’s no way to flood France with euros without also flooding Germany. It’s one big bath and there’s only one tap. Germany wants the tap turned off. And with the ECB, what Germany wants, Germany usually gets.

Deflation in an economy as big as France’s could put at least as much pressure on the euro as Grexit or any of the other crises which have threatened to blow the single currency apart in the last five years.

Germany’s antipathy to even mild inflation is often attributed to the hyperinflation of the 1920s. But it’s worth remembering that it was Heinrich Brüning’s disastrous policy of deflation in the early 1930s that led directly to Hitler’s rise to power.


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