Challenge to Keynesians "Prove Rising Prices Provide an Overall Economic Benefit"

The ECB has been concerned about falling consumer prices. I propose that's 100% stupid, yet that's the concern.

When the euro declined vs. the US dollar, the ECB was happy that inflation would inch back up. The fear now is that falling oil prices will take away the alleged gain of a falling euro.

With that backdrop, credit the Financial Times for the absurd headline of the week: Eurozone Fails to Benefit from Weak Currency as Oil Price Slides.

Pity the policy makers given the job of rescuing the eurozone from deflation.

The unorthodox steps the European Central Bank has taken since June – including a programme of private-sector asset purchases – have caused a steep fall in the euro. The single currency is down 8.4 per cent against the dollar and 4.75 per cent on a trade-weighted basis from its peaks this year.

The weaker exchange rate will ease pressure on the ECB in its fight to raise inflation back to its target of just below 2 per cent. Mario Draghi, the central bank’s president, has said the currency’s earlier strength explains 0.4 percentage points of the fall in inflation since 2012. In that year, prices were growing 2.7 per cent a year.

But just as this depreciation is starting to fuel inflation, the ECB must contend with a fall in oil prices that all but wipes out the effect of a sliding currency. A weaker euro should swiftly raise the cost of imported energy. Instead, Brent crude has fallen 9 per cent in euro terms this month alone. This is the main reason why eurozone inflation fell again in September to 0.3 per cent, a five-year low – a figure confirmed by data on Thursday.

“The drop in oil prices is a problem for the ECB,” says Marco Valli, an economist at UniCredit, adding, however, that the situation would have been far worse without the single currency’s fall.

“The impact on inflation is already visible and significant – if you still had the euro at 1.40 to the dollar, eurozone inflation would probably be zero.”

1. If price of food drops will people stop eating?
2. If the price of gasoline drops will people stop driving?
3. If price of airline tickets drop will people stop flying?
4. If the handle on your frying pan falls off or your blow-dryer breaks, will you delay making another purchase because you can get it cheaper next month?
5. If computers, printers, TVs, and other electronic devices will be cheaper next year, then cheaper again the following year, will people delay purchasing electronic devices as long as prices decline?
6. If your coat is worn out, are you inclined to wait another year if there are discounts now, but you expect even bigger discounts a year from now?
7. Will people delay medical procedures in expectation of falling prices?
8. If deflation theory is accurate, why are there huge lines at stores when prices drop the most?

The idea that falling prices are bad for the economy is ridiculous. Taking out insurance against falling prices is even more absurd.

Ask any consumer if he wants lower gas prices, lower food prices, lower hotel prices, lower computer prices, or lower prices on any consumer items and the answer will be yes.

Keynesian Theory vs. Practice

Keynesian theory says consumers will delay purchases if prices are falling. In practice, all things being equal, it's precisely the opposite.

If consumers think prices are too high, they will wait for bargains. It happens every year at Christmas and all year long on discretionary items not in immediate need.