ECB "Public Spending Can Be a Means to Overcome the Low Inflation Crisis"

[Image source=Reuters Yonhap News]

[Asia Economy Reporter Park Byung-hee] Bloomberg reported on the 24th (local time) that the European Central Bank (ECB) released a report stating that public spending can be a means to escape from a low inflation environment.

In the report, the ECB analyzed that advanced countries need to rely more on fiscal spending to avoid facing a situation like Japan, where there is no appropriate monetary policy for low inflation.

Japan has been suffering from a long-term recession since the bubble economy collapsed in 1991. While the US and European governments have significantly increased fiscal spending after the spread of COVID-19, causing prices to rise sharply, Japan is an exception. Japan's Consumer Price Index (CPI) in May actually fell by 0.1% compared to the same month last year. The Bank of Japan (BOJ), Japan's central bank, introduced unlimited quantitative easing policies after Governor Haruhiko Kuroda took office in 2013, but prices have hardly risen.

The ECB diagnosed in the report that Japan has fallen into a self-fulfilling prophecy as the low inflation situation has prolonged. As prices remain at a low level, businesses and households come to believe that prices will not rise, and the central bank has no way to counter this pessimism. The situation in Japan, where prices do not rise despite the introduction of unlimited quantitative easing policies, illustrates this.

The ECB advised that other advanced countries need to increase government fiscal spending to avoid being trapped in the self-fulfilling prophecy like Japan.

In fact, after COVID-19, Europe and the US have seen the economy recover faster than expected as central banks' monetary policies and governments' fiscal policies have worked together. Although rapid price increases have been pointed out as a risk factor, both the ECB and the US Federal Reserve (Fed) have expressed the view that this is only a temporary phenomenon and there is no need for major concern yet.

The ECB analyzed that when central banks can no longer lower benchmark interest rates and monetary policy tools are exhausted, fiscal policy can protect the economy from the crisis of entrenched low inflation.