Defeating deflation in EU and Japan key to global economic outlook

PUBLISHED : Saturday, 30 August, 2014, 4:46am
UPDATED : Saturday, 30 August, 2014, 6:35am

For a long time now, bad news has been good news for the US stock market. Now the Europeans are taking their cue. Economic news from the euro zone has got so bad that markets were expecting "Super Mario" to come to the rescue. And sure enough, Mario Draghi did not disappoint. Departing from his prepared speech at the annual central bankers' summit in Jackson Hole, in the United States, the European Central Bank president warned about low inflation expectations in the euro zone and promised to use "all the available instruments" to combat the threat of deflation there.

The bank had earlier cut its growth targets for the single-currency zone to 1 per cent this year and revised down its inflation forecasts to 0.7 per cent this year and 1.1 per cent in 2015. In the following days, markets rallied on Draghi's warning, with the S&P 500 index in the United States breaching the 2,000 level for the first time.

In 2012, Draghi declared the European Central Bank was ready to "do whatever it takes" to save the euro zone, thereby helping to end the most acute phase of the crisis there. This earned him his nickname "Super Mario". The signs are that he is ready to perform his "superhero" duties again.

The consensus view is that the European Central Bank will now pursue its own version of quantitative easing, that is, the massive purchase of asset-backed securities to keep borrowing costs down. Finally in the euro zone, austerity may be out and stimulus in.

This is despite the purging of left-wingers from the French government by Socialist president Francois Hollande for trying to stage a revolt against austerity policies.

The world economy cannot be fully restored until the largest economies are back on a healthy growth trajectory. The US is now on a convincing steady growth path, leading the Federal Reserve to phase out quantitative easing. But Japan and the euro zone are still on shaky ground. And not a day goes by without some news about a major sector of the Chinese economy being exposed to this or that calamity.

Haruhiko Kuroda, the Bank of Japan's governor, is trying to drag his country out of two decades of deflation. Draghi is trying to stop the euro zone from sliding into one.

It's too early to tell whether they will succeed. But the outlook for the world economy will darken considerably if they fail.