Why Spain outperforms other developed markets (Part 6 of 8)
Inflation and Spanish equities
Inflation is important as a measure of both the level of demand in a country and any potential cost issues, such as rising commodity prices, that could hurt a country’s economy. Inflation in the Eurozone has been very low for the past five years, which implies low aggregate demand and poor economic conditions. Over time, however, economies can adjust to a new trend level of inflation. This is known in economics as the “neutrality of money.” Changes in the rate of inflation can be disruptive in the short term, such as lower inflation causing unemployment and recession. But over longer periods, prices and wages adjust and allow output to recover.
Core CPI, which measures inflation excluding volatile commodity prices, was only 0.8% in September. The Spanish economy will take a long time to adjust to this level of inflation. Earlier in the series, I mentioned that wage growth in Spain was negative last quarter. Since the ECB (European Central Bank) hasn’t used the same sort of easing policy as the Fed in the US, wages need to adjust. Downward adjustment in wages takes a long time, resulting in prolonged recessions when monetary policy isn’t accommodative enough.
Housing prices have also been falling steeply over the last five years. This is important because it drives consumer behavior and credit expansion. Like many other economic indicators, housing prices are falling less quickly than they were in 2012.
Stock prices in Spain have been anticipating recovery, and with inflation still low, unemployment still high, and production below peak, there’s still much recovering left to do.
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