To most people, the idea of falling prices sounds like a good thing. But it poses serious economic and financial risks – just ask the Japanese, who only now finally have the upper hand in a 20-year battle to drag their economy out of deflation.
That front is shifting westward, to the euro zone.
Deflation tempts consumers to postpone spending and businesses to delay investment because they expect prices to be lower in the future. This slows growth and puts upward pressure on unemployment. It also increases the real debt burden of debtors, from consumers to companies to governments.
In many ways, policymakers fear deflation more than inflation as it’s a more difficult spiral to exit. After all, interest rates can only go as low as zero and if that doesn’t kickstart spending, they’re in trouble. Again, just ask the Japanese.
European leaders and financial markets insist the threat of deflation in the euro zone is low. Outside experts surveyed by the European Central Bank said this week they saw a “very low” probability of deflation. And this is what European Central Bank president Mario Draghi said last week:
“We have to dispense once more with the question: Is there deflation? and the answer is ‘No’.”