The Spectre of Deflation in Europe

The era of inflation

Inflation signIn the 1970s and 1980s most of the world had high inflation. This meant a persistent increase in the general price level of goods and services. The value of money was reduced. In some countries inflation was so high that the citizens’ bank savings, and all ideas of value, were wiped out.

Inflation can be kept in check by the central banks, who keeps control of the supply of money and of the interest rate levels. In popular perception and in their own minds, the central bankers are the technicians who fought high inflation in the 1980s and reduced the level to lower numbers in rich world’s economies. Still, most central banks main official goal is to keep inflation low and their credibility is tied to keeping it low.


Inflation’s effects on an economy are various and can be simultaneously positive and negative. Negative effects include an increase in the opportunity cost of holding money, uncertainty over future inflation which may discourage investment and savings, and if inflation is rapid enough, shortages of goods as consumers begin hoarding out of concern that prices will increase in the future. A positive effect is that real assets increase in value over time, so investing in construction of real estate or factories can in general be a good idea.

The average inflation rate in the OECD countries was 1.5% in 2013, far below from the high figures of the 1970s and 1980s and down from 2.2% in 2012. The current inflation levels are well below central banks’ official targets, which typically is around 2%.

The spectre of deflation

Deflation signThe biggest problem facing the rich world’s central banks today is that inflation is too low and keeping on falling. In economics, deflation is a decrease in the general price level of goods and services. Deflation occurs when the inflation rate falls below 0%.

Economists generally believe that deflation is a dangerous problem in a modern economy because it increases the real value of debt, and may aggravate recessions and lead to a negative spiral.

Deflation is often accompanied by a psychological element. As consumers and companies grow more pessimistic about the economy or their standard of living, they tend to hoard cash instead of spending it. Likewise, banks tend to slow their lending and companies delay their expansion plans. This leads to a negative circle which may cause recessions that can be very difficult to get out of.

As Japan’s experience in the past 20 years shows, deflation is both deeply damaging and hard to escape in weak economies with high debts. Since loans are fixed in nominal terms, falling prices increase the burden of paying them. And once people expect prices to keep falling, they put off buying things, weakening the economy further. There is a real danger that this may happen in parts of Europe. Both Greece’s and Spain’s consumer prices are now falling, and other countries are close to zero inflation.


This morning, Financial Times published a video where Stephen King, chief economist at HSBC, tells FTs John Authers that Europe’s central bankers today have a hard task.

Stephen King on the spectre of deflation

Leave a comment

Your email address will not be published.

19 − four =