Policy Briefs

P. Canofari, M. Messori: RISKS OF DEFLATION IN THE EMU – Why is this time so deceitful?

The deep recessions characterizing the European Economic and Monetary Union (EMU) between the second semester of 2008 and the end of 2009, and from the last quarter of 2011 to the first quarter of 2013, were particularly severe for the euro area peripheral member states. These countries have been subjected to a longer recessionary phase compared to the EMU‟s average. A large part of them has experienced a compression of the monetary wages and price levels during both the two crisis periods in order to curb their macroeconomic imbalances. Italy has flown into a triple dip since the first half of 2014. Given this picture, it is not surprising that three episodes of decreasing monetary prices for the euro area as a whole can be identified. As shown later, these episodes coincide – respectively – with the peak of the international financial crisis during the last two quarters of 2008, the possible collapse of the American and European economic systems in the first term of 2009, and the main re-adjustment of macroeconomic imbalances implemented by EMU‟s countries in the last year (2014).

This paper aims at showing that the last episode is peculiar with respect to the previous two, due to the fact that the decrease in monetary prices since mid-2014 implies that the euro area has to face for the first time the deceitful problem of deflation. In order to justify this thesis, we will start by analyzing the EMU inflation dynamics starting from the creation of the euro area at the end of the Nineties, and the related evolution of inflation rate expectations (section 2). Then, we will show the 2014 structural deflationary process can be explained by the price compression in the EMU peripheral countries (section 3). Section 4 explains why the reality of the deflation in the euro area as a whole and in its weakest member states is not overrated. This will lead us to stress that the impact of this condition on the functioning of the European economy can be so negative to represent the most dangerous threat, impending on our difficult conditions (section 5). As shown by the Japanese „lost decade‟ and by the ambiguous effects of the consequent credit and quantitative easing measures implemented by the
Japanese central bank, changing a deflationary trend is not easy. However, the EMU has the possibility to implement monetary and fiscal policies apt to face this challenge (section 6). The open question is whether the political and institutional constraints at the European level and the lack of trust between member states at the inter-governmental level could compromise the implementation of the effective policies.

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