Deflation in the euro zone: How serious is the risk of deflation in the euro zone?

Posted: January 14, 2014 in economy
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We are hosting a roundtable discussion of the risk of deflation in the euro zone. Next up is Demosthenes Tambakis, fellow and director of studies in economics and finance at Pembroke College, Cambridge.

In the short-term, evaluating deflation risk requires an assessment of inflation expectations. The latter are stubbornly low and likely to decline further, a situation that may have as much to do with the fragile state of European banking as with most euro-zone countries’ anaemic recoveries or, in the periphery, being mired in recession. Prolonged weakness of aggregate demand is sustained by banks’ reluctance to deleverage seriously and kick-start healthy credit growth—an agonizingly slow process, given record unemployment at 12.2%, for which European politicians are ultimately responsible. In the long-term, my recent work shows that deflation risk increases in the presence of zero-lower-bound (ZLB) events, that is, episodes when policy rates are at or near zero. In normal times, ZLB risk amounts to the average time remaining before policy rates hit zero. In the long run, however, ZLB risk involves the length of time they are expected to be stuck at zero. Viewing euro-zone deflation risk from a long-term perspective, it appears higher today than a year ago. That is partly because the ECB’s mandate is to maintain price inflation just below 2%, while the Fed’s is …

via Economic Crisis http://www.economist.com/blogs/freeexchange/2014/01/deflation-euro-zone?fsrc=rss

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