The chief economist of the IMF has recently disseminated that the EU faces a risk of deflation which may have averse effects in the coming months or year. Recently, the EU has been running well below growth forecasts in lieu of recent global economic volatility. Inflation, which is currently running at .8 percent has been under the 2 percent benchmark set by the European Central Bank. In particular, Spain and Portugal have elicited larger deflation numbers and as a result has dragged inflation below the optimal levels and has been a “double-edged sword.” When currencies are deflated, exports as a result are bolstered due to increasingly cheaper prices for foreign countries but on the other hand can increase the real interest rate, causing real debt to rise in value. With both externalities juxtaposed, many predict the latter to be the greater effect and if this begins to be the trend, can result in even lower output and further deflation as a result.
Oliver Blanchard, the IMF’s chief economist has aroused efforts to counter this negative process for the future, calling upon all central banks in countries around the EU and whoever may want to help. When deflation occurs, this can stray prices from their long term actual values which can result in all sorts of disasters, including potential house or asset bubbles from a housing boom. Blachard raises concerns amongst a fragile environment currently, and his words should be heeded, otherwise the EU could exacerbate the current issue. The longer deflation lasts, the longer the EU could be mired in stagnation, only to make the situation graver and more difficult to get out of. The EU has some serious decisions to make, otherwise may be in even more trouble.