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The euro zone’s consumer price inflation rate declined below 1% in early 2014, getting closer to zero during 2014, nowhere near the ambitious 2% benchmark set by central banks. A further small downward adjustment in the inflation rate has put it into negative territory, so harmonized euro area consumer prices are now declining. Western monetary authorities and economists appear genuinely fearful of deflation. Headlines in leading papers reflect this fear very strongly, describing deflation as “the world’s biggest economic problem”, or a “nightmare that stalks Europe” that could lead to its “demise and collapse”.
The real question is though, why do our governments fear deflation? Why do they perceive it as a chronic disease that could infect the economy and why do they go to such great lengths to avoid this “taboo” event? The mainstream argument is that we should avoid deflation because it causes a drop in overall demand and hence lowers economic growth (Germany and other European countries have experienced a slowdown recently which has resulted in a downgrade of 2014 and 2015 growth expectations). Also, deflation implies lower corporate earnings and asset prices, particularly real estate prices.