Blog Post

Is there a risk of deflation in the euro area?

Even though the euro area as a whole has not yet entered into deflation, this picture is worrying. Low inflation rates will make the relative price adjustment in the euro area more difficult, complicate debt deleveraging and put the sustainability of debt at risk.

By: , and Date: April 3, 2014 Topic: European Macroeconomics & Governance

This is a policy question of high relevance as low inflation rates can undermine the sustainability of public and private debt, make relative price adjustment in the euro area more difficult, and eventually risk creating negative economic dynamics. We review some of the recent evidence and focus in particular on the heterogeneity of inflation developments in the euro area, the expectations of inflation measures and a measure recently used by Mario Draghi, namely the number of items in the HICP basket that are in deflation. We draw a parallel to Japan, where this measure was a useful indicator of deflation.

Inflation developments in the euro area

Panel A of Figure 1 shows that headline inflation has been on a downward trend in the euro area since late 2011. Core inflation – which excludes more volatile components of HICP, namely unprocessed food and energy – shows the same tendency (Panel C).

Figure 1: Inflationary developments in the euro area, January 1999 – February 2014 (percent change from the same month of previous year)


Panel A: Headline inflation Panel B: Constant tax inflation Panel C: Core inflation

Source: Eurostat. Note: core inflation is defined as the ‘Overall index excluding energy and unprocessed food’. Data for core inflation in Slovakia is not available for the full period and therefore this country is not included in the second group. The constant-tax inflation rate is not available for Ireland and Finish data starts only in 2006.

Figure 1 also indicates the existence of major differences across euro-area countries. Countries in the so-called euro area periphery (defined here as Cyprus, Greece, Ireland, Italy, Spain and Portugal) recorded higher inflation rates than the other euro-counties before the crisis and most of them have been experiencing lower inflation rates since 2012. Panel B of Figure 1 shows inflation at constant tax rates, i.e. excluding the potential impact of the increase in consumption taxes (value added taxes and other duties). Correcting for tax-hikes points to more marked deflationary tendencies in the most vulnerable countries since 2012.

Country-level inflation data (figure 2) indicates that some countries are already experiencing outright deflation. Greece and Cyprus entered deflation in March 2013 and October 2013 respectively, and stayed in negative territory thereafter. In February 2014, the Spanish and Irish HICP rates dropped to 0.1%, while Portugal and Slovakia (not shown in the graph) entered negative territory (-0.1% respectively). And the first estimate for the Spanish inflation in March indicates that the country may have also entered deflation, with the HICP rate estimated to fall to -0.3% (INE, March 2014) . Overall, a downward trend in inflation rates is clearly visible, even in the core countries.

Figure 2 – Inflation developments in selected countries, Jan 2012 – Feb 2014 (percent change from the same month of previous year)

Source: Eurostat

During the February 2014 monthly press conference, ECB’s President Draghi pointed out that the ECB does not see “much of a similarity with the situation in Japan in the 1990s and early 2000s” as “during the period of deflation in Japan, over 60% of all commodities experienced a decline in prices” while “the percentage for the euro are much lower”. The data show that the number of items considered for the calculation of the harmonised index of consumer price index (HICP) that are in deflation has increased significantly in recent months to about 20%. This share is much lower than the Japanese share of about 50-60% between 2000 and 2004 and between 2009 and 2012. Interestingly, in 2004-2005 also approximately 20% of the items were in deflation in the euro area, at a time when the headline inflation was about 2%. From this perspective, the euro area seems to be still far away from a Japanese scenario, where deflation was broad-based, as Mario Draghi pointed out.

Figure 3, HICP basket, items count

Source: Bruegel calculations based on Statistics Bureau of Japan, Eurostat, OECD

Inflation expectations

Over the recent months, the ECB has continually stressed that inflation expectations remain well anchored at 2%, and that more forceful action is therefore not needed. Indeed, Figure 4 shows that inflation expectations for the long-term fell only slightly, but this is less true for the shorter term. Professional forecasters have been revising their forecasts downward, reflecting negative surprises in the behaviour of inflation.

Figure 4, Survey of Professional forecasters, 2 year and long-term inflation expectations

Source: ECB

Market-based measures of inflation expectations built from inflation swaps (Panel A of Figure 5) confirm that inflation expectations are well below 2% in the short- and medium term and do not point to a revival in inflation for the near and medium term. More importantly, the fact that long-term inflation expectations have remained anchored around 2%, until now, should not be taken as a fully reassuring. In Japan, long-term inflation expectations(see figure 7 in Antolin-Diaz, 2014) remained around 1% on average between 1999 and 2013, despite actual inflation being negative (-0.2%).

Moreover, Panel B of figure 5 suggests that inflation expectations could have a backward-looking component (i.e. economic agents could use past data to form their expectations on future inflation, especially for the long term). The recent drop in headline inflation could therefore explain why inflation expectations at a ten-year horizon have been falling from 2.5% in 2012 to 1.75% in April 2014. This could be dangerous as a prolonged period of low inflation could dis-anchor inflation expectations, which might become a problem for the ECB in the long run.

Figure 5

Panel A: Market expectations on inflation Panel B: OIS Inflation linked swaps

Source: Datastream

Today, Eurozone inflation is at 0.5%, i.e. its lowest level since November 2009. Inflation expectations and inflation forecasts, including the ECB staff projections, do not suggest a quick return to an overall euro-area inflation rate that can be regarded to being close to two percent in the next few years. Despite this, the ECB has not announced any new measure since last November’s monthly press conference. Even though the euro area as a whole has not yet entered into deflation, this picture is worrying. Low inflation rates will make the relative price adjustment in the euro area more difficult, complicate debt deleveraging and put the sustainability of debt at risk.

A more difficult question is which monetary and/or structural measures would be best suited to increase inflation rates. We address this question in a forthcoming paper that we write together with Zsolt Darvas and Guntram Wolff.


Republishing and referencing

Bruegel considers itself a public good and takes no institutional standpoint. Anyone is free to republish and/or quote this post without prior consent. Please provide a full reference, clearly stating Bruegel and the relevant author as the source, and include a prominent hyperlink to the original post.

Warning: Invalid argument supplied for foreach() in /home/bruegelo/public_html/wp-content/themes/bruegel/content.php on line 449
View comments
Read about event More on this topic

Past Event

Past Event

Perspectives on Universal Basic Income

At this event, we discussed the possible benefits but also the possible disadvantages of Universal Basic Income.

Speakers: Grégory Claeys, Olli Kangas, Professor Philippe Van Parijs and Prof. Dr. Hilmar Schneider Topic: European Macroeconomics & Governance Location: Bruegel, Rue de la Charité 33, 1210 Brussels Date: July 12, 2017
Read article More on this topic More by this author

Blog Post

The forward guidance paradox

What’s at stake: the term “forward guidance” is used in economic jargon to describe central bank communications about the likely future path of policy rates. Standard monetary models imply that far future forward guidance has huge effects on current outcomes, and recent literature has been trying to reconcile this with reality.

By: Silvia Merler Topic: European Macroeconomics & Governance Date: July 10, 2017
Read about event

Past Event

Past Event

Is there a way out of non-performing loans in Europe?

At this event we looked at the issue of non-performing loans in Europe. The event also saw the launch of the latest issue of "European Economy – Banks, Regulation and the Real Sector."

Speakers: Emilios Avgouleas, Giorgio Barba Navaretti, Giacomo Calzolari, Maria Demertzis, Martin Hellwig, Helen Louri and Laura von Daniels Topic: European Macroeconomics & Governance, Finance & Financial Regulation Location: Bruegel, Rue de la Charité 33, 1210 Brussels Date: July 6, 2017
Read article Download PDF More on this topic

External Publication

Review of EU-third country cooperation on policies falling within the ITRE domain in relation to Brexit

What is the possible future relationship between the EU and the UK in light of Brexit? The report provides a critical assessment of the implications of existing models of cooperation between third countries and the European Union on energy, electronic communications, research policy and small business policy.

By: J. Scott Marcus, Georgios Petropoulos, André Sapir, Simone Tagliapietra, Alessio Terzi, Reinhilde Veugelers and Georg Zachmann Topic: European Macroeconomics & Governance Date: July 5, 2017
Read about event

Upcoming Event


Bruegel Annual Meetings 2017

The Annual Meetings are Bruegel’s flagship event. They offer a mixture of large public debates and small private sessions about key issues in European and global economics. In a series of high-level discussions, Bruegel’s scholars, members and stakeholders will address the economic policy challenges facing Europe.

Speakers: José Antonio Álvarez Álvarez, Agnès Bénassy-Quéré, Pervenche Béres, Jean Luc Demarty, Anna Ekström, Lowri Evans, Sandro Gozi, Peter Grünenfelder, Patrick Graichen, Reiner Hoffman, Levin Holle, Steffen Kampeter, Peter Kažimír, Emmanuel Lagarrigue, Steven Maijoor, Nathalie Moll, James Murray, Carlos Sallé Alonso, André Sapir, Dirk Schoenmaker, Mateusz Szczurek, Marianne Thyssen, Liviu Voinea, Johan Van Overtveldt, James Waterworth, Ida Wolden Bache and Guntram B. Wolff Topic: Energy & Climate, European Macroeconomics & Governance, Finance & Financial Regulation, Global Economics & Governance, Innovation & Competition Policy Location: Square - Brussels Meeting Centre
Read article More on this topic More by this author

Blog Post

Eurozone or EU budget? Confronting a complex political question

This week’s European Commission reflection paper is the latest document to ponder a distinction between EU and euro-area budgets. But do we need to split the two, and what would each budget be used for? In this post, I present an analytical framework for assessing this ultimately political question

By: Guntram B. Wolff Topic: European Macroeconomics & Governance Date: June 29, 2017
Read about event

Upcoming Event


Unfinished business: The unexplored causes of the financial crisis and the lessons yet to be learned

At this event Tamim Bayoumi will present his upcoming book on the financial crisis, showing how how the Euro crisis and U.S. housing crash were, in fact, parasitically intertwined.

Speakers: Tamim Bayoumi, Maria Demertzis and Aerdt Houben Topic: European Macroeconomics & Governance, Global Economics & Governance Location: Bruegel, Rue de la Charité 33, 1210 Brussels
Read article More on this topic More by this author

Blog Post

Raising the inflation target: a question of robustness

In an unexpected move, the Federal Reserve Chair Janet Yellen has recently brought up the issue of raising the inflation target. This blog argues that an increase in inflation targets may prove to be beneficial in achieving price stability in the long run. This would increase the credibility of central banks in achieving inflation goals and stave off the distortionary effects of deflation.

By: Maria Demertzis Topic: European Macroeconomics & Governance Date: June 22, 2017
Read article More on this topic

Blog Post

Can EU actors keep using common law after Brexit?

English common law is the choice of law for financial contracts, even for parties in EU members with civil law systems. This creates a lucrative legal sector in the UK, but Brexit could make UK court decisions difficult to enforce in the EU. Parties will be able to continue using English common law after Brexit, but how will these contracts be enforced? Some continental courts are preparing to make judicial decisions on common law cases in the English language.

By: Uuriintuya Batsaikhan and Dirk Schoenmaker Topic: European Macroeconomics & Governance Date: June 22, 2017
Read article More on this topic More by this author

Blog Post

The size and location of Europe’s defence industry

There is growing debate about a common European military policy and defence spending. Such moves would have major economic implications. We look at the supply side and summarise some key facts about the European defence sector: its size, structure, and ability to meet a possibly increased demand from EU member states.

By: Alexander Roth Topic: European Macroeconomics & Governance Date: June 22, 2017
Read article More by this author

Parliamentary Testimony

House of Commons

Exiting the European Union Committee

On 19 April 2017 Zsolt Darvas appeared as a witness at the Exiting the European Union Committee, the House of Commons, United Kingdom.

By: Zsolt Darvas Topic: European Macroeconomics & Governance, House of Commons, Testimonies Date: June 20, 2017
Read article More on this topic More by this author

Blog Post

Brexit and the future of the Irish border

The future of the Irish land border has been thrown into uncertainty by Brexit. The UK's confirmation that it will leave the EU's single market and customs union implies that customs checks will be needed. However, there is little desire for hard controls from any of the parties involved. This is especially true for Theresa May's potential partner, the DUP. Creative solutions are needed to reach a solution.

By: Filippo Biondi Topic: European Macroeconomics & Governance Date: June 19, 2017
Load more posts