Deflation and the eurozone: why falling prices aren’t always good news
As oil prices continue to fall, a strange phenomenon is making its presence felt across Europe: deflation. Familiar in Japan since the 1990s, consistently falling prices for the goods we buy are almost unheard of in Europe, not seen since the grim years of the 1930s. But according to figures released in December, prices inside the eurozone are now falling by 0.2% a year.
You might think this is good news. After all, as wages and salaries stagnate, declining prices means an increase in people’s real purchasing power. Each euro in your pocket stretches, on average, just a little bit further than before. And in the short term, the decline in the price of oil alone has fed into some improvements in real living standards – or, at the very least, set a floor to their decline.
If the price falls were confined to just falling costs of energy and transport, this positive argument could hold. In the mid-1980s, a sharp fall in the price of oil led to briefly falling prices in Germany and other European countries without further consequences.
The reality of falling prices
But should declining prices spread and persist, there are two serious causes for concern. First – if you know that the price of anything you buy will be less in the future, why not wait until the future to buy it? A general expectation that prices will fall rather than rise creates a major disincentive to buy. Demand falls, less is sold, the recession worsens.
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