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By HaleStewart April 16, 2014 8:25 am
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Crunch Time For the EU on Deflation

Today we learned that EU inflation has dropped again.  Eurostat announceed:

Euro area1 annual inflation was 0.5% in March 20142, down from 0.7% in February. A year earlier the rate was 1.7%. Monthly inflation was 0.9% in March 2014.

European Union3 annual inflation was 0.6% in March 2014, down from 0.8% in February. A year earlier the rate was 1.9%. Monthly inflation was 0.7% in March 2014.

As the accompanying chart shows, inflation is clearly moving lower:

While declining prices may seem like a benefit to an economy, they can create a deflationary spiral.  When this happens, consumers continually put off purchases as they think prices will be lower in the future.  This slows economic activity which leads businesses to slow their activities.  This leads to increased lay-offs which begins to lower aggregate demand, leading to lower prices etc....  At some point, this process becomes a circle moving forever lower and is typified by the Japanese economy over the last 20 years.

There is no magical economic line that deflation must cross in order to a central bank to act.  However, we are now at the point when the ECB has to act if only to begin a prevention of the deflationary cycle progressing further.

Hale Stewart is a former bond broker who has been writing about economics and financial markets since 2006 on the Bonddad Blog.  He is also a tax attorney with a domestic and international practice while also forming and managing captive insurance companies for US companies.   You can follow him on twitter at:@captivelawyer

 

 

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