It's official: Inflation in Europe has shifted into reverse. But growing worries about a prolonged, painful bout of deflation may be premature.
The European statistics office confirmed Wednesday that prices in the 18 countries using the euro were 0.2 percent lower in December than a year before, after rising 0.3 percent in November. The last time prices slipped into reverse, in October 2009, the euro zone was in the grip of the global Great Recession.
Now, as Europe—and much of the rest of the world—slogs through a faltering recovery, there are fears that falling prices in the euro zone's stagnant economy could spark an extended period of deflation, when the consumer prices of finished goods fall over an extended period.
If it takes hold, deflation can be agonizingly difficult to reverse. A downward price spiral could prompt businesses and consumers to cut back on spending and investment, waiting for prices to fall further, setting off an economic contraction that can deepen.
That's why European central bankers are scrambling to avoid that scenario. One widely expected antidote would involve massive bond buying to pump cash in the European banking system and revive spending and lending. The European Central Bank is set to consider such a move at its next meeting Jan. 22.
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Until then, the price crash has rattled investors. Demand for the safe haven of German bonds was so strong this week, the yields on some issue actually turned negative—meaning investors were willing to lose a little money to avoid the risk of losing more in other investments.
But those worried about deflation may be jumping the gun. There are reasons to believe this initial flirtation with deflation may not be as painful as the economic textbooks warn.