The Risks of Deflation
When prices start falling, economies stop growing.
Lots of chatter these days about the chance of deflation (falling prices) and the risk of a slow-growth trap in the European Union and other major economies. So how great a risk is global deflation? What would it mean to the U.S.? (Inflation here is creeping up, though still only 1.5%.) And aren’t falling prices supposed to be a good thing?
SEE ALSO: 5 Reasons Bull Markets End
While the chances of worldwide deflation are modest, recent trends in Europe have been worrisome. Inflation rates have been slowing in the region’s powerhouse economies over the past year. Germany’s most recent 12-month inflation rate of 1.0% was 1.4% a year ago; the UK’s rate has fallen from 2.8% to 1.6%; France’s, from 1.0% to 0.6%; and Italy’s, from 1.6% to 0.4%. Many of the European periphery countries are experiencing outright price declines: Spain, Sweden, Greece, Portugal, Slovakia, Croatia, Bulgaria and others.
Inflation rates look better in the advanced economies outside Europe, though they are still low: The rate is 1.5% in the U.S., Japan, and Canada, and 2.4% in China. Chinese producer prices, however, have been declining for two years, indicating potential oversupply in the industrial sector.
From just $107.88 $24.99 for Kiplinger Personal Finance
Be a smarter, better informed investor.

Sign up for Kiplinger’s Free Newsletters
Profit and prosper with the best of expert advice on investing, taxes, retirement, personal finance and more - straight to your e-mail.
Profit and prosper with the best of expert advice - straight to your e-mail.
Deflation can be good for consumers, but it’s a high-stakes risk. Once deflation takes hold, an economy can get stuck in a no-growth trap. A downward price cycle is self-reinforcing in the same way that an upward inflationary price spiral is, as Japan has cause to know. In 1999, when prices there started to slide, consumers put off planned purchases and businesses delayed investments, assuming prices would be better tomorrow. Slower consumption threw a wet blanket on output, hiring and income, which in turn dampened prices and buying even more, and Japan spent a decade struggling to grow. Two decades later, prices are still below their 1994 level, despite massive increases in both public spending and debt.
What’s more, deflation is nearly impossible to uproot. Interest rates can go only so low, and, in real terms, deflation erodes their stimulative effect. So even a slim prospect of deflation can spook investors and businesses.
The European Central Bank is preparing to do what it takes to head it off. Already, the ECB has cut its interbank lending rate (similar to the federal funds rate set by the Federal Reserve) to 0.25%. Buying up bank loans in a kind of quantitative easing, like the Fed’s QE3 bond buying, may well come next, though that will take time. Another option is for the ECB to charge a fee for banks to keep their reserves parked there, a kind of negative interest rate, meant to encourage banks to plow their reserves into the economy instead.
But there’s little margin for error in Europe. Any negative shock to the economy would likely tip it into deflation and derail the region’s slow move back to health. Failure would mean slower exports and stronger headwinds for U.S. growth. In China, any deflation preventive may be as bad for the U.S. as the disease. Because it’s only producer prices that are sliding in China, Beijing will be tempted to bolster industrial production rather than try to spur more consumer spending. That would translate into a lower value for the yuan and more exports pumped out.
Profit and prosper with the best of Kiplinger's advice on investing, taxes, retirement, personal finance and much more. Delivered daily. Enter your email in the box and click Sign Me Up.

David is both staff economist and reporter for The Kiplinger Letter, overseeing Kiplinger forecasts for the U.S. and world economies. Previously, he was senior principal economist in the Center for Forecasting and Modeling at IHS/GlobalInsight, and an economist in the Chief Economist's Office of the U.S. Department of Commerce. David has co-written weekly reports on economic conditions since 1992, and has forecasted GDP and its components since 1995, beating the Blue Chip Indicators forecasts two-thirds of the time. David is a Certified Business Economist as recognized by the National Association for Business Economics. He has two master's degrees and is ABD in economics from the University of North Carolina at Chapel Hill.
-
Sam's Club Extends A Popular Shopping Perk
Sam's Club has adopted a new policy on Sundays and holidays. Learn what it is and how to save on a membership.
-
The Ultimate Cruise Packing List for Retirees
Ready to set sail on your dream cruise? Here’s a no-fuss packing list tailored for older travelers to keep your trip stress-free.
-
Apple Readies for AI Upgrade with New iPhones
The Kiplinger Letter The tech giant has stumbled when it comes to artificial intelligence, but a new batch of iPhones will help it make headway.
-
Japan Enters a New Era of Risk and Reform
The Kiplinger Letter Japan has entered a pivotal moment in its economic history, undertaking ambitious policy and structural reforms to escape from decades of stagnation.
-
How Consumers Are Tinkering with Cutting-Edge AI
The Kiplinger Letter Companies launching artificial intelligence tools are jostling for consumer attention. Some products are already building a deep connection with users.
-
After Years of Stagnant Growth, Hope Emerges for EU Economy
The Kiplinger Letter Can a German fiscal push outweigh French political peril?
-
Small Businesses Are Racing to Use AI
The Kiplinger Letter Spurred on by competitive pressures, small businesses are racing to adopt AI. A recent snapshot shows the technology’s day-to-day uses.
-
How AI Puts Company Data at Risk
The Kiplinger Letter Cybersecurity professionals are racing to ward off AI threats while also using AI tools to shore up defenses.
-
AI Start-ups Are Rolling in Cash
The Kiplinger Letter Investors are plowing record sums of money into artificial intelligence start-ups. Even as sales grow swiftly, losses are piling up for AI firms.
-
What is AI Worth to the Economy?
The Letter Spending on AI is already boosting GDP, but will the massive outlays being poured into the technology deliver faster economic growth in the long run?