Deflation Risk in Europe and the United States

The United States and Europe are at risk of deflation, says John Malkin, a resident scholar at the American Enterprise Institute.

Quantitative easing sparked widespread fears of inflation, and the focus on the potential for hyperinflation led many to fail to notice a drift toward deflation.

Europe is heading quickest toward deflation.

– In 2011, Europe’s overall inflation rate was 3 percent year over year. By the end of 2012, it had fallen to 2 percent. In October, the euro area inflation rate dropped from a 1.1 percent pace in September to 0.7 percent.

– If this pace keeps up, Europe could be in full deflation next spring. Bulgaria, Greece and Latvia have already seen outright deflation. Even Germany, the best performing European nation, saw a drop in its inflation rate from 1.6 percent year-over-year in September to 1.3 percent in October.

– Disinflation (a period of falling inflation) has accelerated due to the European Central Bank’s tight monetary policy and Europe’s austerity measures. To halt deflation (negative inflation), Europe would need to increase quantitative easing, tax cuts or spending growth. This seems unlikely, as Europe is reducing its deficit, cutting spending, and instituting higher taxes.

Central banks should stop worrying about asset bubbles and future inflation and instead focus on the potential for deflation. Both the Federal Reserve and the European Central Bank should look for a balance between quantitative easing and tightening their monetary policy.

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