© Carsten Brzeski
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The main cause lies in the process of structural adjustment and the fact that the liquidity that the ECB has been pumping in the economy was only into the banking sector. Therefore, it has not reached the real economy that has been in a long recessionary environment considering also that the recovery now is very gradual.
Moreover, we are now in an economic environment of deleveraging, which goes hand-in-hand with deflation. Deleveraging implies that we have fiscal austerity, households paying off their debt, the fact that households are being unemployment, and the corporate sector, especially in many peripheral countries, that is also engaged in deleveraging. Thus, all of the aforementioned aspects have contributed to the low inflation.
In case inflation continues to slow down, what are the main risks that will be faced by the Euro area economy and how could it impact other economies like the U.S. and China?
It should be noted that at the moment we have faced disinflation - low inflation that is currently set at the 0.8% level, but it is not falling prices. There is a risk of deflation, however, we are not in deflation, as deflation is defined as constantly dropping prices, and we are clearly not in that situation yet.
If it is to ever happen, the direct impact on other economic regions is not obvious. If you look at Japan, for example, which is a country that has been in a long period of real deflation, their impact on other regions was also limited or hardly visible. What is possible in a real deflationary environment, if you make a parallel with Japan, is a stronger Euro exchange rate.
Do you personally see inflation dropping even lower when we face real deflation?
No, and this is due to the fact that at the same time we see that the recovery is ongoing. Just recently we had the Eurozone confidence indicator at a 2-year high, thus, we do see that the recovery is gradual and fragile, but it is there. This means that there should be economic activity throughout 2014 and with economic activity the risk of deflation should gradually fade.
Do you see prices also picking in 2014 in such countries like Latvia and Cyprus, where prices have been falling significantly during the past months?
If you look at headline inflation, a lot, of course, also depends on commodity prices, which is hard to predict. However, normally I would also expect that if you look at a country with a negative inflation rate or deflation, then inflation there should also pick up gradually in the second half on this year.