Deflationary risk: Which countries are most likely to be impacted?

Then we look at the forecast output gap in 2014 for those countries. We then rank the countries for both variables, and add the two results to rank the countries again based on this combined score. That final ranking is thus based on an unweighted average of the other two ranked scores.

Those most susceptible to lowering prices are generally the peripheral countries that are currently working to recover their economies from the crisis and to regain competitiveness with the core, as shown in Table 1. But one of the core countries, France, also makes the list. Taking into account the weak economic growth in France and Italy over the first half of 2014, these two are especially likely to face further disinflationary pressure.

deflationary risk

As mentioned, one of the main ways in which low inflation reduces economic growth is by raising the real debt burden. Chart 6 ranks the selected countries by the total debt in their economy. The combination of low inflation and high debt will make the economic recovery more difficult and vulnerable to setbacks in these markets, with a subsequent negative impact on the overall Eurozone economy.

Since the Eurozone is the world’s second largest economy, persistent low inflation or deflation may also pose a severe risk for other countries, especially its primary trading partners in the rest of Europe. Countries like Hungary and the Czech Republic, both of which export goods worth about half of their GDPs to the Eurozone, may face weaker growth potential as a result of lower demand from the Eurozone. This may also be exacerbated by depreciation of the euro and lower confidence.

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