The IMF issued a report on the rising risk of a debt deflation spiral in the eurozone. It views the eurozone as half finished project. The financial crisis has created de-integrating forces that cannot be addressed in its current form. One analyst claims that there are no policy measures in sight that address the downward spiral.
Deflation often accompanies serious recessions. Households stop spending because they believe that prices will be lower in the near future. Falling asset prices exacerbates the problems for banks that already have problem loans, and falling product prices creates profit problems for businesses that lead to decreased investment and layoffs. Even a mild recession could ignite a deflationary spiral. Economic growth in large economies like Italy and Spain is necessary to reduce the risk of price deflation.
The US faced similar problems during the financial crisis. The Federal Reserve took steps to recapitalize the banks and to increase the money supply. The central bank in the eurozone does not have the freedom of operation that is available to the Federal Reserve. Angela Merkel has attempted to provide support for the ECB but she is faced with legal and political problems in Germany that create uncertainty about the role of the ECB in this crisis.
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