The inflation rate in the EZ fell to 0.7% in October. That is well below the inflation target of 2% and it increased concerns about the threat of deflation. It is very difficult to control price deflation once the deflation spiral gets started. When prices fall, corporate business profits fall and wages must be reduced. That leads to a fall in consumer spending which further reduces profits. Deflation is also bad for debt holders. The value of their loans remain constant but they must service their debt with falling income. Their debt burden is therefore increased and the risk of default rises along with reduced access to credit.
The rate reduction by the ECB will not be popular with central bankers in Germany. They believe that deflation is good for the EZ periphery. Falling wages will make them more price competitive and increase their ability to grow their economies through exports. The problem with that theory is that it is impossible for every country in the EZ to run trade surpluses without increasing trade deficits among their trading partners. Global current accounts must balance out at zero.
The action by the ECB also raises concerns about slow economic growth in the EZ. Price deflation is usually associated with recession or depression.
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