The Money Trap

By PAUL KRUGMAN, NYT

When Greece hit the skids almost four years ago, some analysts (myself included) thought that we might be seeing the beginning of the end for the euro, Europe’s common currency. Others were more optimistic, believing that tough love — temporary aid tied to reform — would soon produce recovery. Both camps were wrong. What we actually got was a rolling crisis that never seems to reach any kind of resolution. Every time Europe seems ready to go over the edge, policy makers find a way to avoid complete disaster. But every time there are hints of true recovery, something else goes wrong.

And here we go again. Not long ago, European officials were declaring that the Continent had turned the corner, that market confidence was returning and growth was resuming. But now there’s a new source of concern, as the specter of deflation looms over much of Europe. And the debate over how to respond is turning seriously ugly.

Some background: The European Central Bank or E.C.B., Europe’s equivalent of the Federal Reserve, is supposed to keep inflation close to 2 percent. Why not zero? Several reasons, but the most important point right now is that an overall European inflation rate too close to zero would translate into actual deflation in the troubled economies of southern Europe. And deflation has nasty economic side effects, especially in countries already burdened by high debt.

So it’s a source of great concern that European inflation has started dropping far below target; over the past year, consumer prices rose only 0.7 percent, while “core” prices that exclude volatile food and energy costs rose only 0.8 percent.

(More here.)