The probability of a Eurozone break-up

Deflation refers to the generalised negative change in the level of prices. Once it sets in it leads to a phenomenon called debt deflation which, if not checked through fiscal or monetary policy, the effects for the economy will be certainly dire.

Debt deflation refers to the causal interdependencies between debt, deflation and default. Under this process, a generalised fall in prices triggers the sale of financial and real assets in order to pay off debts. But the sale of these assets leads to a further fall in the prices of goods which reduces profits and leads to job losses. These in turn reduce wages and demand leading to a further fall in prices.

Yet, despite the fact that wages and profits fall, debt payments do not decline, a fact which increases real debt levels and hence defaults leading to a rise in non-performing loans which threatens the integrity of the banking system. In the context of the Eurozone, deflation would also be a big problem for the heavily indebted peripheral states which would see their borrowing costs increase and their tax revenues reduced.

The probability of a Eurozone break-up | Cyprus Mail.

 

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