CeBER Working Paper No. 2017-12

Two main issues, closely related to each other, have occupied the European Central Bank in recent years: the sovereign debt crisis and the possibility of deflation in the Euro Zone. In this paper we discuss the causes, the consequences and the policy options regarding deflation. In addition, we assess the magnitude of the risk of deflation in the Euro Zone. For this purpose, we will employ the methodology of Kilian and Manganelli (2007). Our results suggest that the threat of deflation in the Euro Zone is related to the international financial crisis and to the sovereign debt crisis in Europe. Thus, the probability of deflation in the Euro zone increased in recent years. Nevertheless, it appears to have subsided in 2017, justifying the view taken by the ECB’s Governing Council, according to which deflation is no longer a problem for the Euro zone.