ECB Chief: Eurozone May Get Caught In Negative Spiral

ECB Chief: Eurozone May Get Caught In Negative Spiral

President of the European Central Bank, Mario Draghi has indicated there is a risk that the euro zone may be caught in a negative spiral of falling prices. Draghi acknowledges the danger of the euro zone getting caught in a “classic deflationary cycle”. This will require massive purchase of bonds or other assets to effect a reversal.

The central bank's president is yet to provide details of what action banks might take to meet the situation's demands ahead of the meeting on June 5. In recent weeks, Mr. Draghi has joined other members of the ECB in indicating that they are now contemplating further steps for reviving the euro zone economy.

Members of the governing council are still debating regarding the right response to 3 particular issues of falling prices, uneven growth and tight bank credit. The central bank has to push inflation currently at an annual rate of 0.7% to the official target of below 2 percent.

Mario Draghi has indicated that the ECB is now on the lookout for signs of deflation. He spoke in direct language about the risk regarding the fall of the euro zone into a deflationary state. This is when expectations of fall in prices lead to delay in purchases. This then damages corporate profits and prevents job growth or healthy hiring patterns in the economy.

What is now needed is to be watchful for the time when the potential for the negative spiral occurs between low inflation, a fall in the expectations of inflation and credit. This is more so in particular countries under stress, according to Mr. Draghi.

He has also discussed how a over prolonged period of inflation below current expectations will lead to a more expansionary stance. This is the context of a broad based asset purchase program.

Several economists have urged the ECB to follow the US Fed and purchase large quantities of government bonds and assets to pump cash back into the economy. However, leading analysts have indicated the ECB may not resort to an asset program. It is more likely that there will be a cut of the benchmark interest rate to 0.15% along with a negative deposit rate.

A negative deposit rate will push down the value of the euro relative to currencies such as the dollar. Mr. Draghi had discussed how the rise in euro had been the reason why commodity prices fell and led to low inflation.

Critical action is needed to revive the euro zone economy. The slow recovery in 18 countries which share the euro currency is the reason why many economists feel that it is critical to act soon. This is essential to prevent Europe from falling into a downward price spiral.

Some analysts are also suggesting the imposition of a negative interest rate on money deposited in banks leading to lending rather than hoarding of money. Mr. Draghi is no doubt considering all the angles. A recovery of the euro zone economy will reap rich benefits, especially for many countries still struggling with financial crises. Unemployment has currently reached 11.8% here.