## Disinflation in EU Countries outside the Eurozone _IMF Blog, February 2, 2015_ ## Source details **Canonical URL:** [Disinflation in EU Countries outside the Eurozone](https://www.imf.org/en/blogs/articles/2015/02/02/disinflation-in-eu-countries-outside-the-eurozone) ## Other formats - [Markdown version](/en/blogs/articles/2015/02/02/disinflation-in-eu-countries-outside-the-eurozone/index.md) - [Structured JSON version](/en/blogs/articles/2015/02/02/disinflation-in-eu-countries-outside-the-eurozone/index.json) - [Bundle manifest](/en/blogs/articles/2015/02/02/disinflation-in-eu-countries-outside-the-eurozone/bundle-manifest.json) ## Bibliographic details - Authors: Plamen Iossifov, Jiri Podpiera - Published: February 2, 2015 --- ### Overview and context - Authors: Plamen Iossifov, Jiri Podpiera - Date: February 2, 2015 - Key observation: Inflation has been falling sharply across Europe since 2012. - Affected groups: - Countries pegging currencies to the euro: Bulgaria, Croatia, Lithuania (adopted the euro on January 1, 2015). - Inflation targeters experiencing declines: Czech Republic, Hungary, Poland, Romania. - Related IMF commentary: Risks from low inflation in the euro area discussed in the March 2014 iMFdirect post. ### Drivers of disinflationary dynamics - Primary drivers: - Falling world food and energy prices. - Cuts in administered prices of energy where relevant. - Core inflation trends: - Core inflation (excluding food and energy) has drifted down, tracing euro area price trends and diverging from the rest of the world. - Suggests disinflationary spillovers from the euro area via close trade links. - Findings from IMF Working Paper (Iossifov and Podpiera, 2014): - Falling world food and energy prices and related cuts in administered prices account for the largest share of the inflation decline in non-euro area EU countries in Central and Eastern Europe. - Falling euro area core inflation spills over through lower prices of imports to countries with currencies pegged to the euro and, to a smaller extent, to inflation targeters with higher foreign value-added content in domestic demand. - The domestic economic cycle (measured by the unemployment gap) has had a marginal impact in the recent disinflationary episode. - The nominal effective exchange rate has been proportionately more important in inflation targeters. ### Short-term benefits vs. medium-term risks - Short-run gains from lower oil and energy prices: - Lower energy prices boost purchasing power of households and businesses. - With still negative output gaps throughout the region, a pick-up in demand would benefit domestic producers. - Lower outlays ease liquidity strains of debt service for heavily indebted firms and households, reducing default risk and related negative effects on consumption and investment. - Medium-term costs and risks: - Risk of “second-round” disinflationary effects that can be difficult to reverse, increasing debt sustainability risks. - Falling prices could suppress domestic demand if households and firms revise down wage and profit expectations and cut consumption and investment, potentially triggering a self-feeding deflationary trap. - Persistent disinflation/deflation can complicate deleveraging by increasing the real debt burden, exacerbated if stagnating nominal incomes are not offset by lower nominal interest rates passing through to debt servicing costs. ### Near-term outlook and projections - With rapidly falling world oil prices, disinflation pressures are unlikely to abate soon. - According to the latest WEO forecasts and IMF estimates: - Headline inflation is expected to stay low through 2015 in euro peggers. - Headline inflation is expected to remain below targets in Hungary, Poland, and Sweden. - The sharp decline in oil prices since June 2014 will continue to drag inflation lower as the commodity price drop filters through to domestic prices. ### Policy implications and options - Constraints and considerations: - Countries pegged to the euro lack independent monetary policy and must rely on the ECB’s quantitative easing (QE) response to persistently low euro-area inflation. - Where fiscal space allows, fiscal policy can be used to stimulate demand. - Inflation-targeting central banks should aim to bring inflation closer to target and prevent “second-round” disinflationary effects. - Policy instruments are at historical lows or at the zero lower bound, complicating further easing. - Further monetary easing must weigh benefits of normalizing price pressures against risks to financial stability and capital flows (and hence exchange rates). - Easing too much may prompt capital outflows; while outflows can help depreciate exchange rates and raise inflation, there is a risk the process may go too far—especially for countries with high shares of debt in foreign currencies. - These countries are more exposed to changing investor risk appetite, geopolitical concerns, and global financing conditions. - The recently announced QE by the ECB opens additional space for monetary easing by inflation-targeting central banks outside the eurozone. - Overall policy assessment: - The greater concern at present appears to be very low inflation and the possibility of sliding into a deflationary trap rather than financial instability from capital outflows. - Policymakers need to keep a watchful eye on markets while focusing on preventing second-round disinflationary effects. *Source: Disinflation in EU Countries outside the Eurozone — Plamen Iossifov, Jiri Podpiera (February 2, 2015).* --- ## References - [iMFdirect](http://blogs.imf.org/2014/03/04/euro-area-deflation-versus-lowflation/) - [https://www.imf.org/wp-content/uploads/2015/01/eur-disinflation-charts-1-2.jpg](https://www.imf.org/wp-content/uploads/2015/01/eur-disinflation-charts-1-2.jpg) - [https://www.imf.org/wp-content/uploads/2015/01/eur-disinflation-chart-3.jpg](https://www.imf.org/wp-content/uploads/2015/01/eur-disinflation-chart-3.jpg) - [https://www.imf.org/wp-content/uploads/2015/01/eur-disinflation-chart-4.jpg](https://www.imf.org/wp-content/uploads/2015/01/eur-disinflation-chart-4.jpg) - [IMF Working Paper](http://www.imf.org/external/pubs/cat/longres.aspx?sk=42411.0) - [https://www.imf.org/wp-content/uploads/2015/01/eur-disinflation-chart-5.jpg](https://www.imf.org/wp-content/uploads/2015/01/eur-disinflation-chart-5.jpg) - [WEO forecasts](http://www.imf.org/external/pubs/ft/weo/2014/02/) _Source: https://www.imf.org/en/blogs/articles/2015/02/02/disinflation-in-eu-countries-outside-the-eurozone_