A Weaker Euro for a Stronger Europe

CAMBRIDGE – Despite the recent upturn in some of its member countries, the eurozone’s economy remains in the doldrums, with the overall rate of annual GDP growth this year likely to be only slightly higher than 1%. Even Germany’s growth rate is below 2%, while GDP is still declining in France, Italy, and Spain. And this slow rate of growth has kept the eurozone’s total unemployment rate at a painfully high 12%.

Slow growth and high unemployment are not the eurozone’s only problems. The annual inflation rate, at just 0.5%, is now so close to zero that even a minor shock could push it into negative territory and trigger a downward price spiral. Deflation would weaken aggregate demand by raising the real (inflation-adjusted) value of household and corporate debt, and by increasing real interest rates. Lower demand could, in turn, cause the fall in prices to accelerate, sending prices into a dangerous tailspin.