As European deflation risks rise, Italy stands to suffer more

Italy's finance minister said Tuesday he is convinced that compatriot, European Central Bank governor Mario Draghi, will begin taking steps to combat the risk of deflation -- a risky prospect all across the euro-zone but an especially dangerous one in heavily indebted countries like Italy.

Pier Carlo Padoan, Italy's finance minister, said in a radio interview that he is "convinced that the [European Central Bank] is getting ready to do more, also given the dismal inflation figures we recently got, with some deflationary cases."

As usual, Draghi's office was mum on the European Central Bank' s plans. But the prospect of falling prices in the euro-zone would have seemed an extreme long shot as recently as two years ago, when economists warned that prices were rising too quickly.

Since early 2012, however, inflation in Italy and for the European Union as a whole has fallen steadily, from an annualized rate of a little over 4 percent to annualized rates of 0.7, 0.5, 0. 5, 0.4, and 0.1 percent, respectively, in the five months through the end of July.

"The trend in recent months has been for the rate to fall and fall now it is approaching zero," University of Rome economist Salvatore Panaro said in an interview. "It's getting to the point that deflation is a real and serious risk."

Economists define deflation as a phenomenon in which prices fall over time rather than rise. But while it can have short-term benefits for consumers, who would pay less for some purchases, its negative consequences are more severe because it makes employers less likely to take on new workers for fear of being obligated to pay a salary that could become unsustainable over time, and because it increases real value of debt.

Those risks are especially poignant in Italy, where the biggest economic problems stem from an already high unemployment rate and the second highest level of government debt, in gross domestic product terms, in the European Union.

Deflation makes it more difficult for a country to spark growth, another challenge Italy's government is facing.

"There's no doubt that if sustained deflation sets in it will hurt Italy more than most other countries," Panaro said.

Some of Italy's largest cities including Rome, Turin, and Florence in July have already started to experience deflation, according to Italy's National Statistics Institute. Prices in Italy as a whole were just 0.1 percent higher than in July 2013, and were actually lower in big cites.

The news was enough for Codacons, the consumer advocacy group, to state its worries.

"There is a full deflation risk alarm in Italy," the group said in a statement. "The Italian economy is now facing the possibility of cardiac arrest."