With the eurozone flirting with deflation, solutions to this problem are urgently needed. One of them – the integration of markets and institutions – offers hope, according to Italy's minister of economy and finance, Pier Carlo Padoan.

A fear of a decline in prices has been taking shape over the past two years. The first mentions of deflation have been appearing in private conversations and public debate among economists in this time. However, caution and scepticism has prevailed.

Since then, the Italian ministry of economy and finance has recorded data that shows a continuous decrease in the level of prices in Italy. Is it necessary to intervene? Do we already have deflation? The problem with these questions is that by the time we wake up and realise there is deflation, it will already be too late. Exiting from deflation is very difficult, because if consumers start to expect lower and lower prices, they will develop a propensity to postpone spending and their expectations will be confirmed.

The eurozone is flirting with deflation, a prospect that should concern everyone within it. The European Central Bank's announced intervention seems to hold some promise of bringing price trends in line with its target level of inflation (below but close to 2%), and it is essential that this succeeds.

Taking control

With such a level of inflation, countries with a high national debt that also have firm control over their budgets – with a primary surplus and even reasonable growth – will be able to start reducing their debt. At the same time, this level of inflation would not erode the wealth and income of countries that are enjoying sustained growth.

However, monetary policy is only one of the levers that European institutions need to use. Equally important are the structural policies designed to help European economies recover the competitiveness needed in the global market. And finally, there are fiscal policies: countries with high debt need to use fiscal policy to ensure both the maintenance of their accounts and a better use of public resources.

Furthermore, at the level of the monetary union, fiscal policies must be employed also to ensure a recovery in domestic demand, mostly thanks to the investment of countries with budget surpluses. All countries in Europe would benefit from a growth in domestic demand, where a very low level is one of the causes of deflation.

Italy's answer

Italy's economic policy, in a country with high debt, is based on the integration of distinct policy levers. On the one hand, there is the stimulus to growth caused by the reduction of the tax burden offset by spending cuts, and more generally a change in the mix of income and expenditure that is improving the quality of public finance. On the other hand, there are reforms that are able to help the country get beyond the structural problems amassed over time, from the inefficiency of the labour market to the slow pace of the civil justice system. Finally, there are measures of liberalisation, simplification and incentives to finance and support private investment.

The coordinated use of different policy levers available to the European institutions, and the greater integration of national policies, are two plans that should be developed to respond definitively to the financial crisis that originated in the US and that may transform into a trap squeezing Europe into the grip of stagnation and deflation.

The key word here is integration. Market integration promotes growth, while institutional integration promotes mutual trust between communities and trust between citizens and institutions. More importantly, integration promotes confidence in the future. Without trust, the time horizon shortens and causes a deferral of consumption and investment decisions that should fuel the engine of recovery and employment generation.

Pier Carlo Padoan is Italy's minister of economy and finance.

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