A case study taken from Italy's situation: Deflation in Italy and the Euro zone

1. The Euro zone fell into deflation in October (see Chart): prices fell by 0,2 % . Italy has experienced deflation for a few months. Unemployment in Italy is over 13% with youth unemployment 43.9% Contractionary policies in Italy have led to a fall in output and an increase in the debt to GDP ratio from 116 % to 133% over the past three years. The velocity of circulation of money in Italy has been falling despite of very low interest rates.

(a) Using MV=PY what can we say about the causes of deflation in Italy and Europe?

(b) When inflation “takes off” there is frequently a difference between the “official” statistic and the “real “statistic? Might the same also be true for deflation?

(c) How would Quantitative Earning attempt to deal with deflation?

(d) Could fiscal policy through tax cuts or increased government spending help?

(e) Is there a difference in deflation which results from (i) a fall in M, the stock of money (ii) an increase in the demand for money (drop in (V) velocity of circulation of money), (iii) an increase in the real output of the economy through improvements in technology, higher productivity, innovation?