Our wage and price setting mechanisms are simply not flexible enough to allow widespread or persistent deflation in the absence of a severe or prolonged recession. Although formal wage indexation in Europe is considerably lower than in earlier decades, we are not at the point where nominal wage cuts are likely to be broadly accepted. Similarly, nominal price declines are also rather rare.
Deflationary risks generally arise from one or more of the following factors – the bursting of an asset price bubble, difficulties in the financial sector or ongoing losses by businesses. Clearly these triggers are generally interconnected, and can reinforce each other. These interdependencies make deflation such a difficult problem and its impact widespread and corrosive.