Although most observers shake their heads when they discuss inflation, the truth is that inflation is generally easier to handle than deflation. True, the purchasing power of your savings declines, but during inflationary periods interest rates move higher, pay packages go up, and debt burdens become more manageable.
Deflation, on the other hand, can be depressing - interest rates move to extremely low levels (see Japan) and the massive leverage that has built up in the system becomes very difficult to repay.
I believe that the turmoil in the euro block will lead to even more deflationary trends if the latest rescue package doesn't work. Today's evidence comes from Spain, which has 20% unemployment and huge fiscal debts. I suspect the Spanish government would welcome a little inflation but that's not what is happening:
Spain’s economy emerged from an almost two-year recession in the first quarter, even as unemployment rose to 20 percent. After the third-largest budget gap in the euro region prompted a surge in Spain’s borrowing costs, the government announced a 5 percent reduction in civil servants’ wages this week and said the measures could undermine the return to growth.
“It’s the start of a trend,” said Luigi Speranza, an economist at BNP Paribas in London who first forecast deflation in Spain more than a year ago. “It’s an adjustment mechanism, a way of gaining competitiveness.”
Spain’s Core Inflation Turns Negative for First Time (Update3) - BusinessWeek
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