Spain became the latest European country to report sliding prices, underlining fears that with inflation already at 0.7% across the 17 country single currency area in October, sky-high unemployment and a prolonged economic malaise may be dragging the eurozone towards a Japanese-style deflationary slump.

Madrid said prices in the crisis-hit country declined by 0.1% in the year to October, adding Spain to a list of countries – including Ireland, Greece and Cyprus – that are already mired in deflation.

Europe's policymakers insist the eurozone as a whole does not face a threat of falling prices. Jens Weidmann, the president of the Bundesbank, told an audience of German co-operative banks yesterday: "To say it very clearly: the European Central Bank council does not expect a deflation scenario."

But the very fact that Weidmann, who is known for his fierce anti-inflation stance, felt forced to make such a strenuous denial was revealing. While consumers in Britain are in the grip of a "cost of living crisis", as they struggle to cope with rocketing bills, across the Channel in the eurozone it is the spectre of falling prices that is starting to loom large.

When the European Central Bank unexpectedly cut interest rates to a record low of 0.25% last week it was widely interpreted as a strike against deflation. The bank's president, Mario Draghi, conceded: "We may experience a prolonged period of low inflation." But some commentators fear the ECB may have done too little, too late.

Dario Perkins, of consultancy Lombard Street, said the spectre of deflation was alarming, because the ECB has few weapons left in its armoury to fight it.

"If the ECB is right, and the economy improves from here, and we start to get some growth, then inflation shouldn't reach a negative level. If they're wrong, which we think they are, and you get continued stagnation, then deflation becomes a threat, and then they really are stuck," he said.

With little enthusiasm among eurozone politicians – not least in Weidmann's home country of Germany – for either the quantitative easing or the large-scale fiscal stimulus that would be the textbook response, it is unclear how policymakers could tackle a prolonged slide in prices.

"They're still very resistant to QE: they're opposed to it on a philosophical level," Perkins said.

The aggressive approach of the US Federal Reserve since the financial crisis struck has been a deliberate effort to ensure that the world's largest economy decisively avoided deflation, the causes and effects of which Ben Bernanke described in vivid terms in a widely-read speech back in 2002, before he succeeded Alan Greenspan as Fed chairman.

"Deflation is in almost all cases a side effect of a collapse of aggregate demand – a drop in spending so severe that producers must cut prices on an ongoing basis in order to find buyers. Likewise, the economic effects of a deflationary episode, for the most part, are similar to those of any other sharp decline in aggregate spending – namely, recession, rising unemployment, and financial stress," he said.

Speaking long before the crash, he mooted the idea of QE as one potential solution, once interest rates are close to zero.

Japan's experience certainly suggests that once deflation is allowed to take hold it can be difficult to break out of. Inflation plunged below zero in the mid-1990s, after the 1980s property boom turned spectacularly to bust.

In the decade from 1998, as the economy bumped along the bottom, prices barely increased; and the large-scale new bout of quantitative easing launched under the banner of "Abenomics" earlier this year is aimed at finally jolting inflation into positive territory.

Once prices start falling consumers pull in their horns, believing the car or the fridge they are thinking about buying will be cheaper in six months' time. Profits tend to fall; wages are dragged down in turn; and debtors struggle to meet their repayments – which are fixed – with declining wages.

There is early evidence that elements of this scenario are starting to take hold in some parts of the eurozone.

Wages are already falling fast in some of the worst-hit peripheral economies – by 0.1% a year in Portugal, 4.6% in Cyprus, and an extraordinary 10.1% a year Greece. Some economists interpret this as a sign that these recession-hit economies are becoming more "competitive" – squeezing labour costs is one of the few ways countries locked into a fixed exchange rate can make their goods cheaper on international markets. As Draghi put it in his press conference last week, "some of it is actually welcome in a sense because it shows that there are some relative price adjustments, a certain amount of rebalancing across countries".

But with the eurozone countries that could best afford to buy those goods, notably Germany, preferring instead to practise strict spending restraint and rely on their own exports to drive growth, others fear the more likely outcome is a renewed collapse in spending, and hence economic growth, in economies that have already suffered deep downturns. New data released in the Netherlands yesterday showed retail spending down by an alarming 6% on last year's levels.

Russell Jones, of Llewelyn Consulting, says: "All the old reasons for not liking deflation are very valid: it makes getting debt levels down tougher; it might encourage people to delay spending; it serves to raise real, ie inflation-adjusted, interest rates when you really want them to come down; and it can become embedded in people's expectations, and once that's done, it becomes hard to shift, as Japan demonstrates. It destroys demand."

Heavily indebted governments will be particularly vulnerable to a fall in inflation. Other things being equal, lower inflation tends to push up debt-to-GDP ratios, because nominal GDP, which includes inflation, is the key measure for assessing the size of a country's debt burden.

Recent research by the City consultancy Fathom suggested that even weak inflation – of, say, 1% – would be enough to make Italian government debt unsustainable, for example, particularly if the Fed goes ahead with phasing out quantitative easing, known as tapering, which could potentially push up bond yields worldwide.

"While sovereign debt is decreasing for all countries (even Greece) with inflation at 2%, once we dial inflation down to 1% and assume a mild tapering-induced rise in interest rate of 1.50 percentage points over two years, debt becomes unsustainable for most of the peripheral sovereigns," said Fathom's Danny Gabay.

Any sign that debt levels were again at risk of becoming unmanageable in countries such as Italy and Spain would be likely to spark renewed financial turmoil in the eurozone, after months of relative calm.