Deflation is better than soaring inflation
After all those years fighting inflation the government finds itself criticised for abolishing price rises! True, the government is criticised for everything now, but this is a problem for later, not the present.
Past UK recessions have been accompanied by high inflation. We should be grateful that in the midst of slump and financial crisis we do not have soaring prices too.
The negative inflation is both the effect of recession and the measures to counter the slump. Low consumption has reduced demand, especially for commodities, thus cutting prices, but the cut in interest rates to ease financial pressures has lowered housing costs too, having a direct effect on the retail prices index.
Deflation is a problem however, if only because it is part of the recession. Western economies are geared to a steady increase in prices. Look how falling house prices, for instance, wipe out owners’ equity and erode lenders’ collateral, creating a financial crisis even though the physical assets are unchanged.
Look what it does for companies’ working capital when reduced revenues from today’s lower-priced sales do not cover yesterday’s higher costs. See the effect of falling revenues for firms whose finance, rents or supply costs are fixed. Look how we happily confuse inflation with growth and thus think deflation is the recession rather than a symptom of it.
However, good can come of this fall in prices if it allows the habit of annual pay rises to be broken – or ends annual revisions of company’s price lists. It needs a change of attitude by employers, workers and unions to achieve this, but it will be of lasting value well after inflation returns.
And the government has the greatest interest in making inflation positive again. With borrowing so high, its debt – or the cost of repaying it - is effectively rising each year that prices fall. Soaring inflation, taking GDP and tax revenues with it, is the easiest way to repay loans.
Deflation is a problem that will go away in time, but given Britain’s other problems it is the least of troubles to have in the short-term.
