UK inflation has fallen to 1.2%, as measured by the consumer prices index (CPI), which is the government's preferred measure. The retail prices index measure of inflation is, admittedly, higher at 2.3%. Either way, these are exceptionally low figures. But does this fall matter? I was a question I was asked on Twitter, yesterday.
The answer is that it matters, a lot. Deflation is pretty disastrous for an economy for two fundamental reasons. The first is that investment spending can grind to a halt when deflation occurs. The reason is obvious: if you expect something to be cheaper soon you may defer buying it. If that becomes habitual money suddenly stops flowing into the economy. And given that we're already in a pretty marginal economic situation where growth is having no real impact on the well -being of most people, withdrawing money from the economy is the last thing we need. So, let's be blunt, deflation removes any prospect of any form of growth in the economy - sustainable or otherwise. Human nature and the desire for a 'bargain' guarantees that.
Then there's the second problem. This is if anything more serious for anyone who owes money (and most households in the UK do). Deflation increases the value of that debt. It actually increases the real amount that has to be paid. This has the effect of taking yet ore money out of the economy - because it increases the cost of loan repayment which has the economic impact of increasing savings, and more savings are the last thing we need right now when the economy is short of spending.
There are two further impacts of this increasing cost of existing loans. The first is that this increases the risk of loan defaults - and that could create another banking crisis.
And if the value of loans goes up inequality increases because those to whom the money is owed see the value of what they will be repaid increase. And since loans are taken out, pretty much by definition, by the have nots and are repaid to the haves (and yes I am allowing in saying that for the fact that loans are created by banks) then inequality will inevitably rise, which is bad for the economy because those with wealth do not spend all their income, almost by definition, because that is how they became wealthy in the first place.
Deflation does then have no real advantages at all. Thankfully it can be easily addressed. Simply having the government invest significantly more to boost economic activity solves the problem whilst creating wealth and long term assets of value. When interest rates are also very low - as they are - the cost is virtually negligible as well in real terms, which makes ignoring this option something akin to economic madness.
The only problem is that economic madness has gripped the upper echelons of the UK political classes. So don't expect action to prevent deflation any time soon.
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This is a good quote from Keynes on deflation
http://socialdemocracy21stcentury.blogspot.co.uk/2012/10/keynes-on-nature-of-deflation.html
Indeed
Recommended to anyone that they go and take a read
How do you explain the electronic goods industry? Surely a highly successful one despite persistent and high levels of price deflation.
Deflation there is technological change
Not general deflation
The two are entirely different economic phenomena
While it is likely that people wait for items in shops to get reduced again once they notice that prices are falling, I doubt that this is the reason for the start of deflationary periods. The prices start falling because a large number of people have less money, and are using what little they have to pay off debt. Irving Fisher complemented Keynes analysis in the link above – he called this debt deflation. It affects debtors by making them poorer. The rentier classes gain because businesses lose profit but their debt stays the same, so the rentiers gain. (The banks). But without a government bailout the banks would find that they could not keep getting blood out of a stone, as the squeezed economy cannot pay it all.
I think this is why Lord Adair Turner and Martin Wolf have suggested that government takes over the creation of money “overt monetary finance” or helicopter money, to clear debt and stimulate the peoples economy.
Martin Wolf here, has contemplated this idea more robustly, very recently, here:
http://www.positivemoney.org/2014/10/martin-wolf-financial-times-stop-banks-creating-money-video/
“And since loans are taken out, pretty much by definition, by the have nots and are repaid to the haves.”
Though you also need to factor in age. Most people are wealthier at 60 than they are at 30. They’ve been working for 40 years and acquiring assets (housing & pensions).
But I wouldn’t describe a pensioner with a low income & £30k in the bank as a “have” and a 40 year old six figure lawyer with a £500k mortgage as a “have not”.
Elsewhere today on Twitter you linked to an interesting piece of research showing that adjusting for spending patterns the poorest have seen the highest levels of inflation in recent yeras and thus the greatest collapse in household income. I’d be interested in how you would explain to them how deflation in the form of a collapse in the oil price or their heating costs isn’t going to benefit them.
I would strongly recommend that you read this article by Michael Hudson, as the paragraphs under “why is inequality increasing?” he describes the fallacy of the “life cycle theory of savings.” It is important to realise that the money supply is created by private banks when they make loans, and this is why a a macro economic level the debt is growing exponentially- before you read it.
Debt is not paid by the debtors to savers, it is paid to an elite finance industry who extract the economic surplus as interest, Hudson calls it a form of rent, or unearned income. He factors in the drop in wages since 1980, and inherited wealth, and the rent gained by predatory takeovers and privatisation. Also the drop in taxes on economic rent/interest, for the vast accumulation of wealth at the top, and the eye watering increase in private and public debt.
http://michael-hudson.com/2014/10/piketty-vs-the-classical-economic-reformers/
We are in danger of losing sight of a crucial issue here, in technicalities. The Governments of Europe, including our own, are pursuing deflationary economic policies, and you, Richard, have put your finger on the link between deflation and the growth in inequality.
Thomas Piketty, too, has pointed out how the rentier class is profiting at the expense of the rest of society, and how we are reverting to a situation in the second decade of the 21st Century last seen in the late 19th and early 20th Centuries.
This is utterly and completely intolerable, and yet our pusillanimous and vapid soi-disant ‘left-wing’ politicians are apparently prepared to go along with it, lacking the spine of a jellyfish. Will no-one stand up for the poor and the dispossessed? Will no-one make a stand for justice? Will no-one have the courage to speak truth to power? If no-one else will, then I will. But it seems like I am a lone voice, crying in the wilderness. If I must be St John the Baptist, and am destined to have my head cut off, then so be it, but it would be good to have a few companions in my desert fastness.
I’m not sure this is correct. A few points ;
1) Inflation is not a ‘natural’ phenomenon unless linked to a constantly rising GDP & we can’t afford such a GDP because the resources of the planet aren’t rising. They are, in fact, diminishing fast.
2) Japan has had deflation for over a decade. We’re told that that makes it a basket-case but no-one in their right mind would actually say Japan is a bad place to live. It has the world’s highest life-expectancy. I don’t, personally, see that as a very good thing but it is indicative of a country that has sound health-care, moderate crime & moderate pollution(except for the odd reactor).
3) The reason for our domestic debt crisis isn’t deflation from 2010, it is absurdly high house prices, driven by greedy &, frankly evil, banks since 2006 & aided & abetted by both main political parties. House prices can be d/w if there is the will to do so.
4) Our response to the 2008 crisis was, with benefit of hindsight, as bad as could possibly have been the case. The effect of QE has been to slosh vast amounts of wealth into banks from whence it has flowed out to only a tiny number of, already wealthy, financiers. The results are apparent in the prices of Central London houses, self-indulgently wretched conceptual ‘art’ pieces & premiership footballers.
5) Inflation punishes those who had the least to do with the financial crisis. It erodes the savings of poor old pensioners not ‘rentiers’ who can actually adapt very well to it.
Richard
I agree with much of what you say but I think its far too simplistic to say inflation = good & deflation = bad.
An ideal world, IMO, would feature deflation & would feature a lot of austerity, as we in the West realise that our lifestyle is simply incompatible with the natural resources available. The problem, to me, is that the Cons have made clear that what they meant was “austerity for you proles & excess for our chums”.
Asset price deflation is not in the ‘inflation’ measure
I do not agree that the word austerity should,babe used to describe the realignment of the economy as we reduce carbon and other usage since we may actually be richer as a result – achieving our full pitential in areas other than material consumption
I disucss this in The Courageous State
“I do not agree that the word austerity should,babe used to describe the realignment of the economy ”
Babe?
I admire your acute analysis of accounting & economic issues, Richard, but I shouldn’t try to channel 70s soul icons, it really wouldn’t suit you!
Seriously, I think we should use the word ‘austerity’. People will have less ‘stuff’. Osborne’s austerity crusade has been surprisingly popular because most people are able to see that continuous consumption was taking us to hell in a handcart. Labour need to make the point that Cameron & Osborne’s deep hypocrisy has been to propose austerity for only some small, marginalised, sections of society. The very words “we’re all in this together” constitute a wide-open goal that it beggars belief Labour can’t score in.
Milliband & Balls come over as politics’ answer to Mark Hateley.
The curse of auto correction
And I am an appalling proof reader
But actually I still refuse to recognisea austerity when we might be so much better off