Over the last few years I have mentioned, every few months, that one of the real economic risks facing the UK has been deflation. I admit my thinking on this issue was influenced by two things. The first is that I have always - since the 1980s - seen some benefit to inflation. The second was the warnings on deflation and debt from my Green New Deal colleague, Ann Pettifor.
Now deflation looks likely. CPI is at 0.5% and Mark Carney says it will drift lower. That, inevitably, means negative territory. Commentators are already trying to say this will be temporary and are using the term disinflation for it. I do not share their optimism. I will call it what it is: deflation.
Deflation is a serious threat to economic well being. Some are saying that because it provides a short term boost to earnings by reducing the cost of living it's useful but this ignores all the potential longer term impacts.
The first is that by default interest rates rise: when there is deflation the capital value of a loan increases in real terms and that increases the debt burden of the person due to make repayment. The real interest rate increases as a result. That reduces the capacity of many to spend on supposedly cheaper goods and services. The realisation will not happen overnight, but happen it will.
Second, in the short term deflation makes it look like real wages have risen and that appears to be good news. And then, before long pay rises disappear as employers have reduced capacity to make them, and the pressure for pay reductions, or changed conditions of employment to achieve the same net effect (because pay itself is downwardly sticky) will become the norm. Given that low pay and the total inability of the UK economy to boost real earnings is one of the major reasons why we have remained stuck with real GDP per capita below 2008 levels this matters, enormously. Wage stickiness also increases the risk of unemployment: that should not be ignored.
Thirdly, those on benefits see them fall. Relative inequality can increase.
Then there's the impact on investment and bigger ticket spending by consumers. Both have a tendency to fall when there is deflation: if people think it will be cheaper to buy an item in the future they defer spending now. And deflation, by producing higher real interest rates creates a second reason for deferring spending. We are already facing a real problem with a shortfall of business investment in the economy, in particular. Deflation exacerbates that and the consequence will be declining GDP.
Next there is the problem that wealth inequality increases in a period of deflation. The owners of debt - who by definition have wealth - see the value of their asset rise. The people who owe that debt - their creditors - see their loans increase in real terms. Inequality is already creating real problems in our society: deflation will increase them.
And the fact that deflation is partly being caused by a decline in oil prices that is bound to cause environmental harm by encouraging over-use of carbon is another negative consequence.
Temperamentally there is also an issue with deflation: we are simply not suited to managing downsides where things appear to get smaller. Like it or not, and even when it is real or not, humans like the perception of positive outcomes that increasing numbers supply. Decreasing ones appear (as they are) to be negative and that depresses the human spirit. This has always been one of my reasons for feeling comfortable with modest inflation. Deflation suppresses the economic mood. We cannot afford that.
There are then no gains to be had from deflation. But there are many costs.
And we do not need deflation. We could print money and stimulate economic activity and boost real earnings at this moment to prevent deflation happening. This, of course, is another reason for using Green Quantitative Easing which would, in the current environment achieve all those goals and deliver real, long term and tangible benefits for society as a whole.
Without such action we face a potentially major economic crisis. With action the current situation provides opportunity for positive change. I fear that politicians will opt for the crisis but hope for something altogether better.
Thanks for reading this post.
You can share this post on social media of your choice by clicking these icons:
You can subscribe to this blog's daily email here.
And if you would like to support this blog you can, here:
Do any of our ‘politcal parties’ actually want to ‘win’ the next election? i see a lot of pointers that make me suspect they ate just playing with the system to ensure that one party will be elected almost by default. Whether by design or otherewise we no longer seem to have ademocracy.
Interesting question I have also asked, in private
I agree Chris- there is a strange feeling that the whole thing is a facade and a deeper sense that it is a one party state.
You have predicted the coming of deflation for some time, certainly since late 2010. Now it’s tapping on the window with a mallet.
I’d blame Labour if I was a Tory. Or the poor, having too much incentive to breed and over-populating “our country”, or immigrants, for using up the resources needed for the indigenous population. And I’m sure I’d come up with more crap if I could only be better incentivised to so do by a share-option scheme. Oh, yes, the size of the state. That’s the fellow – spends too much to balance the books. Too high public sector wages, anyone? Again?
How will Osbourne climb out of this hole – or will he be for digging deeper?
> How will Osbourne climb out of this hole?
He’ll brag about how the long term plan is boosting the spending power of hard-working families.
Interesting, helpful summary.
Duncan Weldon was good on Newsnight last night, explaining that the decrease in the price of oil was mainly beneficial, but that that is only part of the explanation for low inflation. The prices of many commodities are falling and this is a reflection of a downturn in demand both here and in the global economy.
So far as oil is concerned, as many have already said, this is an ideal opportunity to introduce a carbon tax (Fee and Dividend), which can be done on a country-by-country basis.
Didn’t see Neesnight but agree on your second para
An excellent appraisal Richard! I’ve not much to add other than that this was always inevitable when you have consumer-led economies relying on credit [i.e.debt] supplied [i.e. money created] by commercial banks who are programmed for Boom and Bust – as Private Eye would emphasise “It’s in their DNA”! In 1970 50% of money – £50bn [with M3 @ £100bn] – was debt-free created by BOE and 50% “manufactured out of thin air” by commercial banks when they made loans. Before QE began the commercial banks “funny money” as debt to themselves had reached £1,700bn against £100bn BOE sovereign debt-free money – 95%!! No wonder it all went pear-shaped in 2008.
Roll on QE – Green or otherwise – as there is no other way: 100% QE with the remuneration focussed as sovereign wealth for the unexpired duration of the re-purchased bonds, abolish the treasury bond system, hike up commercial bank capital reserve requirements to curtail bank lending/money creation/inflationary excess, utilise sovereign debt free capital expenditure, reduce taxation in a more easily balanced budget.
The slack of treasury bonds would allow investment funds [eg pension and insurance] to concentrate on corporate bonds freeing companies from bank borrowing and allowing commercial banks to concentrate on SME and private funding in a utility role with no need for obscene salaries and bonuses.
I know I’ve posted this before but I think it’s worth repeating. “Global firms sitting on $7 trillion war chest The world’s corporate giants are poised to tap into record cash reserves and embark on a long-awaited spending spree, fuelling hopes of a massive boost to the global economic recovery. Companies, together with private equity firms, are coming under mounting pressure to delve into a global cash mountain of $7 trillion (£4.1 trillion) that has been amassed since the dark days of the financial crisis.” http:://www.telegraph.co.uk/finance/11038180/Global-firms-sitting-on-7-trillion-war-chest.html. Trying to deconstruct this; either private equity is going to be the bubble that is created to ‘grow’ the global economy after the next financial crash. Or it will be THE bubble that crashes a global economy that already has enough bubbles in it to make an Aero bar proud. Either way, it’s bad sh*t. So the question I pose is this: with overall tax take forecast to reduce as a proportion of expenditure (tax cuts, tax dodging, a low income economy producing less overall tax income) and with economies around the world borrowing money to meet the shortfall, what is going to happen when private investment and priveq is allowed to run riot when all public services are privatised because government say there isn’t enough public money to maintain them? With a decreasing amount of public money going to meet profit targets, shareholder demands, executive pay and bonuses and private equity debt, even less money will be spent on delivering actual services (for the most recent example see Phones4U, Punch Taverns, CityLink,, the Swissport fiasco at Gatwick Airport). With austerity and now deflation hobbling the ability of people to move their money into the economy beyond their non-discretionary costs, how will private equity backed enterprises pay back their debts when they are receiving less money? When the creditors of nations want their money back and it isn’t there because tax money is being used to support other private wealth, what happens when they realise they’re never going to get the money back? Because there will never be enough public money to meet the voracious demands of the market? One could predict an apocalyptic outcome. Do the 1% want an apocalyptic outcome.
Back in September 2012 I commented on this Guardian article ” UK inflation falls to 2.5% despite rising fuel costs.
18 Sep 2012 1:53pm
Deflation is the natural condition of hard currency economies when the supply of money is not increased as much as positive population growth and economic growth. When this happens, the available amount of hard currency per person falls, in effect making money more scarce; and consequently, the purchasing power of each unit of currency increases. In mainstream economics. Historic episodes of deflation. as with the Great Depression and possibly Japan in the early 1990s, have seen the demand for goods going down combined with a decrease in the money supply. Demand-side causes are: Growth deflation: an enduring decrease in the real cost of goods and services resulting in competitive price cuts. A structural deflation existed from 1870s until the cycle upswing that started in 1895. The deflation was caused by the decrease in the production and distribution costs of goods. It resulted in competitive price cuts when markets were oversupplied. Deflation was present during most economic depressions in US history. Deflation is generally regarded negatively, as it causes a transfer of wealth from borrowers and holders of illiquid assets, to the benefit of savers and of holders of liquid assets and currency, and because confused pricing signals cause malinvestment, in the form of under-investment. Familiar?
The daft thing is money is costless and so need never be scarce
If money wasn’t scarce it wouldn’t be money. It must be scarce to do what money does.
Of course
But when it is too scarce we get deflation
Stop being pedantic
Agreed. The whole concept of money is a value system purely of humankind’s own construct and can work any way we want it to; however as James G has shown we have an annoying tendency of going along with the value system and way of working that the minority who control money and Capital want.
How Osborne can brazenly claim credit for the reduction in inflation is quite amazing – but that’s what he did yesterday and no one challenged him.
“no one challenged him.” Quelle surprise -this was, no doubt, the BBC? The is NO attempt on the part of the mainstream media to offer other narratives.
Deflation has one main cause: prior credit expansion. So fighting it by printing money and loose monetary policy only results in a bigger deflationary problem later on.
That is truly bizarre and so wrong it is laughable
So what causes deflation then?
A lack of demand
A lack of credit
A lack of government spending
A lack if credit – yes. If credit is suddenly withdrawn you get a credit crunch and deflation. This is obvious. You get a credit crunch after credit expansion. look at house prices after banks stopped lending – fast falls in prices.
A lack of demand? You mean too much saving?
Not enough government spending? It hasn’t really fallen much has it. Or are you proposing a failure to continue to increase government spending causes deflation?
I am sorry to say this is not worth engaging with
Robert Reich, secretary of Labor in Clinton’s administration, wrote a post yesterday -robertreich.org – why wages won’t rise.
also on that page an interesting view on the Pacific version of TTIP.
may be of interest to readers.
I like Reich and I’d recommend his film ‘Inequality for All’ to anyone who is concerned about this topic.
Thanks for the heads up concerning his blog – ‘shall take a look.
As for Richard’s deflation blog, the whole thing comes across like a perverse game of snakes and ladders.
The question is, who is rolling the dice and are they loaded?
I suspect they are.