economonkey

I’ve been waiting to finish this article until the UK’s inflation figures were released. They show the CPI figure for November to be 4.1%, higher than predicted by the majority of economists. This figure is more than double the 2% target that the Bank of England’s Monetary Policy Committee is supposed to aim for, yet [...]

I’ve written in a previous article about the various concepts involved in economic inflation and how it can affect the value of your money, your wages and the things you buy.

The opposite of inflation is deflation, which I’ll explain in this article before going on to discuss the probable and possible situations in the UK for the next few years. The ‘deflation versus inflation’ argument is more important in the UK today than it has been at any time in the last 30 years, so it’s worth thinking about in some depth.

So, deflation. If inflation is a general increase in prices and/or wages driven by the greater availability of money (whether ‘real’ money or debt), then deflation is a general decrease in prices and/or wages driven by the much reduced availability of money. This is widely considered to be a bad thing.

But isn’t a reduction in prices a good thing? At a simple level, yes it is. Your wages – assuming they aren’t cut at the same rate – go further, your savings buy more over time and there’s less of a ‘treadmill’ effect where people feel that they are working ever harder to chase money to buy the same purchases, as happens in inflationary environments.

But politicians and economists fear deflation for a good reason. Fundamentally it stops the economy dead in its tracks. Nobody will buy something today that they don’t really need if they know it’s going to be cheaper tomorrow. This applies to companies as much as to individuals, which means that investment stops, companies cut back their staffing levels and unemployment rises. We end up with a deflationary spiral that’s every bit as traumatic as a highly inflationary one.

Deflation also makes it harder to pay off the principle amount of any debts, because wages tend to go down in nominal terms but the amount owed remains the same. This, incidentally, is why some newspaper pundits are now calling for deliberate inflation in order to wipe out the value of many people’s (and the nation’s) ill-advised debts, though such pundits are ignoring several important points about the banking industry’s methods of counteracting inflation through charges and wider interest rate spreads.

Over in America the property market crash and banking bailouts are old news for their economic agitators and malcontents, at the moment all eyes are on Detroit, home of the country’s once mighty automotive industry. It seems that US carmakers simply can’t compete with their leaner, more agile Asian counterparts and, having seen the massive [...]