David Blanchflower: Deflation is bad news - and Britain is likely to be next to get it

Despite what Governor Mark Carney has claimed the Bank of England does not have the tools to make it go away

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The Independent Online

There is major economic pandemic spreading around the world. There is contagion in the air. It is called deflation, which means falling prices.

Some have claimed that deflation is a good thing. But if it was so good why have successive Chancellors set a goal for the Bank of England’s Monetary Policy Committee of generating 2 per cent inflation? If deflation was so good why didn’t successive Chancellors set minus 2 per cent as a goal?

The problem with deflation is that once you have it you can’t get rid of it. Central banks know what to do about inflation but they are pretty clueless about what to do about deflation when interest rates are as low as they can go (known as the zero lower bound). Just look at Japan, which had deflation in nine separate years from 1999-2012, with two additional years at zero, averaging minus 0.3 per cent. The highest in any single year was minus 1.3 per cent in 2013, but even a little wouldn’t go away. In 2008 there were fears of deflation coming but central banks had the ability to slash interest rates by nearly 5 percentage points.

Europe now, in particular, has a problem of deflation. The data from the European Union’s statistical agency last week made clear that both the eurozone and the EU28 had entered deflation, with prices falling at 0.6 per cent and 0.5 per cent respectively.

This was driven primarily by declines in energy, but there was also deflation in non-energy industrial goods and telecommunications. As the table makes clear 23 of the 28 EU countries are now in deflation, plus Iceland and Switzerland. The UK looks to be the next to tumble over the precipice, with inflation at 0.3 per cent. Watch out for the next data release on the 24 March, when it is likely that the CPI will go into negative territory for the first time in 170 monthly observations since the index was started in January 2001. Only Norway, Sweden, Austria, Romania and Malta are not in deflation yet.


Then on Thursday we had data for the United States. The US now also has a problem of deflation. The Consumer Price Index for All Urban Consumers (CPI-U) declined 0.7 per cent in January on a seasonally adjusted basis, the US Bureau of Labor Statistics reported. Over the last 12 months, the all items index decreased 0.1 per cent – the first negative 12-month change since the period ending October 2009.

The food index was unchanged in January, with the food at home index falling for the first time since May 2013. Used cars and apparel also saw price falls. Fed chair Janet Yellen made it clear in her congressional testimony this week that rate rises will depend on inflation rising and moving back to the 2 per cent target. Everyone is hoping this is just because of the fall in the oil price and not down to a broad collapse in global demand.

The collapse in the Baltic Dry, which indicates the cost of shipping dry goods, potentially suggests something deeper is going on. Fingers crossed it goes away. Despite what Mark Carney has claimed, the MPC does not have lots of tools to make deflation go away if it becomes entrenched and broad-based. It’s like being up that famous creek without a paddle.

There was also some not so good pre-election economic news as the ONS confirmed that the UK economy slowed in the fourth quarter of 2014. Business investment fell by 1.4 per cent, which is the fastest rate since the financial crisis, and for the second month in a row. This is bad news for the MPC, who need investment to grow like gangbusters so that productivity rises.

There was also evidence of an increase in the number of zero hours contracts (ZHC) by 110,000, or a 19 per cent increase over the last year. Of the 700,000 workers who said they had such contracts, 20 per cent said they wanted more hours, compared with 10 per cent of workers who were not on such contracts. A further 10 per cent said they wanted a replacement job with longer hours, versus 2 per cent of workers not on these contracts. This adds to the view that the growth in jobs is mostly low-paid, insecure jobs.  

There were a couple of other interesting UK specific developments last week that were not good news for the Coalition. First there was the evidence that net migration was close to 300,000 in the year to September 2014, which was highly embarrassing to the Prime Minister, who made a “no ifs, no buts” promise to cut the number to “tens of thousands”. There were just lots of tens of thousands. Indeed, net migration was 54,000 higher in the latest data than it was in June 2010, just after he took office. It never made sense to make such a boast, especially as the Government has zero control over the number of people who leave the UK, let alone the numbers who move to this sceptred isle. A pre-election gift to Ukip.

The Treasury Select Committee (TSC) published a highly critical bipartisan report on the UK’s EU Budget contributions and a damning indictment of the claims made by George Osborne that he had “halved the bill” of £1.7bn demanded by the EU. He later described this as the result of “hard-fought negotiation” with the Commission to ensure that the consequential change to the UK’s rebate would apply. The TSC noted that the calculation of the rebate, and the circumstances in which it applies, are embedded in EU law. The Committee concluded that “it does not appear… that these documents left a great deal of room for uncertainty”.

The Chancellor and his senior adviser had insisted that there was “real doubt” and “absolutely no clarity” that the rebate would apply. The TSC found such arguments “unpersuasive”. The Committee concluded that “it should have been unambiguously clear to the Treasury… that the UK was entitled to a rebate on any additional budget contributions… We note that the Commission did not at any stage suggest to HM Treasury that the rebate would not apply”. The TSC concluded the Chancellor’s claim that the EU bill had been halved was not supported by the facts. Not good just before an election.