Economic view: We're the new Elizabethans
Prices rose four-fold in Tudor times, then remained stable until the Napoleonic Wars and tended to decline during the 19th century
Sunday 11 May 2003
The Big D – deflation – took a step nearer us last week. The two biggest guns of the central banking world, Alan Greenspan of the US Federal Reserve and Wim Duisenberg of the European Central Bank, both acknowledged the danger of the world slipping into this condition. Dr Greenspan thought it unlikely and Mr Duisenberg was sufficiently relaxed to delay another cut in interest rates, but at least the danger is acknowledged.
Now, anyone reading this column regularly will have been aware that some of us have been paid-up members of the "deflation danger" club for the best part of a decade. It seemed obvious that the Japanese experience might spread to the rest of the world. But of course we economic scribblers have the freedom to write about unpleasant possibilities. It is rather different having central bankers whose bailiwicks cover some 60 per cent of the world economy join the club, even if so far as non-playing members.
Why now? In reality there is no significant new economic news to justify greater concern. The US recovery is proceeding slowly but anyone who expected it to rip away was being unrealistic. Competitive pressures will keep price rises low, even if the dollar falls further and there is some imported inflation. In Europe, Germany has been unable to make much of a recovery and that too is holding down prices. The strong euro will depress Germany still further and nudge down prices across the whole of the zone. But we knew all this – anyone who thought that Germany, or indeed the eurozone, would stage a decent recovery this year has been reading the wrong papers.
Rather than go into another "will it, won't it?" debate, it seems more sensible to ask what a world of general price stability might look like: a world where prices are just as likely to come down as they are to go up. That may technically not be deflation, where prices overall fall; instead, general price stability implies many prices falling, and some inevitably rising. And general price stability would also mean some years when prices fell as well as some years when they rose.
General price stability in any case has been the normal state of affairs in Britain for about 500 of the past 750 years. The graph above has had an airing here before but it is such a cracker that it deserves another. It comes from a famous study of prices in southern England from 1250, published in 1956 and updated with current data. As you can see there was a long period of stability during the Middle Ages. Prices then rose four-fold in Tudor times, following the exploitation of America. There was another period of stability until the Napoleonic Wars, when prices doubled. Then they tended to decline during the 19th century and did not rise significantly until the 1960s, when they took off. So the second half of the 20th century, the period we think of as normal, is actually very abnormal.
So how is a world of price stability different from our experience? Here are five suggestions, the first four of which I am fairly sure about, the last less so.
First, you cannot assume that an asset – a share, a bond, a house, an antique, whatever – is likely to go up in price. So buying a home has to be thought of as consumption rather than investment. You buy a property because you like it and can afford it, not because you think you will make a profit. You buy shares because they will provide you with an income later in retirement, not because they will necessarily go up. You will hope they will go up but you cannot assume it.
Second, on the other hand, if you do save you can be reasonably confident that those savings will not be wiped out by inflation, as happened to two generations of middle-class Britons during the last century. So it is rational to save, even though interest rates will remain low.
Third, people will have to get used to small increases in nominal wages, maybe no increases, maybe wage cuts. But most people will still be able to increase their standard of living because many of the things they buy will become cheaper. This is already happening in Japan and to some extent here too.
Fourth, governments will no longer be able to conceal tax rises as people's rising money income brings them into higher tax bands. Councils will no longer be able to use "inflation" as an excuse for increasing council tax. This will force financial honesty on to government and make voters demand value for money – just as they did in the 19th century. Just as inflation is associated with bigger government, so price stability seems to be associated with smaller government.
Fifth, and really most interestingly, social attitudes will shift as price stability becomes the norm. Society as a whole will become more orderly, maybe in some ways more moral. The capricious way in which inflation distributed rewards and punishments will end. Sky-high salaries for executives will attract even more scrutiny. People will be more careful with money in general because they will realise it will keep its value. Like the late Victorians, we will want quality when we spend our hard-earned cash.
I think you can see some elements of this shift already in the present Government: in what it says, perhaps more than what it does. But this is not really an issue driven by politics. Rather, politicians will have to respond. The financial implications of their decisions will be much more explicit. You can fudge things in a world of inflation. With price stability there are fewer places to hide.
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