Rates hope as Greenspan warns on deflation

Central bankers may find themselves having to fight the effects of deflation or falling prices rather than the traditional enemy of inflation, Alan Greenspan, chairman of the Federal Reserve said at the weekend in a speech some interpreted as a signal that US interest rates would remain on hold for much of this year or possibly even fall.

Meanwhile, the new year has brought a wintry flurry of glum reports forecasting that the British economy is on the verge of a sharp slowdown. Diane Coyle, Economics Editor, examines the change in mood.

Mr Greenspan told the American Economic Association that "inflation has become so low that policymakers need to consider at what point effective price stability has been reached. Indeed, some observers have begun to question whether deflation is now a possibility, and to assess the potential difficulties such a development might pose for the economy".

Mr Greenspan made his comments in the context of a wide-ranging and, at times, esoteric speech about the difficulties of measuring price changes in the modern world, and he stopped short of saying whether he believes deflation to be a real threat or how the Fed might respond to such an eventuality.

Even so, Alan Sinai, chief economist at Primark Decision Economics, said that by even mentioning deflation and particularly by discussing its policy implications at such length, Mr Greenspan was at least saying the issue merited discussion. "The Fed seems to be as concerned about deflation as inflation," Mr Sinai, who attended the speech, said. "It's a tip-off they won't raise rates."

However, others cautioned against over-interpretation of Mr Greenspan, who once famously remarked that if anyone understood what he was saying then he had probably been misunderstood.

Mr Greenspan insisted that deflation in the price of goods and services can be as bad for the economy as inflation. "While asset price deflation can occur for a number of reasons, a persistent deflation in the prices of currently produced goods and services - just like a persistent increase in these prices - necessarily is, at its root, a monetary phenomenon," he said.

"Just as changes in monetary conditions that involve a flight from money to goods cause inflation, the onset of deflation involves a flight from goods to money. Both rapid or variable inflation and deflation can lead to a state of fear and uncertainty that is associated with significant increases in risk premiums and corresponding shortfalls in economic activity.

"Even a moderate rate of inflation can hamper economic performance, as I have emphasised many times before; and although we do not have any recent experience, moderate rates of deflation would most probably lead to similar problems."

Mr Greenspan warned that deflation could also be detrimental for reasons that go beyond those associated with inflation. "Nominal interest rates are bounded at zero, hence deflation raises the possibility of potentially significant increases in real interest rates. Some also argue that resistance to nominal wage cuts will impart an upward bias to real wages as price stability approaches or outright deflation occurs, leaving the economy with a potentially higher level of unemployment in equilibrium".

However, the Fed chairman also said that the present debate about deflation lacked clarity and was hampered by the present difficulty of defining what constituted falling prices.

The bogeyman of world-wide deflation has been raised by a number of leading economists and market pundits following escalation of the economic crisis in the Far East. Nearly all economists predict that the crisis will, at least, put a severe break on growth.

Ahead of this week's meeting of the Bank of England's Monetary Policy Committee to decide whether or not to raise UK interest rates, three new reports predict slower growth than in 1997, with a risk that further turmoil in Asia or in the world's stock markets could make the outlook even bleaker.

The most pessimistic vision comes from Oxford Economic Forecasting, a commercial forecasting group, which puts this year's GDP growth at just over 2 per cent or about half the 1997 growth rate. It says the Asian crisis will have a bigger impact on British exporters than many commentators recognise, and adds for good measure that still-buoyant consumer spending is vulnerable to a stock market collapse.

Only slightly more upbeat is Cambridge Econometrics, which foresees 1998 growth of 2.5 per cent, down from 3.5 per cent in 1997. But its vision of a "soft landing" for the economy is darkened by the prediction that the slowdown will last through 1999 and 2000.

Separately, Lloyds Bank warns this morning that middle market businesses will see their profits squeezed by slower growth and the impossibility of pushing through higher prices, even though more of them than ever are now operating at full capacity.

A survey of 2,000 businesses with annual sales between pounds 1m and pounds 100m showed only one in 10 believed they could raise prices during the next six months. More had cut prices than raised them in the past six months.

Even so, nearly half said they were having trouble recruiting skilled staff and a quarter said they could not find enough unskilled employees. Only 11 per cent believed profits would rise in the next six months.

Michael Riding, managing director of Lloyds Bank Commercial Service, said: "Profit growth is at its lowest since 1993 when businesses were still feeling the effects of recession. This will be compounded by an economic downturn."

According to the Oxford forecasters, the downturn will be steep because of the triple whammy of a tough Government budget policy, high interest rates and the strong pound. The economic crisis in South-east Asia will have a bigger impact on the UK than many anticipate, according to Adrian Cooper, one of Oxford Economic Forecasters' economists. "The falls in Asia's currencies have added to the UK's competitiveness problems, particularly for industries such as textiles and consumer electronics."

The report reckons prospects for consumer spending remain bright and will barely slow down from 1997. But confidence is vulnerable to the danger of a stock market crash.

Start your day with The Independent, sign up for daily news emails
ebooksA year of political gossip, levity and intrigue from the sharpest pen in Westminster
Latest stories from i100
Have you tried new the Independent Digital Edition apps?
Independent Dating

By clicking 'Search' you
are agreeing to our
Terms of Use.

iJobs Job Widget
iJobs Money & Business

Selby Jennings: VP/SVP Credit Quant- NY- Investment Bank

Not specified: Selby Jennings: VP/SVP Credit Quant Top tier investment bank i...

Selby Jennings: Quantitative Research | Equity | New York

Not specified: Selby Jennings: Quantitative Research | Global Equity | New Yor...

Selby Jennings: SVP Model Validation

Not specified: Selby Jennings: SVP Model Validation This top tiered investment...

Selby Jennings: Oil Operations

Highly Competitive: Selby Jennings: Our client, a leading European Oil trading...

Day In a Page

A timely reminder of the bloody anniversary we all forgot

A timely reminder of the bloody anniversary we all forgot

Who remembers that this week we enter the 150th anniversary year of the end of the American Civil War, asks Robert Fisk
Homeless Veterans appeal: Former soldiers pay their respects to a friend who also served

Homeless Veterans appeal

Former soldiers pay their respects to a friend who also served
Downfall of Dustin 'Screech' Diamond, the 'Saved By The Bell' star charged with bar stabbing

Scarred by the bell

The downfall of the TV star charged with bar stabbing
Why 2014 was a year of technological let-downs

Why 2014 was a year of technological let-downs

Security breaches and overhyped start-ups dominated a year in which very little changed (save the size of your phone)
Cuba's golf revolution: But will the revolutionary nation take 'bourgeois' game to its heart?

Will revolutionary Cuba take 'bourgeois' golf to its heart?

Fidel Castro ridiculed the game – but now investment in leisure resort projects is welcome
The Locked Room Mysteries: As a new collection of the genre’s best is published, its editor Otto Penzler explains the rules of engagement

The Locked Room Mysteries

As a new collection of the genre’s best is published, its editor explains the rules of engagement
Amy Adams on playing painter Margaret Keane in Tim Burton's Big Eyes

How I made myself Keane

Amy Adams hadn’t wanted to take the role of artist Margaret Keane, because she’d had enough of playing victims. But then she had a daughter, and saw the painter in a new light
Ed Richards: Parting view of Ofcom chief. . . we hate jokes on the disabled

Parting view of Ofcom chief... we hate jokes on the disabled

Bad language once got TV viewers irate, inciting calls to broadcasting switchboards. But now there is a worse offender, says retiring head of the media watchdog, Ed Richards
A look back at fashion in 2014: Wear in review

Wear in review

A look back at fashion in 2014
Ian Herbert: My 10 hopes for sport in 2015. Might just one of them happen?

Ian Herbert: My 10 hopes for sport in 2015

Might just one of them happen?
War with Isis: The West needs more than a White Knight

The West needs more than a White Knight

Despite billions spent on weapons, the US has not been able to counter Isis's gruesome tactics, says Patrick Cockburn
Return to Helmand: Private Davey Graham recalls the day he was shot by the Taliban

'The day I was shot by the Taliban'

Private Davey Graham was shot five times during an ambush in 2007 - it was the first, controversial photograph to show the dangers our soldiers faced in Helmand province
Revealed: the best and worst airlines for delays

Revealed: the best and worst airlines for delays

Many flyers are failing to claim compensation to which they are entitled, a new survey has found
The stories that defined 2014: From the Scottish independence referendum to the Ice Bucket Challenge, our writers voice their opinions

The stories that defined 2014

From the Scottish independence referendum to the Ice Bucket Challenge, our writers voice their opinions
Stoke-on-Trent becomes first British city to be classified as 'disaster resilient' by the United Nations

Disaster looming? Now you know where to head...

Which British city has become the first to be awarded special 'resilience' status by the UN?