Falling prices set to become the norm

Click to follow
The Independent Online
WILL DEFLATION - a period of falling prices, rather than rising ones - be the feature that defines the next global downturn?

In Britain and the United States there is still some evidence of inflation, though earlier this week the Bank of England cut not only its growth forecast but also its inflation one. But elsewhere, first in Japan, and also now in France and Germany, prices have started to fall, while in East Asia, where the global downturn started, prices are plunging.

Of course no one can predict the extent to which prices might fall in the early part of the next century, any more than they could have predicted the scale of the inflation of the 1970s and 1980s. But there are several reasons to believe that price stability, or even slowly falling prices, may become the norm.

First, the present expansion of the world economy has not generated serious inflation anywhere. Commodity prices have tended to decline, wage demands have been muted and the price of some products, such as computers, has fallen very quickly. Britain has shown more signs of inflation than most other developed countries, with headline inflation at more than 3 per cent. But even here inflation is only 2 per cent, if you allow for the effect on prices from higher taxes (on items such as petrol) and changes in interest rates, and 1.5 per cent under the European Union harmonised index. If there has been very little inflation at the top of the growth phase, expect it to disappear during the downswing.

Second, the world has (more or less) independent central banks, committed to price stability. Whether they should be allowed to operate beyond political control is open to debate, but the plain fact remains that this trend towards independence has swept the world. It will be further enhanced when the European Central Bank takes over European interest rates in January.

Third, these central banks are buttressed by powerful financial markets, which compel them to follow anti-inflationary policies. Central banks only control very short-term interest rates and if they cut rates too much, the markets are liable to increase long-term rates. When Alan Greenspan, head of the US Federal Reserve Bank, unexpectedly cut US short rates last month, bond yield rates rose.

Finally, new communications technologies are cutting the production cost of many new goods and services dramatically.