So you thought the economic recovery was under way? Well, I’ve got a word of warning for you – deflation

As prices keep falling, so customers think about waiting before buying


Sometimes a small news item rings the loudest bell. When I read earlier this week that retailers in the UK had cut their prices during the January sales at the fastest rate for seven years, I was taken aback. Was this a wake-up call? Are we about to experience deflation – an unpleasant state of affairs not seen in this country since the 1920s and early 1930s?

The retailers’ trade body said prices had been falling for nine consecutive months. Discounting in shops selling clothing, electrical equipment and furniture was partly behind the drop. Prices had also declined in flooring, books, stationery and home entertainment, while DIY, gardening and hardware shops had entered “deflationary territory” in January. Yes, the trade body actually used the dread word. And I say “dread” because sustained deflation would bring about a serious recession. As it did in the 1930s.

The scary thing is that deflation has a doomsday-machine quality to it. Shop prices begin to fall, as described above. Gradually customers notice this and say to themselves: perhaps if I wait a few months, what I want to buy will be even cheaper.

They postpone their purchases, but as they do so they unwittingly bring further pressure to bear on the retailers – who in turn demand lower prices from their suppliers. And then perhaps these same manufacturers have to lay off staff in order to cut their own costs. Which reduces purchasing power within the economy. At this point falling prices are beginning to get very dangerous.

But first, there is an important distinction to be made between what I call “technical” deflation and the real thing. By the former I mean a short period of price declines that fortunately fails to start the doomsday machine because the episode is soon over. The eurozone as a whole, for instance, experienced deflation for five months in the second half of 2009.

Second, while an increasing number of experts have been issuing warnings about the risk of deflation in recent weeks – among them Christine Lagarde, the Managing Director of the International Monetary Fund – their worries focus on the eurozone countries rather than on Britain or the United States. Inflation averaged across the eurozone fell to 0.7 per cent in January, down from 0.8 per cent in December. Compare this with the UK inflation rate as measured by the Consumer Prices Index, which was 2 per cent in December compared with 2.1 per cent the month before.

I am not saying that Britain faces no risk of deflation, but that if it were coming, it would strike our Continental neighbours first. And there is indeed good reason to worry about them right now. For if you strip out increases in value added tax from Continental retail prices, then you find that Italy, Spain, the Netherlands, Portugal, Greece, Estonia, Slovenia, Slovakia and Latvia have all been in outright deflation since May.

Underlying prices have also been dropping in Poland and the Czech Republic since July, and France since August. There are also the first signs of consumers delaying their purchases. For retail sales in the eurozone fell sharply over the Christmas period.

This raises the possibility that deflation will arrive in Britain by the back door. For if the eurozone were seriously affected, then our substantial export business with the rest of Europe would suffer. That would be a serious shock to our economy.

Yes, but cannot the world’s finance ministers, central bank governors and their assorted officials take actions that would make deflation a non-starter?

After all, they succeeded in containing the 2007-2009 banking crisis by one means or another. Unfortunately not. The cure is easy to describe – deliberately create inflationary conditions to get prices rising again. But very hard to carry out.

Before he was chairman of the United States Federal Reserve, Ben Bernanke claimed in 2002: “... sufficient injections of money will ultimately always reverse a deflation”.

But that policy proved incapable of halting Japan’s long deflationary spiral. And we have recently been through an extensive period when money has indeed been “injected” by central banks (so-called “quantitative easing”).

It chased up asset prices, such as shares, property and pictures at auction, but made no impact whatever on the prices for goods and services. Perhaps that is why the Nobel prize-winning economist, the late and famous Milton Friedman, once proposed what he called the “helicopter drop” of banknotes as a remedy for deflation. Which only serves to emphasise that we don’t really know how to stop it once it gains a hold.

React Now

Latest stories from i100
Have you tried new the Independent Digital Edition apps?
iJobs Job Widget
iJobs General

SThree: Trainee Recruitment Consultant

£20000 - £25000 per annum + uncapped commission, Benefits, OTE £100k: SThree: ...

Guru Careers: Dining Room Head Chef

£32K: Guru Careers: We are seeking a Dining Room Head Chef to work for one of ...

Guru Careers: Pastry Sous Chef / Experienced Pastry Chef

£27K: Guru Careers: We are seeking a Pastry Sous Chef / Experienced Pastry Che...

SThree: Trainee Recruitment Consultant

£20000 - £25000 per annum + competitive: SThree: Are you a recent graduate loo...

Day In a Page

Read Next
The Irish referendum was the first on the issue of same-sex marriage anywhere in the world  

Don't be blinded by the Yes vote: Ireland is still oppressing its LGBT population

Siobhan Fenton

Daily catch-up: union bosses mobilise to try to prevent a Labour government

John Rentoul
Abuse - and the hell that came afterwards

Abuse - and the hell that follows

James Rhodes on the extraordinary legal battle to publish his memoir
Why we need a 'tranquility map' of England, according to campaigners

It's oh so quiet!

The case for a 'tranquility map' of England
'Timeless fashion': It may be a paradox, but the industry loves it

'Timeless fashion'

It may be a paradox, but the industry loves it
If the West needs a bridge to the 'moderates' inside Isis, maybe we could have done with Osama bin Laden staying alive after all

Could have done with Osama bin Laden staying alive?

Robert Fisk on the Fountainheads of World Evil in 2011 - and 2015
New exhibition celebrates the evolution of swimwear

Evolution of swimwear

From bathing dresses in the twenties to modern bikinis
Sun, sex and an anthropological study: One British academic's summer of hell in Magaluf

Sun, sex and an anthropological study

One academic’s summer of hell in Magaluf
From Shakespeare to Rising Damp... to Vicious

Frances de la Tour's 50-year triumph

'Rising Damp' brought De la Tour such recognition that she could be forgiven if she'd never been able to move on. But at 70, she continues to flourish - and to beguile
'That Whitsun, I was late getting away...'

Ian McMillan on the Whitsun Weddings

This weekend is Whitsun, and while the festival may no longer resonate, Larkin's best-loved poem, lives on - along with the train journey at the heart of it
Kathryn Williams explores the works and influences of Sylvia Plath in a new light

Songs from the bell jar

Kathryn Williams explores the works and influences of Sylvia Plath
How one man's day in high heels showed him that Cannes must change its 'no flats' policy

One man's day in high heels

...showed him that Cannes must change its 'flats' policy
Is a quiet crusade to reform executive pay bearing fruit?

Is a quiet crusade to reform executive pay bearing fruit?

Dominic Rossi of Fidelity says his pressure on business to control rewards is working. But why aren’t other fund managers helping?
The King David Hotel gives precious work to Palestinians - unless peace talks are on

King David Hotel: Palestinians not included

The King David is special to Jerusalem. Nick Kochan checked in and discovered it has some special arrangements, too
More people moving from Australia to New Zealand than in the other direction for first time in 24 years

End of the Aussie brain drain

More people moving from Australia to New Zealand than in the other direction for first time in 24 years
Meditation is touted as a cure for mental instability but can it actually be bad for you?

Can meditation be bad for you?

Researching a mass murder, Dr Miguel Farias discovered that, far from bringing inner peace, meditation can leave devotees in pieces
Eurovision 2015: Australians will be cheering on their first-ever entrant this Saturday

Australia's first-ever Eurovision entrant

Australia, a nation of kitsch-worshippers, has always loved the Eurovision Song Contest. Maggie Alderson says it'll fit in fine