January 23, 2015


Don't believe the gloom-mongers: deflation will be good for Britain (The Spectator, 1/24/15)

Deflation is feared because it is an unknown, being beyond the experience of virtually anyone alive in Britain today. But look at what's happening in Spain. Deflation arrived last August and has intensified since. If the gloomy economists were correct, the bamboozled Spanish would be staying away from the shops, counting their money and waiting until it could buy more later. In fact, the Spanish have been delighted by the falling prices and have flocked to the shops - the Christmas retail sales were the best in seven years and car sales are up 18 per cent. In Madrid, the effect of deflation can be summed up in a non-technical word: ka-ching.

Could it happen in Britain? It could - and it did.  Bouts of deflation were a regular feature of economic life throughout the 19th century, a period which saw an explosion in production and wealth on a scale never seen before. Between 1873 and 1896 wholesale prices fell by a third -- and our cities continued to thrive and expand while living standards ratcheted upwards. What mattered was real incomes, which continued to increase.

Even without this historical perspective, it ought to be obvious that the pessimism of many economic commentators is overdone. If people really did put off purchases in the expectation of prices being lower in future then they would never buy electronic goods, which -- regardless of high general inflation for some of the period -- have been in deflation for 50 years. When inflation was nudging 30 per cent in 1975, the price of pocket calculators was falling sharply. Yet people continued to buy them, because they wanted them then, not in a year's time -- and Sir Clive Sinclair grew rich. And the deflation that Britain is now set to experience will be in food and fuel -- both of which people cannot delay buying. So when they become cheaper, it is a moment for celebration.

There is one big change since Victorian times which has made deflation potentially rather less benign: the rise in consumer and government debt. When prices fall, the real value of debt rises. The £1.47 trillion national debt could rapidly become ever larger if falling prices cause a collapse in tax revenues. Yet the cost of servicing debt would fall rapidly too. If deflation persisted in Britain, it is likely that the Treasury would find itself able to do what the Swiss and Danish governments did this week, and issue bonds at negative interest rates -- effectively charging investors for the privilege of lending money to the government.

The virtuous combination of rising wages and falling prices has meant that real incomes are now suddenly increasing strongly for the first time since 2008. Ed Miliband was right -- if a little late -- in identifying a cost-of-living crisis. Yet week by week, the crisis is abating. It is hard to believe that less than 18 months ago his promise of an energy price freeze promised to be a big vote winner. A freeze now sounds like an expensive threat to consumers now that wholesale prices are plummeting.

Posted by at January 23, 2015 6:10 PM

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