Good deflation, bad deflation?

On major economic threats – actual, potential, or just imagined – people are more attuned to spot signs of things that they fear more or the most. So, for example, the fear of inflation is ingrained in the collective German psyche in a way that baffles others, and I am more alarmed by the prospects of deflation after what has happened in Japan in the past few decades. According to the Office for National Statistics, Consumer Prices Index (CPI) fell by 0.1% in the year to April 2015 in the UK.

There was a period when food and energy prices were going up, and the pinch, the squeeze, even the briefly-popular political parole of cost of living crisis did feel real and pressing. There was stagflation and worse: things were becoming more and more expensive in recession. But for quite a while now, I feel that things are getting cheaper: pop down to the local branch of Tesco, and I can pick up 4 pints of milk for :1, a loaf of 800g wholemeal bread for 78p, and six medium eggs for 89p. That is – or certainly feels – much cheaper than a year or two ago.

It sounds like a good news for someone like me, an ignoramus in economics yet fearful of deflation, who drinks a lot of coffee and tea throughout the day with a healthy amount of milk. Besides, falling food and energy prices mean that people can spend a larger proportion of their incomes on non-essential consumption. If the cost of production falls more than the price of goods and services sold to the consumer, then companies make more profit per unit, even if the retail price becomes lower. So everyone wins: consumers feel that their bills on the essentials are coming down thus happier to spend more on other things and can buy more for the same amount money, at the same time businesses are making healthy profits despite lower unit price because the margins are better and they are selling more units. Economy grows yet prices remain low.

There are possibilities that the next harvest fails miserably or the oil price shoots up again, putting pressure on the prices of the essentials, but the danger lurks if people think there is deflation generally and stop investing, i.e. lose confidence about the future or that there is not going to be adequate returns on investment. In such a case, wages will come down, unemployment will go up, and spending will go down. Perhaps the assets in the stock market or in the form of properties are already overpriced now, primed for a burst, and there is a mountain of debt, not just governmental but also consumer debt in the UK, which could cause havoc, as assets might be wiped out and wages become suppressed while debts remain. Incidentally, this fear of a bubble is another thing that is ingrained in me after what happened in Japan. When there is a deflationary recession, such will be difficult to overcome, as people and businesses opt for entrenchment, and that causes further negative cycle. Throw in the political uncertainty about Britain’s membership of the EU, and the difficulty the government will face if it were to switch course from the austerity to stimulus, it can go wrong, and badly so.

Now having argued this case, and on the basis that by making many (contradictory) economic predictions, one will eventually turn out to be correct, I should perhaps write an article on the imminent threat of inflation and how that’s going to be the doom of the UK in the near future.