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Tuesday, February 18, 2014

Lower Inflation - When To Worry?



So inflation has reduced again, now to 1.9%.

Taken as good news – prices are therefore rising at a slightly lower rate than a month ago.  They may even soon be rising at less than wages are.

But at what point does a reduction in inflation become bad news?

Deflation has to be something for the Bank of England to cautiously watch for.  You may think deflation – falling prices – is a good thing.

However, if prices are falling, consumers and firms put off purchases in the expectations that prices will fall further, and firms will then have to reduce prices more, less is produced, less is purchased, there is less requirement for employment and voila - you have a recession.

This is especially pertinent with the consumer-led recovery that we are experiencing in the UK.

Japan's economy since the early 1990's is a very interesting case in which we should follow.  They are only just getting out of their deflationary spiral.  There is a very interesting section on the Wikipedia page about Japan.

There is a way that the Bank of England can increase inflation which is to reduce interest rates.  Well, that is if there was any room to lower them, which at 0.5% there isn’t.  Not effectively anyway.  Or print yet more money.

Or the government can borrow more and go on a spending spree to stimulate the economy out of deflation.  Except we have a horrendous debt as it is and it isn't proven to reverse deflation.

It could get rather interesting in a year or two if inflation continues to fall.  Fingers crossed it stabilises.  Below 1% and time to get concerned.