UK deflation: Why the normal rules just don’t apply

Today, it was announced that the UK is in a period of deflation. It will almost certainly be a brief period.

 

On the face of it, there is not much difference between the price level being stable and the price level falling by 0.1 per cent a year. At that rate, it would take a long time for the currency to regain the value lost since the Bank of England was nationalised just after the Second World War – a good millennium or so.  

 

But, is deflation a bad thing in any case? Is it a bad thing that the value of money in our pockets and current accounts is rising?

 

Certainly the current bout of deflation is not a bad thing. It is largely caused by the fall in commodity prices – especially oil.

 

All the usual arguments about deflation raising the real cost of hiring labour on fixed contracts or raising the value of a company’s debts simply do not apply. Just as household costs are falling, business costs are falling too. Essentially, the economy is becoming more productive – the goods and services we buy are becoming cheaper and the cost of inputs for firms is becoming cheaper. Firms are well able to service their debts – especially at today’s low interest rates.

 

In other words, though economic growth is not very fast, we are in a “growth deflation”. Economic growth would be slower today if it were not for the forces that are causing deflation just as economic growth would have been faster during the commodity price boom if it were not for the rising cost of oil and other raw materials at that time.

 

Could the growth deflation turn into what many economists would think of as being a “bad deflation” or slump? This is unlikely as the conditions simply do not exist for this to happen. However, we should not worry even if it does happen – as long as deflation remains moderate. A flexible, liberalised economy can cope with deflation as long as it does not take us by surprise.