From the TUC

Deflation watch

14 Oct 2014, by in Economics

The Chancellor today described the CPI inflation figure of 1.2 per cent as a ‘double dose of good news’, apparently easing cost-of-living pressures and also meaning gains for pensioners through the ‘triple lock’ (see end). Sticking to the politics, he avoided the economics of inflation repeatedly surprising on the downside and yet remaining above earnings growth.

On the basis of CPI figures, deflation in the shops may be a way off for the United Kingdom. But as has been repeated ad nauseam, deflation is a reality in UK real take home pay. Inflation may have fallen this month, but it is still exactly double the rate of earnings (1.2 per cent v. 0.6 per cent).

Reduced earnings lead to macroeconomic fragilities through reduced demand. Weak demand means fewer purchases and downward pressure on prices in shops. The inflation targeting regime in the UK is based on the idea that too high and too low inflation are both undesirable, distorting the efficient operation of the economy. Problems specific to negative inflation (=falling prices = deflation) are commonly understood as:

  • consumers postponing consumption, on the grounds that future prices will be lower;
  • with falling wages, the burden of debt payments increases: given they are not reduced when inflation falls , interest payments will account for a higher share of income and further depress spending; and
  • uncertainties, caution and fears inhibiting economic activity more generally.

At the extreme, Irving Fisher devised his debt-deflation theory to explain the US Great Depression of the 1930s, based on various processes beginning in financial markets.

For the OECD, these concerns are very real. And this is hardly surprising: the chart below shows the count of OECD countries where CPI annual inflation rates are negative by month. Strikingly, while the September count is currently down a little on August, it is based on returns from only 19 of 32 countries.

Count of countries with negative consumer price inflation

def1

The second chart looks at annual inflation rates across the OECD, with the full sample for August and including those figures that are available for September. (Note that the higher rates have been cut off at 3 per cent so that lower rates can be better seen.)

def2

The growing reach of deflation is plainly apparent. At work are global forces that merit serious consideration, rather than simply being aimed at political ends.

(NB the ‘triple lock’ ensures that pensioners receive the highest of average earnings, CPI inflation or 2.5 per cent, based on today’s September figure. With such low outcomes for the CPI and AWE, this is a relatively big gain for this important group of voters.)

One Response to Deflation watch

  1. Gigi – OverThePeak.com
    Oct 16th 2014, 8:22 pm

    […] TouchStone Deflation […]