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Deflation and the dangers of 'turning Japanese'

Optimists argue that a number of things will occur militating against the normal problems associated with falling prices.

Reading the financial and business sections of newspapers can be frustrating in disentangling the range of differing views that are expressed with respect to the effects of falling inflation.

For some the possibility of below zero inflation, usually assumed to be negative ‘deflation’ (see below), is a good thing.

Optimists argue that a number of things will occur militating against the normal problems associated with falling prices.

Firstly, we are told, the good times have returned and we should experience wages increases in 2015.

The predicted increase in ‘average’ pay when coupled with falling food and energy prices will, according to the Bank of England, mean we experience an effective 3.5% a boost in income.

‘Good’ deflation through additional income will translate into increased spending which, in turn, will mean consumption goes up and feed into growth figures.

The Bank of England predict that economic growth for the coming year will be 2.9% and have raised the forecast for 2016 from 2.6% to 2.9%.

All of which means that the Bank’s governor Mark Carney has asserted that what we are seeing is ‘not’ really deflation, or at least not in the traditional sense.

Carney has stressed that when food and energy are stripped out, 68% of the underlying categories of the CPI (consumer price index) are increasing.

However, there are many who suggest that there are undercurrents that may knock the good deflation thesis off course.

For starters there is the price of oil which is starting to show some tentative signs of recovery.

As history has demonstrated, the price of oil is a commodity which can fluctuate with remarkable rapidity.

Food prices may remain low for longer than oil but no-one should believe that this situation will necessarily pertain in the long-term.

The other key aspect of the good deflation thesis is that wage rises will be enjoyed by all.

Those with specialist skills and good experience in key sectors will undoubtedly benefit.

Data shows that the UK labour market is far more nuanced than it used to be and that general wage increases do not accrue to all; especially those who working in sectors in which self-employment and zero-hours contracts now play a substantial part.

In last week’s Guardian economics editor Larry Elliott made the point that there may be a danger of over-optimism and the last time we witnessed similar economic conditions to those currently being experienced was the mid-1980s which, he wrote, “ended with a colossal consumer and housing boom, followed by an equally colossal crash.”

That this is an election year means that there will be continuing uncertainty about issues such as Europe and immigration up to and, in all likelihood, beyond when votes are cast in early May.

One of the things that may give some comfort to homeowners paying mortgages is that view that interest rates will remain low for the foreseeable future.

The problem with continuing ultra-low low interest rates is the widespread perception that saving money is now pointless which, for consumption advocates is perfectly fine.

But as we have seen, money that is available has increasingly shifted upwards in terms of earners and who, relatively spend less on day-to-day consumption.

Unsurprisingly property is seen as a better way to make money than saving.

That those who wish to get onto the property ladder – the young – possess an increasing propensity to use credit cards adding to unsecured debt may exacerbate the potential for the sort of property crash Elliott and others assert is possible.

Moreover as Elliott suggests, the dynamics of the employment market mean that inflationary pressure resulting in wages going up significantly will “remain muted.”

Bad deflation continues to be a possibility; something that frightens politicians across the world.

And as anyone who has studied economics will acknowledge, what has occurred in Japan for the last twenty years or so is salutary.

The property bubble of the late 1980s crashed spectacularly in the early 1990s and undermined the confidence of a nation that had recovered from the devastation of defeat by America in the second-world-war.

What followed was increasing unemployment and lower wages resulting in a ‘deflationary spiral’ of decreasing demand in turn further reducing prices.

The fact that this situation has existed in Japan for over two decades has been the reason that governments elsewhere had so little reluctance in pumping money into the economy through QE (quantitative easing).

That so little of this money has made its way to business and, more especially, workers is, to say the least, unfortunate.

It’s no wonder that Prime Minister David Cameron is calling on businesses to give their workers a hike in wages.

What’s interesting is Japan has a problem we don’t have; a population that is ageing combined with a low birthrate.

One of the reasons we don’t have these characteristics is immigration which is an issue that generates tension; especially in election campaigns.

A cursory study of the data will provide evidence that immigrants overwhelmingly tend to be young and willing to work.

Immigrants usually spend what they earn – therefore increasing consumption – and are more likely to have children who will in turn add to the birthrate.

Immigration is what Japan really needs but is unlikely as not welcomed by the indigenous population.

What is creating concern is that Japan’s pensioners are increasingly drawing down savings to live which, given that pensions are not increasing, won’t last for ever.

As a consequence Japan’s deflationary conundrum continues.

‘Bad’ deflation is what policy makers fear most.

That Europe, our biggest market for exports, is experiencing deflation should give us all concern if consumers purchase fewer UK goods.

Remember, the current account deficit stands at 6% of national output which is an historic high.

For all of our sakes we should sincerely hope that deflation doesn’t become endemic here (or in the EU) undermining an economic recovery that is still considered too reliant on increased consumer spending and housebuilding which, according to figures published by the ONS last week, is faltering.

Journalists

Graeme Brown
Editor (Agenda and Business)
Enda Mullen
Business Reporter
Tamlyn Jones
Business Reporter
Neil Elkes
Local Government Correspondent
Emma McKinney
Education Correspondent
Ben Hurst
News Editor
Jonathan Walker
Political Editor