. . . . . . but that’s hardly a reason to be cheerful. And deflation might dampen wasteful consumerism. By Peter West
There’s only one thing worse than inflation, and that’s deflation. Inflation got a bad name for itself in the seventies, but just recently when it has looked like being replaced by its satanic brother, deflation, we have had cause to think what a good idea it was after all. Remember, the Monetary Policy Committee’s remit was not to keep inflation below a certain limit, but the Governor of the Bank of England was required to write and explain himself to the Chancellor of the Exchequer if it fell below maybe 2%.
So why is deflation such a bad idea?
Two big reasons: it discourages spending if people know that anything they can buy today is likely to be cheaper if they put off the decision for a month or two; and it discourages investment if you know the returns will continually diminish. How many people would have invested in Buy-to-lets if we didn’t expect a capital gain? Who would buy shares if they thought company revenues and profits would progressively get less?
And why is inflation such a good idea?
Because it makes us go out and spend. If we know the TV that costs £500 today will be £520 in a few months’ time we will buy; and it encourages us to invest because we know the assets we invest in will go up no matter how we manage them. Most of our (older) generation have done very well (thank you) riding the house price inflation train. Whether we cashed it in or not, the fact that the value of our homes was going up made us feel we were doing well, so we went out and spent freely, in the knowledge that that nest egg was there for us.
Inflation is what the Prime Minister dreams of now to stimulate the economy more than anything he can do. Goodness knows we have a right to expect it. Something that has gone largely unreported is that Sterling’s 25-30% decline against the $ and Euro, when most things we buy are imported, should be expected to lead to either serious inflation or savage reductions in company profits.
Inflation is what the banks are crying out for because it will restore value to the assets on which their loans are secured. No wonder Crispin Odey wants inflation back. He has plenty of assets and wants to see them increase in value again.
And why is inflation such a bad idea?
Because it eroded the wealth of those with savings and those on fixed incomes and because it took property out of the reach of people on normal incomes. It created a chasm between those who had and those who hadn’t. House prices became a self-perpetuating bubble – until it burst.
And why is deflation such a good idea?
Because it will bring property back down to more sensible levels – maybe half what the market peaked at (bad news for those that got in late with big mortgages, but good news for those waiting to get a home); and it will discourage people from spending pointlessly in a world where there is an unsustainable level of consumption. This does mean less jobs, but it also means the world’s resources will last just a little longer.
4 Comments
In fact the inflationary 1970s didn’t make it impossible for people to get on the housing ladder – that happened in 1987-89 and again in 2005-07. Again, the reason is inflation, or the lack of it. It’s the reduction in debt repayments as a proportion of spendable income that’s the key factor: inflation makes this ratio fall, hence consumers feel better off.
Deflation as a cure for consumerist ills is simply self-indulgence whose folly is evident if you look at the record of the 1930s. Do you really want to create mass unemployment, hunger and poverty to stop us buying flat screen TVs we don’t really need? Excessive consumption was indeed a feature of the past decade, but it would have already been subject to some natural correction if central bankers hadn’t kept credit conditions too easy and if politicians had run large budget surpluses (= higher taxes), which is the correct Keynesian response to a long-running boom. Instead we’re having a more dramatic correction, which will also run its course.
In response to John Kelly’s point about prices rising faster than incomes: of course that did happen in the 1970s for brief periods, but RPI inflation soon became imbedded in labour contracts (as indeed it is now). And yes, there are losers from inflation: but the point is that they are old and rich (or are institutions that hold money for the old and rich)- and either we take the money from them, via inflation, or today’s workers will have to accept a lower standard of living- the French, as ever, are the first to show us what they think of that.
Chris
My understanding is that with a few brief exceptions, like the early nineties, house prices have outstripped wage inflation, making it harder for first time buyers to get on the property ladder. My point was that it was this increase in perceived wealth for property owners that created the spending boom, more than small decreases in mortgage payments, as people spent virtual gains they thought they had made from property ownership.
As for your comments about my “self-indulgent” “folly” of “deflation as a cure for consumerist ills”, this gets to the heart of a really important question that Thus needs to keep an open mind on if it is going to make an interesting contribution. What makes politics uninspiring to young (and old) nowadays is the consensus which I could describe as Blair-Cameron, but which almost every main stream politician has bought into that says economic growth is good; spending is good; without any regard to the ever-increasing consumption of the world’s resources. For example – the third runway at Heathrow must happen because it will create jobs and it will create vast acres of new shops for BAA. Any environmental, ecological concerns are trumped by the economic growth card.
I was not saying deflation was a cure for consumerist ills, I was saying that a bit less consumption would be good for the planet. How can we preach reducing emissions to the rest of the world if we are always pressing on the consumption accelerator as hard as we can?
Peter West
This takes me back to A level economics…
If the choice is deflation, zero inflation or very low inflation, surely the latter’s the one go to for in that modest inflation is an unavoidable sign of a growing economy?
As the economy grows and demand for goods/services grows, temporary bottlenecks and modest supply shortages are unavoidable… demands exceeds supply for the good/service in question… prices rise.
It’s not a question of aiming for inflation – but aiming for growth, knowing that modest inflation comes with growth, and posting guards to ensure that the inflation does remain only modest.
Michael Prescott
Michael
I agree with your pithy analysis, but, respectfully, you don’t address the question as to what happens when ‘growth’ stops, as it has now, in ways which Gordon Brown, saviour of the universe, describes as ‘without historical precedent.’
I agree that we need to ‘post guards’ to ensure that inflation is kept under control, but wonder if the drooling halfwits whose unbridled public spending sprees have left the country flat broke in the middle of a global slump are the right sentries.
Thanks for your comment, though. You’re a genuine big brain and I suspect you’ve got an answer or two up your sleeve. I personally think we need to abandon the globalisation malarky. This doesn’t imply protectionism, but it does call for taking care of one’s own business and urging others to do the same. I suspect this will be the US agenda, at least until they have licked their wounds. Europe has never really done us any favours: I suspect the Germans and French will be thinking likewise.
John