Deflation, good news or bad news?

Cigarettes and alcohol are cheaper during periods of deflation

Cigarettes and alcohol are cheaper during periods of deflation

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Deflation is a decrease in the general price level of goods and services.

It occurs when the inflation rate falls below zero per cent. Inflation reduces the real value of money over time whereas deflation increases the real value of money. It is generally agreed deflation is a problem in an economy like ours as it increases the value of debt.

In the past deflation was something we had not had to concern ourselves with but during September and October we have had two straight months of deflation for the first time since records began. Prices were pushed lower by; lower university fees, cheaper food, alcohol and tobacco. These falls offset the rising costs of footwear and clothing.

Certainly in the short term deflation may appear to be a good thing for consumers but if it persists it is less clear whether this is the case. Economists are split as to the causes of deflation and its implications for the economy with some believing it is only a temporary phenomenon with prices which will picking up in the near future. Therefore these economists think it is a good thing as it boosts spending during this time and grows the economy as people have more money in their pockets.

Others have a much more drastic view of deflation thinking it could be with us for many years with our debt being amplified. They are worried that if deflation is with us for the long term that as in Japan which has experienced long term deflation, it could alter householders expectations. This could then encourage people to delay their spending in anticipation of lower prices in the future. This would cause lots of uncertainty in the economy with companies delaying investment due to the slowdown, resulting in us all going into a downward spiral and high rates of unemployment.

The only winners would be people who have fixed incomes and perhaps people who have capital who can lend it out at rates above zero. So on balance let’s hope that we have deflation for long enough to boost the economy but not long enough to cause it significant lasting damage.