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Periods of deflation were common in Britain right up until the second world war. In the 19th century there were as many years of falling prices as of rising prices, with the result that the cost of living was lower when the first world war broke out in 1914 than it had been when Wellington triumphed at Waterloo in 1815.
But since 1945, deflation has been considered yesterday's problem - in the UK at least. Japan, Sweden and the Czech Republic have all had periods of negative inflation, but the last time the published inflation rate went negative in Britain was in 1947. For most of the time, policymakers have been terrified at the prospect of an inflationary spiral, particularly in the 1970s and 1980s, when the annual increase in the cost of living rose above 20%.
Mervyn King revived the spectre of deflation when he said yesterday that one of the government's yardsticks of inflation, the retail prices index, would go negative in 2009. The Bank does not believe that the measure of the cost of living used to set the Bank rate - the consumer prices index - will go below zero, but its drastic cut in borrowing costs last week was seen as necessary to prevent inflation falling too far, too fast.
Jonathan Loynes of Capital Economics said that a short burst of deflation driven by tumbling oil and food prices might help the economy, since falling prices mean consumers can buy more with their income. Rising spending power would provide a boost to confidence and could help lift the economy out of recession.
A longer period of deflation would not be such good news, as the experience of Japan in the 1990s illustrates. Expecting prices to be lower in the future than they are at present means consumers defer purchases and thereby cause or prolong recessions.
A second - and potentially even more dangerous - threat is of debt deflation. The big difference between today and the deflationary episodes of the pre-1939 period is that consumer borrowing is now much higher and far more widespread.
Very few individuals had mortgages before the second world war; none had credit cards. The increase in personal indebtedness over recent decades has left individuals highly vulnerable to a period of falling prices. Why? Because the real value of the debt increases if prices are falling (just as it decreases if prices are rising). And, since it is impossible to cut interest rates below zero, there is a limit to what policymakers can do to ease the pain.
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