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News that pubs around the country are offering lunch for £1, shops are slashing prices and Wetherspoon's are offering a pint for less than a pound may look like good news for consumers but it is causing a headache of another sort for policymakers: deflation
Britons have been used to the price of some items such as flat-screen televisions and clothes falling for years, as cheap imports flood in from China. But usually other products were increasing in price. In the past year, food and petrol were rising and this has kept overall inflation at around 2% or 3%. Now, however, the price of just about everything seems to be coming down.
This has pulled inflation on the consumer prices measure down sharply from September's peak of 5.2% and the retail price index (RPI), which includes falling house prices and interest rates, down to just 3%. In his recent letter to the chancellor, Mervyn King, the Bank of England's governor, said it was possible the RPI would fall into negative territory, or deflation, this year. Economists say a short period of deflation would be beneficial to the economy since it would raise people's purchasing power and confidence. But if deflation persists, people hold off buying things, leading to falls in demand and output. Then firms, selling less, cut what they pay staff. They have less to spend and the deflationary spiral kicks off. The spiral is exacerbated as debt deflation kicks in. If inflation is negative, the real value of debt rises, increasing the pain for mortgage holders and reducing further their willingness to spend, since they face a higher debt burden. Since 1945, deflation has been considered yesterday's problem. The last time the published inflation rate went negative in the UK was 1947.
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