If, like me, you’ve spent your entire adult life fearing inflation as the universal bogie, welcome to the pantomime world of Post-Modern economics. Because there’s another bogie even worse: it’s called deflation. For those of you who are not familiar with the great British tradition of Christmas pantomime, the heroes of the drama innocently face the audience, while the monster always sneaks up from behind. And the kids all shriek: It’s behind you!

Let’s be clear about terms. Inflation is the rate at which the price level rises over a given period (normally a year); deflation is the exact opposite: the rate at which the price level falls. (Disinflation – insofar as economists agree at all – is the rate at which inflation falls and is an intellectual nonsense that should be ripped out of the economic textbooks.)

Why all the fuss about deflation?

In the brave new world that emerged after the dust clouds of the Credit Crunch dispersed,monetary policy, previously the domain of academic economists, took centre stage. Just asdemand management (to obtain full employment), the universal mantra from the 1940s to the late 1970s, gave way to the fight against inflation in the 1980s, and then to sustainable non-inflationary economic growth from the 1990s to the first years of the new century, so changing economic conditions have heralded new economic priorities.

In the September 2015 edition of this magazine (Interest Rates are Due to Rise – or Maybe Not) I reflected that central bank chiefs, these days, are more prominent and more influential than finance ministers. The world is actually now run by this high priesthood of unelected sages whose awesome responsibility it is (exercised largely away from the prying eyes of elected legislatures) to do three things.

They set interest rates (essentially, they fix the price of money); they regulate the banking system; and (most obscurely) they maintain price stability. But in practice, these three things amount to managing the money supply. Put very crudely, too much money in the system (and most money is in the form of credit) and prices go up (inflation). Too little money in the system and prices go down (deflation).

David Fuller's view

There has been plenty of disinflation and deflation in the global economy in recent years and counting.  Most commentators regard it as a frightening problem.  Well, yes, if one has lots of debt, which becomes more of a burden in a deflationary environment, because the cost of capital is increasing in real terms and salaries for many people will actually be declining.  Conversely, in an inflationary environment the cost of debt is declining in real terms, and most salaries will be increasing.

What the article above does not discuss, is the crucial difference between destructive deflation and positive deflation.

Widespread destructive deflation (lower sales, prices and profits) compounded by debt can lead to depression.  Conversely, technology driven positive deflation (higher sales, lower prices and rising profits) is mostly good for economies, albeit after an initial shaky period because new technologies are also disruptors. 

I maintain that we are mostly experiencing positive deflation, which is disruptive but will be good for GDP growth over the longer term.