A specter from the past hovers over the major industrialized nations: deflation. A decrease in the overall price level, deflation was a term relegated to economic history, with the notable exception of Japan following the bursting of its land and stock market bubble in the late 1980s. The everyday experience of the post-World War II generations has been inflation or rising prices. Besides a few exceptions, such as New York Times columnist and Nobel laureate Paul Krugman, many economists, central bankers, and Wall Street strategists primarily fret over prospects for inflation. Sure, prices may be tame at the moment, but inflation’s resurgence is inevitable—or so we’re repeatedly told.

Really? The trend in consumer price indices clearly point toward increasing deflationary pressures. The epicenter of current concern is Europe, with its latest consumer price index reading at 0.7 percent, down from 1.1 percent a month earlier. Spain’s year-over-year inflation rate is at 0.1 percent. Germany sports a mere 1.2 percent annual inflation rate, and a number of smaller, troubled countries are in deflation, such as Greece, Latvia, and Bulgaria. A parallel story unfolds in the U.S. America’s CPI is running at a 0.9 percent year-over-year pace, down from 2.2 percent a year ago.

Here’s the thing: Deflation has become the modern condition. The emergence of deflation isn’t a temporary phenomenon reflecting the economic weakness and high unemployment. No, the underlying trend toward deflation stems from heightened international competition for markets (globalization), widespread migration (immigration), and rapid technological advances (Amazon.com (AMZN)). The Great Recession and the anemic recovery simply accelerated the trend from disinflation and toward deflation.

And:

Deflation isn’t always bad, however. Sometimes, mild deflation can signal a vigorous, creative, healthy economy. Good deflation stems from a positive supply shock, e.g., a string of major innovations that combine to push down costs and prices while opening up new markets and opportunities. Productivity-driven deflation was common during the last part of the 19th century. For instance, the wholesale price level fell about 1.5 percent annually from 1870 to 1900, yet living standards improved as real incomes rose 85 percent, or about 5 percent a year. The U.S. economy grew threefold, and by 1900 America was the world’s leading industrial power. “The nineteenth century American experience demonstrated that economic growth is compatible with deflation,” concludes economist George Edward Dickey, writing in Money, Prices, and Growth: The American Experience, 1869-1896.

The commonplace assumption is that the zero-bound, quantitative easing and other extraordinary measures taken by the Federal Reserve and, more recently the European Central Bank, are aberrations from the normal ways of central banking business. The belief is misplaced. The unusual will become normal, with deflation the main price trend in a hypercompetitive global economy and quicksilver technological change. The Fed will need to learn more about how to distinguish between deflations reflecting a healthy economy and a fall in prices that threatens to set in motion debt deflation. Thing is, the central bank can’t manage that difficult task on its own. It’s critical that Congress remove an ingrained bias in the tax code favoring debt financing and putting equity at a disadvantage. Encouraging leverage is toxic in a deflation-prone economy. Welcome to the age of deflation.

David Fuller's view

We live in a fiat currency world, of course, but inflation is not a serious problem for most countries due to three reasons: global GDP growth is still slow following the credit crisis recession; globalisation has increased competition and compressed wages in developed countries, and most importantly, accelerating technological innovation is resulting in very powerful and mostly positive disinflationary and deflationary pressures. 

Inevitably, inflation will increase when the global economy is next synchronised in a period of sustained economic growth.  However, I think competitive globalisation and especially the pace of technological innovation will continue to exert a disinflationary and deflationary influence.  In other words, no reasonably well managed country is likely to experience anything like the inflationary pressures of the early 1970s.  The main wild card exceptions, should they occur, would be sharp increases in global food prices due to a combination of adverse growing conditions and diseases affecting crops or livestock.