{"id":15463,"date":"2020-05-07T13:04:14","date_gmt":"2020-05-07T12:04:14","guid":{"rendered":"https:\/\/ounews.co\/?p=15463"},"modified":"2020-05-07T13:04:14","modified_gmt":"2020-05-07T12:04:14","slug":"inflation-or-deflation-which-would-be-worse-right-now","status":"publish","type":"post","link":"https:\/\/www.open.ac.uk\/blogs\/news\/arts-social-sciences\/inflation-or-deflation-which-would-be-worse-right-now\/","title":{"rendered":"Inflation or deflation \u2013 which would be worse right now?"},"content":{"rendered":"

Alan Shipman<\/a>, Lecturer In Economics at The Open University<\/a>, discusses whether inflation or deflation would be worse for the UK economy in the current climate.<\/p>\n

Inflation among the 37 member states of the Organisation for Economic Co-operation and Development (OECD) fell from 2.3% in February to 1.7%\u00a0in March<\/a>. With all the damage to global health and economies inflicted by COVID-19, this is one \u201ccollapse\u201d that might sound like good news. After such widespread loss of jobs and incomes, the last thing anyone needs right now is goods getting more expensive.<\/p>\n

However, there are dangers in further reducing the already low rate of consumer price inflation. In many countries, it is already below the\u00a0level targeted<\/a>\u00a0by their central banks \u2013 2% in the US, eurozone and the UK. Price rises are being stemmed by the fall in demand caused by the pandemic, plus the\u00a0steep decline<\/a>\u00a0in the price of oil. A slowdown of inflation towards zero or even into negative territory \u2013 deflation \u2013 will bring new economic concerns, potentially turning recession into depression.<\/p>\n

Deflationary downsides<\/h2>\n

Consumer spending is the major component of the demand that drives an economy.\u00a0If people start to think<\/a>\u00a0prices are going to fall, they tend to put off non-essential purchases in the hope things will cost less in months to come. Although falling prices mean a real income gain for those whose pay hasn\u2019t been affected by the current crisis, for many others this will be outweighed by the income they have lost from being furloughed or from being forced onto\u00a0state benefits<\/a>.<\/p>\n

Deflation\u00a0happened<\/a>\u00a0in the early 1930s and also in the 1870s, and when it\u00a0showed signs<\/a>\u00a0of returning in 2008, central banks responded by cutting interest rates and printing money. The fact that this has continued for much of the past decade reflects economists\u2019\u00a0growing belief<\/a>\u00a0that factors ranging from automation and household debt to rising inequality and the ageing population have hardwired low demand into the system.<\/p>\n

Slack demand pressures firms to cut prices and then pare their costs by reducing jobs and wages, compounding the deflationary problem. Many were already struggling to grow their sales even before the pandemic, and won\u2019t be able to cut their prices much further without sacrificing profits. UK producer price rises\u00a0slowed to<\/a>\u00a0just 0.3% in March, even before the lockdown began to rein in people\u2019s spending. Lower profit would squeeze their ability to finance investment, chopping another component of demand.<\/p>\n

UK producer price growth<\/strong><\/p>\n

\"\"<\/a><\/p>\n
<\/div>
Trading Economics\/ONS<\/a><\/span><\/figcaption><\/figure>\n

As well as damaging demand, falling prices also raise the real cost of debt. If you borrow \u00a31,000 and annual inflation is running at 3%, the money you owe becomes worth 3% less each year even before you pay anything off. If there\u2019s 3% deflation, the debt becomes worth 3% more each year in real terms. In a world with\u00a0record levels of debt<\/a>, this could become a very serious problem.<\/p>\n

In the current crisis, central banks around the world have been trying to boost consumer demand and help businesses survive by cutting interest rates to close to zero. Deflation would frustrate this effort: whereas 3% inflation annuls the real cost of a loan that charges 3% interest, a 3% deflation means a real interest rate of around 6%.<\/p>\n

When interest rates are driven down to what economists call their\u00a0zero lower bound<\/a>, governments trying to revive their economies are forced to seek other ways to lighten people\u2019s debts and boost spending power. These include\u00a0underwriting<\/a>\u00a0private sector debt; giving companies and individuals\u00a0temporary protection<\/a>\u00a0from bankruptcy or insolvency; and, in the US,\u00a0directly paying money<\/a>\u00a0into people\u2019s accounts in the hope that they\u2019ll spend it.<\/p>\n

Will inflation return?<\/h2>\n

Inflation has slowed even when some products are in short supply due to industrial stoppages and panic buying. Past experience has made many retailers reluctant to raise prices in case it looks like profiteering. Shoppers who ventured online (or\u00a0into lay-bys<\/a>) in search of missing essentials reported re-sellers charging huge premiums, which the official inflation index does not capture.<\/p>\n

Prices will start to rise again if supply can\u2019t keep up with the demand that\u2019s now being injected into the world\u2019s economies in the form of government stimulus measures to fight recession. This could lead to significant inflation in the next year or two if there\u2019s renewed demand while global supply chains remain disrupted. And it will be aggravated if oil prices rebound sharply from recent 20-year lows.<\/p>\n

If inflation does soar, it will have been fuelled by the extraordinary scale of government borrowing in response to the shutdowns. The US government\u00a0will borrow more<\/a>\u00a0in the present quarter than in the whole of 2019, extending what was already a trillion-dollar budget deficit. The UK\u2019s business-support costs\u00a0have already reached<\/a>\u00a0\u00a3100 billion, far more than the bank bailouts of 2007-09.<\/p>\n

Fiscally stronger countries like the US are financing much of the increase spending by issuing new public debt, which in principle absorbs some demand and reduces any inflation pressure. But other governments,\u00a0including the UK<\/a>, may literally print some of the additional money.<\/p>\n

Policymakers are rediscovering the\u00a0Keynesian thinking<\/a>\u00a0that deficits will create enough economic growth to prevent the public debt-to-GDP ratio from getting out of hand. Some have\u00a0also embraced<\/a>\u00a0the\u00a0once fringe<\/a>\u00a0idea of\u00a0modern monetary theory<\/a>, which argues that any country with its own currency can increase spending by printing money rather than having to increase taxation or take on more debt.<\/p>\n

Before these views edged into the mainstream, the dominant \u201cmonetarist\u201d narrative was that increasing the money supply by running large fiscal deficits was\u00a0bound to ratchet<\/a>\u00a0inflation. Some monetarists viewed this as secretly part of a political plan. Governments, they argued, invariably run up debts and don\u2019t want to repay them by raising people\u2019s taxes. Instead they unleash inflation, which makes these debts worth less while also \u201ctaxing\u201d the value of people\u2019s wealth.<\/p>\n

Today\u2019s governments will certainly hope that their fiscal and monetary stimulus packages cause some further increase in prices, as well as averting falls in income and industrial capacity. Because whatever the downsides of inflation, the prospect of deflation in a world with such high debts is considerably worse.<\/p>\n

Alan Shipman<\/a>, Lecturer in Economics, The Open University<\/em><\/a><\/p>\n

This article is republished from\u00a0The Conversation<\/a>\u00a0under a Creative Commons license. Read the\u00a0original article<\/a>.<\/p>\n","protected":false},"excerpt":{"rendered":"

Alan Shipman, Lecturer In Economics at The Open University, discusses whether inflation or deflation would be worse for the UK economy in the current climate. Inflation among the 37 member states of the Organisation for Economic Co-operation and Development (OECD) fell from 2.3% in February to 1.7%\u00a0in March. With all the damage to global health […]<\/p>\n","protected":false},"author":19,"featured_media":15470,"comment_status":"closed","ping_status":"closed","sticky":false,"template":"","format":"standard","meta":{"footnotes":""},"categories":[3,15,21],"tags":[587,755,869,1141,1525,1640,1643],"class_list":["post-15463","post","type-post","status-publish","format-standard","has-post-thumbnail","hentry","category-arts-social-sciences","category-society-politics","category-uncategorized","tag-deflation","tag-economy","tag-fass","tag-inflation","tag-news-home","tag-ou-home","tag-ou-news"],"_links":{"self":[{"href":"https:\/\/www.open.ac.uk\/blogs\/news\/wp-json\/wp\/v2\/posts\/15463","targetHints":{"allow":["GET"]}}],"collection":[{"href":"https:\/\/www.open.ac.uk\/blogs\/news\/wp-json\/wp\/v2\/posts"}],"about":[{"href":"https:\/\/www.open.ac.uk\/blogs\/news\/wp-json\/wp\/v2\/types\/post"}],"author":[{"embeddable":true,"href":"https:\/\/www.open.ac.uk\/blogs\/news\/wp-json\/wp\/v2\/users\/19"}],"replies":[{"embeddable":true,"href":"https:\/\/www.open.ac.uk\/blogs\/news\/wp-json\/wp\/v2\/comments?post=15463"}],"version-history":[{"count":0,"href":"https:\/\/www.open.ac.uk\/blogs\/news\/wp-json\/wp\/v2\/posts\/15463\/revisions"}],"wp:featuredmedia":[{"embeddable":true,"href":"https:\/\/www.open.ac.uk\/blogs\/news\/wp-json\/wp\/v2\/media\/15470"}],"wp:attachment":[{"href":"https:\/\/www.open.ac.uk\/blogs\/news\/wp-json\/wp\/v2\/media?parent=15463"}],"wp:term":[{"taxonomy":"category","embeddable":true,"href":"https:\/\/www.open.ac.uk\/blogs\/news\/wp-json\/wp\/v2\/categories?post=15463"},{"taxonomy":"post_tag","embeddable":true,"href":"https:\/\/www.open.ac.uk\/blogs\/news\/wp-json\/wp\/v2\/tags?post=15463"}],"curies":[{"name":"wp","href":"https:\/\/api.w.org\/{rel}","templated":true}]}}