The deflation myth

I expect you’re worried about deflation by now. If you aren’t, most economists and politicians will say you should be. Look, they say, at the failure of all the prices around you to rise as central bankers think they should.

The Consumer Price Index (CPI) in the UK is supposed to be rising at 2% a year. But last month the prices it measures only rose 1.7%. In the US, inflation is a mere 1.1%. Worst of all, in Europe prices are refusing even to rise at an average rate of 1%.

Look at those numbers, say our monetary leaders, and you will see why interest rates are so low: they must stay lower for longer to stop the economic nightmare that is deflation getting out of hand.

But there’s a problem with all this. First, it isn’t clear that flattish prices are a bad thing. Japan’s GDP per person has grown perfectly well all the way through its periods of stable prices and even deflation over the last 20 years. And second, it isn’t remotely clear that deflation is anything to worry about.

Think about it for a minute. If we live in deflationary times, why is the next election gearing up to be all about the ‘cost of living crisis’? Why is our old measure of inflation – the Retail Prices Index – at 2.5%? Why don’t you feel richer (as you would if prices were falling)? Why can’t young people find anywhere affordable to live, and how is it that you would have doubled your money on a Hammersmith flat if you had bought in 2006?

Why are beef prices knocking around new highs and why is the spot price of US foodstuffs in general up 19% this year? You can blame the weather for some of this shift (although my Australian farming friends tell me it is still about Chinese demand), but I’m not entirely sure you can blame it for the fact that ex-council flats in Hackney now cost £300,000 a bedroom.

Then look at wages. We said earlier this year that 2014 would be the year of rising wages, and we still think it will be: note that this week, teachers across England and Wales went on strike over pay and conditions; that wages in China have been rising fast and are forecast to keep doing so (think 10%-15% this year alone); and that in the US, President Obama recently raised the minimum wage for federal contract workers by 39% (albeit from shockingly low levels).

Finally, don’t forget geopolitics – do you think more trouble in Ukraine will raise or lower UK energy prices? Quite. Add it all up and you might wonder if we aren’t all falling for the deflation story just a little bit too easily.

I interviewed US economic guru Dr Pippa Malmgren this week. She is also concerned that we are falling for the deflation story too easily – there is, she says, no such thing as a government that can’t create real inflation if it tries hard enough. And America and Britain clearly intend to try at least hard enough. My full interview with Dr Malmgren will be in next week’s magazine. I think you’ll enjoy it.

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