Deflation may add to Britain’s economic woes
22 Apr 2009
Deflation has hit Britain once again after 50 years say economists. The 49 years since the last time Britain was hit by deflation in 1960 have seen prices rise steadily on different cues. Inflation exploded in the 1970s and though was kept under control, it was never defeated in the 1980s.
The 1990s saw prices dip across the world with the impact of cheap products from developing countries mainly China. The latest fall follows the collapse of oil prices since the peak levels in the range of $140 a barrel of last summers.
Additionally the cut in interest rates has seen the Retail Price Index (RPI) inflation falling from 4.2 per cent at the worst in October to -0.4 per cent in March.
Under normal circumstances inflation is beneficial in small doses and serves to keep the economy growing and standards of living rising according to economists.
However, there is a fear that inflation could heat up leading to a devaluation of savings, wages and products. Bank of England policy has therefore been directed towards containing inflation.
Deflation is rare, but in the short term it can be good for some and may also provide a e a boost to the economy.
However, the Japanese experience has shown that prolonged periods of deflation can lead to stagnation in the economy with depressed consumer spending and a corresponding drop in production and jobs. It could drive wages down and lower the standard of living.
There are short term benefits to deflation though, as consumers will pay less for goods with the fall in RPI. Those who have already secured pay rises can look forward to gain the most, however for those who have not deflation could well mean a freeze in salaries or even cuts.
Also there may be more trouble in Septembter when deflation is expected to be at its worst and could have an adverse impact on state pensions that are linked to the RPI analysts point out.
People who owe money could also end up losers as deflation intensifies debt.
Analysts point out that the RPI measures of the cost of living which will fall a lot more heavily over the coming months. This is expected as last year's big increases in energy prices will not be repeated. As in many cases, pay is linked to the RPI, it would be likely that pay freezes may rise leading to even pay cuts in some cases.
Analysts fear that just as the 1970s prices spiraled to new highs pushing up wages, there could be a downward spiral driving down purchasing power.
Meanwhile union leaders in Britain have warned employers not use deflation as an excuse to introduce measures like salary freezes or pay cuts.
As the prospects of widespread pay freezes loom large economists say it is the last thing the UK's struggling needs at the time as it would force families to cut back on their spending which will hit recovery.
