There is a new fear abroad. There is the fear of deflation gripping the world economy in its icy hands. So is deflation terrible? And is it likely? I suggest the fears are being overdone.
Deflation means a general fall in the price level of a country or currency zone, not a fall in some prices like energy whilst others may rise. Falling prices can then react to encdourage falling wages, which in turn can generate falling output. As prices fall so people hold off buying the inessentials, knowing they will be cheaper later. This in turn can induce further price falls as stocks hang heavy on producers which they need to discount to sell.
This is not currently happening in any major economy in the world. The world’s two largest economies, the USA and China, are both growing at satisfactory speeds, and both have low levels of inflation, not falling prices. The same is true of the UK. Latin America’s largest economy, Brazil, has the opposite problem. Inflation and currency weakness have been too pronounced, so Brazil has hiked interest rates and is forcing down the growth rate to try to get inflation down. India has quite high inflation and good growth. Russia has high inflation following a currency collapse. Even Japan, a country which had no inflation to speak of for over 20 years, now has some inflation mainly thanks to a tax hike, and a monetary policy designed to get price rises up to 2% per annum.
So the worry comes down to Euroland. There inflation is now very low, and may dip further into negative territory this year. Growth is very sluggish, and parts of the zone including Italy are back in recession. The fear of deflation is being used by the doves at the European Central Bank to encourage moves towards creating more money to ease the squeeze on the distressed parts of the zone.
Deflation is to be feared if a substantial fall in the price level is part of a general slump in incomes and output, as in the early 1930s. Even the Euro area is not on the threshold of such a development, barring a sudden whirlwind Euro crisis and collapse which is unlikely at the moment. Sharp falls in some prices like energy can provide a stimulus, especially for countries which import a lot of it. Price stability or even a small fall in the general price level need not mean recession or worse, as Japan, Switzerland and some others have demonstrated in recent decades. Deflation only gets serious when it is spurred by banking collapse or consolidation, leaving an economy short of credit for worthwhile new ventures.