Britannia Radio

It was about time, I felt, that the worries about DEflation should 
get a simple explanation.  Today the Telegraph obliged!

When deflation locks in I am not quite sure myself what happens whe 
INflation is imported.   Because if unemployment is rising and wages 
are falling the only answer must be that the economy suffers a 
further blow because can pay the increased prices.

xxxxxxxxxxx cs
===========================
TELEGRAPH   20.11.08
Deflation: why it is dangerous
Economists warned today that the UK economy is likely to suffer from 
deflation next year, after the latest official data showed inflation 
was slowing sharply.

By Harry Wallop, Consumer Affairs Editor


Deflation is when prices fall year-on-year - a phenomenon that has 
affected the electrical goods market for a long time. Each year, 
televisions get bigger, thinner and cheaper.

So why is this a problem?

Cheaper products, be they gadgets, cashmere jumpers or utility bills, 
are excellent news for consumers, especially when they have suffered 
from a relentless squeeze on their standard of living over the last 
two years.

A short burst of deflation is, indeed, a good thing. It makes 
everyone feel a little bit richer.

But this is only true if prices fall for a short time.

A prolonged period of deflation can have a pernicious affect on an 
economy and was one of the main causes of the Great Depression of the 
early 1930s and of the damage wreaked on Japan's economy in the early 
1990s.

There are two main reasons why deep-rooted deflation is so dangerous, 
especially when it is combined with job losses, as is expected to 
happen next year.

It encourages people to defer spending, as they wait for prices to 
fall further. This in turn forces down the price - as retailers slash 
prices in a vain attempt to attract shoppers.

As retailers cut prices, so too do manufacturers, who then have less 
money to invest in new technology, equipment and, crucially, staff.

Wages then start to fall - psychologically very damaging for 
consumers, even those that keep their jobs. As they fret about less 
money in their pockets and their job prospects, they further postpone 
spending, starting the deflationary spiral once again.

The other main reason why deflation can cause so many problems is 
that it serves to make debt more expensive.

Here's why. If you borrow £1,000 at the start of the year to pay for 
a new sofa, the cost of the loan does not change throughout the year. 
It remains at £1,000. But the sofa is falling in price. So at the end 
of the year - when you are still paying back the loan - you have 
ended up taking out £1,000 to pay for a sofa now worth just £900 or 
£800.

Think of it as negative equity on a grand scale, spreading itself 
into every corner of consumer credit.

Of course, in theory there are some winners: savers.

Deflation should encourage people to save, because a £1,000 saved at 
the beginning of the year, should be able to buy more than £1,000-
worth of goods at the end of the year. That is if they can find a 
savings account that pays out a decent level of interest, which can 
be very tricky when the Bank of England has slashed interest rates to 
just 2 per cent or even 1 per cent.