The 19th century and the first half of the 20th again had rough overall price stability, with prices at first gradually falling and then gradually rising Then, during the last 50 years there was a 40-fold increase We regard that as normal, or at least fairly normal. Actually, such inflation has never happened before in the UK – or the US – in recorded history.Thus the world has little experience of managing the transition from rapid inflation to price stability. The developed country that is in the front-line of the transition, Japan, has made a hash of it, condemning the country to a decade-long recession. The test for the rest of us during the year ahead will be to do better.But how? There are two simple mistakes that Japan has made which neither the US nor the UK is likely to make. One is to allow the banking system to become paralysed by its bad debts.
The other is to load regulations on to the economy that inhibit competition – in the case of Japan, one of the most serious inhibitions to economic growth is excessive regulation.Even so, there must be some danger. The Bank of England thinks there isn’t, but at a retail level a large chunk of the items in the shops are now selling at a lower price than they were a year ago. Commercial rents are down too and residential rents are teetering. So here in the UK, where the risks of deflation are arguably less serious than in continental Europe or the US, there must be some danger.
Fortunately, we to have scope to cut interest rates and cuts are likely to be effective, thanks to the links through the housing market.In the US and in the eurozone the threat is greater. A new paper by Merrill Lynch argues that deflation is not on the cards in the US yet, though were US growth to remain sluggish for long enough, it could eventually emerge. That may be right, but were it indeed to emerge, there would not be a great deal that the US could do about it. Yes, the Federal Reserve can cut rates, but with short-term interest rates at 1.75 per cent, they are so low that cutting further might be counter-productive.
