Business Debtline – June 2015

Deflation – what does it mean and should we be concerned?

History was made when the Consumer Price Index (CPI) fell 0.1% in April – the first time it has happened since official records began in 1996.

The news and media have been reporting that “deflation” has arrived – this is the word used to describe the situation as there is no other word in the English language that is suitable for what is happening.

What does deflation mean, and why is it such a big thing?

The easiest way to describe deflation is a long term trend of declining prices. However, deflation can be destructive to the economy. If we believed that prices were set to fall month after month, we would spend less - in the hope of picking up better bargains later - and employers may pay less or stop future salary increases.

That would place a deadening weight on our ability to grow the economy - a weight made heavier by the problem of our massive household debts, in that our capacity to service those debts is diminished when incomes don't grow and the lack of spending will leave the economy stagnating.

But most experts think that these current price falls won't endure much more than a month or two, mainly due to the fact that oil prices are rising along with the value of the euro against the pound.

Therefore for now at least, we should maybe talk about what's occurring as - "good" deflation. The fact that there've been falls in the prices of essentials - food, non-alcoholic drinks and transport - actually increases our standard of living in the short term. Because we have no choice but to eat, when food prices fall, our money goes further - and we are better off.

So this kind of deflation may in fact be stimulating consumer spending and economic activity. But unless we experience a bit of proper inflation back in the system, we'll never break the shackles of our cursed enormous debts. Nevertheless, small firms should keep a very tight hold on costs during the low inflation/deflation period to ensure they emerge unscathed when inflation rises once more.