City Guide to Edinburgh, Scotland

City Guide to Edinburgh, Scotland

Living With Deflation

By edg - Posted on 24 March 2009

One of the effects of the massive evaporation of easy credit both in Britain and around the world in recent months has been deflation. In 2009, Britain is expected to officially enter into its first deflationary period in 49 years when the Retail Price Index, which measures the price of goods and services, drops below zero.

Deflation occurs when there is a general falling off in the availability of money and credit. With deflation comes job and salary cuts, a reining in of consumer spending, and a fall in the value of property and shares. In severe bouts of deflation, a vicious cycle of falling prices, that can last years, takes hold as people keep postponing purchases. Stuff gets cheaper, but as economic growth slows, income is harder to come by, and debt becomes more onerous.

Deflation is seen by some as a necessary part of the business cycle - a clearing out of the economy of the overhang of debt and a return to more sustainable prices.

However, deflation puts the brakes on economic growth and politicians and central bankers will do anything to prevent deflation taking hold. Japan's painful credit crunch in the Nineties ("the lost decade") is uppermost in many minds.

Hence the Bank of England has taken the decision to pursue an aggressive policy of "quantitative easing" (aka printing money).

The big danger is that inflation will take hold instead of deflation. The Consumer Price Index, which doesn't include mortgage interest, has remained stubbornly high above the BoE's target of 2% by one or two percentage points for some time and the purchasing power of the pound has slipped by a third against major currencies.

That's good news if you are visiting Edinburgh from abroad - your money goes further - but for those living here these are interesting times.

More on deflation

One economic commentator who foresaw the current global deflationary period some years ago is U.S. based Elliott Wave forecaster Robert Prechter.

He also accurately predicted the stockmarket rally of March 2009, citing an excess of pessimism about the future as a sign that a temporary market bottom was being reached.

Prechter has posted a free 60-page ebook on deflation (free registeration required) which explains deflation and how you can protect yourself against it.