Macroscope | Deflation is not all bad news for consumers and businesses
The "cost-push" effect from falling oil prices has seen more money spent on goods and services and may have wider implications for growth
Deflation is not all bad news and there are times when consumers and businesses can benefit.
Deflation is the stuff of nightmares for central bankers. The dread of falling consumer prices and negative inflation has spurred major central banks into taking unprecedented steps in recent years to stop sliding prices from turning into deeper economic turmoil.
Deflation gets very bad press as something unfamiliar to most of us and is often portrayed as an affliction to be feared. Sure enough, it can pose huge challenges for policymakers, but it is not all bad news. There are times when deflation can offer positive spin-offs for consumers and businesses, which can also have better implications for growth.
"Bad" deflation happens in times of severe economic duress, when weak demand has a downward drag on prices for goods and services. It is known as "demand-pull" deflation, which can spin out of control when economic confidence is at a very low ebb.
Consumers and businesses can be put off spending and investment in the hope of getting better deals in the future. This delayed spending sets off a chain reaction of weaker demand and more price-cutting, leading to a downward spiral of deep recession.
The worst case of severe demand-pull deflation is evident in Greece where the economy has lost 25 per cent of national output in recent years and domestic prices have collapsed, thanks to very tough austerity conditions. Consumer inflation is still stuck at minus 2.8 per cent now.
It was the fear of these trends getting a grip at the height of the financial crisis that drove the US Federal Reserve and the Bank of England into quantitative easing programmes. And it is the motivation behind recent decisions by the European Central Bank and Sweden's Riksbank to adopt quantitative easing to stop deflation getting out of control.