Fears that the falling inflation rate might ultimately lead to a deflationary economy are growing.



The rate of inflation as expressed through the Retail Price Index and the alternative Consumer Price Index, which is the Bank of England's preferred measure, are showing the rate of growth in the economy as slowing and there are some indications that we might be heading into a deflationary period.

What is “deflation"?

Deflation is generally accepted to mean a reduction in overall price levels and is sometimes confused with related but different terms such as “depression" or “disinflation".

Deflation typically has four causes;

•Decreasing Money Supply

•Decreasing Demand for Goods

•Increasing Demand for Money

•Increasing Supply of Goods

All forms of the media are dominated at the moment with the worsening economic situation. Whether cause or effect we are seeing a related falling off in consumer confidence and a rapid increase in the unemployment totals. These factors are worsening the conditions referred to above.

Is deflation good or bad?

Whether Deflation is good or bad depends on its cause and duration. It would be a bad thing for the economy to move into a deflationary situation at the moment as the cause would be a lack of demand for goods coupled with a reduction in the availability of money. Unfortunately when this happens the situation is often made worse by job losses brought about by consumers further restricting their spending.

As credit becomes harder to get people find it harder to refinance their debt and their situation can worsen significantly. The availability of debt help is critical at these times and many turn to specialist debt advice companies.

The lack of available credit will force people to consider all available options including Debt Management Plans (DMP) or Individual Voluntary Arrangements (IVA) as they consider how to solve their debt problems.

Debt management can be offered by many companies, however IVA advice and specific IVA help needs to be carried out by someone with a full understanding of the legal procedure (because IVA's can only be administered by a qualified Insolvency Practitioner).

As the recession deepens and becomes more prolonged, the risk of deflation multiplies - with scarce demand from worried consumers forcing companies to cut prices, and rising unemployment meaning rare pay rises, and in many cases a reduction in wages.

A downward spiralling economy is the fear of many economists. As consumers delay purchases, further price cuts will follow in the chase for sales. This puts even more pressure on staffing levels as company cash flows worsen and will for some lead to business failure.

How can deflation be stopped?

There is no easy way to reverse a deflationary trend. Increasing the supply of money is one way. The Bank of England have reduced interest rates in an attempt to achieve this however banks need to pass these cuts onto customers for them to benefit with reduced repayments on mortgages and other sources of credit.

Another potential solution open to Government in its efforts to reflate the economy is to pour huge sums of money into the financial systems. They could do this by making significant reductions in the tax burden of both individuals and companies. However the strategy carries significant long term risks to the economy. The acquisition of bank assets is an option giving the banks access to a source of cheap money.

Confidence was shaken recently when the Governor of the Bank of England, Mervyn King, doubled his prediction of three months earlier and stated that the UK economy would shrink at a rate of 4% - a rate not seen since in this country since the depression of the 1930’s.