Low inflation is something to be welcomed generally, but when it hits zero, there is always the risk that a country could be heading for a Japanese-style period of no growth and permanently low prices. Ben Broadbent, the Deputy Governor of the Bank of England, told the Times newspaper recently that he was certain that this would not happen in the UK.
Broadbent and his team of economists at the Bank of England looked at the inflation history of 70 countries since 1960 and found that there were only 70 examples of a fall in annual consumer prices and that this represented "barely 2 per cent of the sample". In only 24 of these instances did the price fall last longer than a year and all but four of these cases occurred in developing countries with pegged currencies. So, according to Broadbent, there is only a 0.12 per cent chance that the UK is entering a period of sustained low inflation or deflation.
The UK consumer is not accustomed to waiting to spend
Prices in the UK have mainly been driven down by lower oil and food prices. There is no evidence currently of a broad-based fall in prices. However, the fear is that as prices fall, consumers will delay purchases and that deflation will set in. Broadbent argues that UK consumers are viewing the recent windfall gains from lower petrol and food prices as good news and that the low level of inflation also means that we have real wage increases in the UK for the first time in a long time, which is also good news for consumers.
But, the UK continues to carry a heavy debt burden at both government and individual level and. against this background, some inflation would be helpful. This was the main point of QE after all and the UK's normal way of getting out of a debt hole is to let inflation rise. If Broadbent is right and the consumer spends the unexpected gains from lower prices, then economic growth will be sustained, inflation will rise, tax revenues will increase and the government can make the planned progress towards balancing the books. If consumers decide to save the gains or repay debt, that would not be such good news for the economy or the government.
My bet is that the UK consumer is not accustomed to waiting to spend. There is a culture of going for instant gratification, and consumer expenditure has been one of the major drivers of the economy over the last thirty-five years, leading to a large service element to the economy. I find it unlikely that patterns of spending will suddenly change and so the fact that UK inflation is zero currently is something to be celebrated.