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Is deflation good or bad?

Deflation is the watchword of economists as inflation drops in many of the world’s leading economies and the spectre of deflation looms large for many governments.

Inflation is an increasing cost of living, while deflation is a fall in day-to-day costs.

Several economies are in or around deflation, including the Eurozone, which is already there, the UK and Japan, which has been there for 20 years.

However, economists are quick to explain to investors and businesses that deflation is not necessarily bad, depending on the factors that are dragging down prices.

In Britain, the annual rate of inflation is now 0.5% against a Bank of England target of around 2% for the first time since June 2000.

Deflation spiral

No one seems too worried about this slide towards deflation as the economy has seen the cost of living steadily fall over recent years.

And as the statistics show, Britain has trodden this path before in the not too distant past.

The issue is whether the forces driving down prices are deflation, which is defined as a net reduction in the cost of goods and services or disinflation, which is falling prices due to other factors affecting the economy.

In Britain, the economists are talking about deflation, which is good, but in the struggling and stagnating Eurozone, the opinion is disinflation is pushing prices down, which is not so good and indicates deeper problems within the economy.

The negative forces can range from a slowing economy to a lack of demand in internal and external markets.

Eurozone arriving late

Many economists cite the plunging price of oil as the major deflationary force on the British economy.

The cost of a barrel of oil has plummeted from more than $100 to around $50 in the past year and this low cost is starting to show in the cost of goods and services.

Azad Zangana, senior European economist at Schroders, said “A low inflation rate is often an indicator of a weak economy, but what we are seeing is the cost of oil and energy falling out of the reckoning, which should give households more to spend. This should raise economic growth rather knock it back.”

In the Eurozone,  the annual cost of living fell by 0.2%, prompting calls for the European Central Bank to try to resuscitate the economy with quantitative easing – a policy successfully implemented in the UK and the USA.

“The Eurozone is coming late to the quantitative easing party and we have yet to see whether they join in and if they do, what effect this will have on the economy,” said Zangana.

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