U.K. Economics Professor: Inflation, Deflation and Debt

A British economics professor says that a surge in the inflation rate would quickly reduce Europe's debt burden.

By contrast, deflation would stifle economic growth.

The professor considers deflation unlikely. However, should deflation develop, she believes the United Kingdom would face "the prospect of lost decades."

Here's an excerpt from the professor's April 6 Financial Times article:

When I was in my early teens in the 1970s, my mother kept a cupboard stuffed with goods such as coffee and sugar. She bought them when there was an offer, or she had the money to hand, because inflation was running well into double digits, and ahead of the growth in wages in most families, including ours. Stockpiling dry goods was a small defence of our standard of living.

Now westerners confront a different worry: prices might start going down. In some parts of the eurozone they have been falling for some time. Last month recorded price increases in Britain also fell to zero. ….

At times of rapid innovation, prices are likely to fall in quality-adjusted terms and they might fall in straightforward pounds and pence terms, too. A wave of innovation that reduces many prices, which explains some of the periods of negative inflation in the 19th century, is welcome. This might be part of what is happening now.

But economists worry about a more ominous explanation: a sustained general decline in the price level.

This would matter if it turned into a downward spiral in the economy because people kept postponing consumption in the expectation of lower prices in future — the opposite of my mother’s stockpiling in the 1970s. This at present seems unlikely. The UK’s current zero CPI inflation is largely due to the falling price of energy, and the economy is still growing.

A more serious reason for concern is the effect deflation would have on real debt burdens. Like Japan after 1991, the European economies have a debt overhang, inhibiting a return to growth. A quick and politically painless way to reduce debt burdens, private and public, is a bout of high inflation.

This would arbitrarily redistribute resources from savers to borrowers, but it would clear the decks for the economy to grow again. If we face sustained low or negative inflation, by contrast, the prospect of lost decades looms large.

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