Short- and long-run inflation forecasts:

Why might the appearance of deflation leave us nostalgic for the 'good old days' of rising prices?

Some economists believe the long-run factors of globalisation and technological advances responsible for the taming of inflation in the developed economies, may eventually produce the problem that the Japanese are struggling to manage: deflation, or falling prices.

In such a scenario, falling prices lead to a vicious circle of low investment, low demand, low profits and falling share values. The economists point to the high levels of economic growth experienced in the USA and UK in the last decade of the 20th century, and note that even in these strong conditions, price pressures remained low.

What would happen, they ask, if there was an economic downturn?

The Japanese Economy: Inflation and GDP 1990 - 99

Source: Bank of Japan

The above table contains data to help you discuss the issue of deflation.

Firstly, chart your findings using an appropriate format.

The following questions are for discussion purposes:

1. What does the Japanese data show?
2. Why should falling prices lead to low consumer demand?
3. How could a government respond to the negative effects of economic deflation?

To conclude, it is worth reminding ourselves of the inflation target that the Bank of England was set by the incoming Government of 1997: That was to deliver inflation at 2.5 %, not zero. This is in contrast to the mandate set for the European Central Bank, which is responsible for delivering inflation at 2 % or below. The difference between the two approaches is that whereas the ECB may be seen to be risking a deflationary approach, the UK authorities' target is 'symmetrical'. This means that an inflation rate below the target 2.5 % should be treated as seriously as a rate above the target.

How well do you think the Bank has performed in meeting its target. What do you think are the dangers to the UK economy of an over-deflationary approach?

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