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The Adam Smith Institute Blog

In Britain, deflation's still the worry

Despite the government's efforts to pump money into the economy, Britain still faces the threat of deflation.

By Dr Eamonn ButlerGuest blogger / March 6, 2010

A man passes a doorway at the Bank of England in the City of London. The bank's quantitative easing program has many commentators worried about the threat of inflation. Actually, the bigger threat to Britain is deflation.

Toby Melville/Reuters/File

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While many lesser commentators are worried about the threat of inflation after the Bank of England's £200 billion Quantitative Easing giveaway (though most of it seems to have been given away to the government), our ASI Fellow Richard Jeffrey says there's actually a real risk of a deflation spiral.

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In his latest Cazenove Capital newsletter, he notes that rises in the cost of living (with RPI heading up to 5%) are massively outpacing wage rises (at 1.2% – but just 0.2% in the hard-pressed private sector). Which leaves households pretty skint. Normally the authorities would help out at this stage with a business-boosting cut in interest rates, but they've already taken them down to about as low as you can get. And even these low rates aren't encouraging people to cash in their savings and spend, because in this economic hurricane, they want to keep their rainy-day money to hand.

Sure, business has bounced back a little, as firms who ran their stocks down at the start of the crisis have started producing again. But who has the cash to buy their product? The rising number of unemployed people certainly don't. Neither do those who are in work, since a bloated public sector continues to suck high taxes out of their wage packets (and there's no sign of the public sector, or taxes, being cut anytime soon).

It's a dangerous cocktail, Jeffrey reckons. Consumer confidence remains upbeat, though, so maybe it will work out. But many economists can't see much solid foundation for that confidence. If households too come to believe their hopes are built on sand, well...you don't really want to think about it.

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