Why do central bankers scaremonger about the implications of low inflation?

A clear feature of 2015 has been the disinflationary pressure provided by the fall in the price of crude oil and other commodities. This has meant that in the UK the official Consumer Price Index has pretty much been at 0% so according to it there has been no inflation. Regular readers will be aware that I think that there are a litany of problems with that but I would like us for a bit to move forwards in a world where we are less well-informed. This of course is the alternative universe in which central bankers like to live so with further ado let us take a look at the thoughts of the Bank of England’s Underground blog on this. As it is nearly the weekend let us not wait for some jam tomorrow when we can have the Jam today.

I’m going underground, (going underground)
Well the brass bands play and feet start to pound
Going underground, (going underground)
Well let the boys all sing and the boys all shout for tomorrow

The Mantra

I think that this must be printed on the corridors of the Bank of England or is a compulsory screensaver. So here is the opening salvo in the deflation expectations war.

If the car you’re thinking of buying may be £500 cheaper in six months’ time, why not wait until then to buy it? This kind of thinking is one reason why falling prices trouble central bankers. The spectre of deflation is especially dangerous when households keep delaying their spending in expectation of further price falls.

Er because you may need a car now? Or in our increasingly fast paced world where nobody seems able to wait for anything how many would do that? Sorry for such heretical thoughts and let us carry on in our alternate universe.

The latest Bank of England survey asked questions about such matters but had an obvious problem for even a central banker. We do not have deflation. Oh Well! As Fleetwood Mac put it we can tell everyone how good inflation is.

Households who expect prices to rise more quickly are often thought to be more likely to raise spending now. If things will be more expensive tomorrow, why wouldn’t you buy them today and beat the price rise if you can afford to do so.

The last sentence is a statement when I think that it is in fact a question. So how does it work exactly?

More technically, one channel this works through is a lower real interest rate – the rate paid to borrow money minus the expected rate of inflation.

Ah so central bankers sometimes struggle with real interest-rates but the ordinary citizen or what in America is called Joe Sixpack has no trouble at all apparently! Perhaps it is something like Arsene Wenger and goalkeeper selection which also exists in an alternate universe which nobody else can fathom. I wonder if these sort of economic models have been affected by the fact that mostly people spend pretty immediately these days and until recently we have had inflation leading to the conclusion that inflation is good.

Now please do not misunderstand me I am sure that someone somewhere delays spending due to deflation and that someone spends in say Ukraine because things will be more expensive quickly. But overall how much of an impact is it? Also deflation can be caused by policy mistakes as we have seen in Greece so policy makers such as central bankers need to take care here. After all they have proved to be far from omnipotent – well outside their own press releases – in the credit crunch era and indeed before it.

A problem for central banker think

You might like to peruse the chart below which is something of an own goal.

We have a Houston we have a problem moment. Our intrepid central bankers seem to have overlooked somewhat that the inflation expectations surveys  are giving a very different answer to the central banker inspired CPI! It is 0% but they are roughly in the 1% to 2% range. A bit like in a Pantomime when the audience shout out “We don’t believe you” and “behind you”. Perhaps they have been looking at house prices or their rent bills which in a central bankers world are redacted.

Also is it rude to point out that the surveys gives quite a similar answer to the much derided Retail Price Index? Whilst it has flaws in its composition I have long argued a case which was put well by Sherlock Holmes.

How often have I said to you that when you have eliminated the impossible, whatever remains,however improbable, must be the truth?’

The issue of real wages

These do appear in the analysis if you dig away..

There is clear evidence that income expectations are important for spending decisions, and these have been improving recently.

True although it gets meshed it with income actually rising and of course we have the issue of trying to differentiate between nominal and real incomes. Actually in the UK if we use official inflation we do not have to as it is 0%. Meanwhile in the real world anybody who goes to buy a house suddenly faces falling real incomes. Oh Well say our central bankers. Perhaps they model themselves on the arithmetic of Alice In Wonderland.

I’ll try if I know all the things I used to know. Let me see: four times five is twelve, and four times six is thirteen, and four times seven is – oh dear! I shall never get to twenty at that rate!

My contention is that lower inflation has boosted the economy via improving real wages.These had something of a nuclear winter back in 2010/11 as the Bank of England looked the other way as inflation surged and explain why our economy struggled back then but now they are benefiting from lower inflation as I explained back on January 29th.

However if we look at the retail-sectors in the UK,Spain and Ireland we see that price falls are so far being accompanied by volume gains and as it happens by strong volume gains. This could not contradict conventional economic theory much more clearly.

If we look at the retail sales pattern for the UK in 2015 this theme has continued.

the volume of retail sales in August 2015 is estimated to have increased by 3.7% compared with August 2014……..Average store prices (including petrol stations) fell by 3.3% in August 2015 compared with August 2014.

Unlike central bankers I realise that other factors are also at play but so far things have turned out much more in line with my thoughts in this area than theirs. If we go back to January 29th then I predicted how they would behave.

If the history of the credit crunch is any guide many will try to ignore reality and instead cling to their prized and pet theories but I prefer reality ever time.


Lower inflation has clear benefits as I have explained above. However the picture is not as simple as central bankers and their acolytes would have us believe. In the UK currently we have disinflation in the retail sales sector but inflation in house prices and rents as I discussed only yesterday. By obsessing on the deflation issue central bankers are in danger of creating Monsters of the Id as the film Return To The Forbidden Planet put it. Or singing along to the song below may create something of a self-fulfilling prophecy. As AC/DC put it.

I’m on the highway to hell
On the highway to hell
Highway to hell
I’m on the highway to hell

Of  course other combinations between England and Australia are not likely to be so fraternal this weekend!

Thank you to those who were complimentary on my entry into the City AM top hundred economists list last week at number 23 . This week I rose to number n-n-n–nineteen.

Some Friday Music

Perhaps for the weekend or to while away the time before the US Labo(u)r Market numbers but Twitter has sprung up with some suggestions.

Lady FOHF:  Alabama Song (Whisky Bar) by The Doors

Shireblogger: Bad To the Bone by George Thorogood and the Destroyers.

I had seen a mention of George for years and added this

I Wont Back Down by Tom Petty and the Heartbreakers


29 thoughts on “Why do central bankers scaremonger about the implications of low inflation?

  1. Hi Shaun

    Great article as always. Its a shame the MSM do not question this mantra and repeat the ‘dangers’ of deflation ad nauseum. The only people who fear deflation are those up to their necks in debt. The that would be….the British government and the tax payer.

    Hopefully this period of ‘deflation’ will send the central bankers and economists into a fit of navel gazing. And they might produce some papers which dispel the myth of deflation/reduced spending.

    Personally I won’t be waiting until next year to switch on the heating or to buy some food.

    • Hi Jason

      What this style of analysis does do is concentrate on a single outcome where in fact they do not need the word deflation as depression would do the job. My point is that there are a range of alternative ahead of us and is we look at services (inflation 2%+) or housing where it is higher you would come to a different conclusion.

      Back in the day I pointed out that hyper-inflation was unlikely and in a way this is the same with one caveat. Excessive moentary responses to deflation paranoia could push us towards much higher inflation

  2. I have never believed that deflation postpones expenditure to any great degree, unless it is rampant like -10 % or -20%. Even then it would only be on non essential, big ticket items – my TV is bust so I will wait 6 months to replace, to save a few quid! I don’t think so.
    People stop spending if they are short of money or they perceive bad times ahead, neither of which applies to most people at the moment.
    B of E and lazy journalist are scaremongering to prop up their bankrupt theories.
    As Edwin Starr, with apologies, put it
    ” …. what are they good for,absolutely nothing. Uh-huh”

    • Hi Foxy

      I tend to agree and in a way central bankers have confirmed this with their plunge into negative interest-rates. That world too is not quite what they may have expected. As for me I bought my tablet a year ago partly because I had seen it and liked it and noticed a few days later it was £30 cheaper which seemed a good deal to me!

      Perhaps central bankers will explain to us how a good deal becomes a downwards deflationary spiral? For me it requires something like Greece which got there partly through official mistakes, oh dear….

  3. Great column, Shaun, as usual. However I don’t agree with you that household inflation perceptions can be taken at face value as defining the actual inflation rate. There is a lot of evidence that those perceptions tend to relate to more frequently purchased items, which often have a higher inflation rate than other goods. Here is a link to an American study by Polina Vlasenko and a colleague:
    There are also links to similar European studies. My former colleague, Allan Chaffe put together a paper on a consumer price index for frequently purchased goods for Canada but I couldn’t locate it in a quick google search.
    RPI inflation for August (1.1%) looks from your chart to be at the lower bound of the range of household household inflation expectations surveys. RPIJ inflation for August (0.5%) is below that lower bound but still positive. It is remotely possible that the RPI inflation rate more closely reflects cost-of-living inflation in the UK than RPIJ inflation does. Gareth Jones has raised serious concerns about underestimation of rent inflation in UK consumer price series. However, I can’t see that this would account for a 0.6 percentage points downwards bias in the RPIJ. With all due respect, I think Britons who really prefer to have the Carli formula play a major role in their official consumer price series should move to Saudi Arabia, where they will find lots of things as backward as the index number procedures, rather than try to resurrect the RPI.
    By the way, the Bank of Canada July Monetary Policy Report forecasts the Canadian economy operating at full capacity in 2017 with inflation at the 2% target rate and real GDP growth of 2.6%. So it seems that our central bank sees something close to 2.6% as the maximum growth rate for output that would satisfy both production capacity and inflation constraints. So what to make of the host of the flagship program of the CBC TV network calling a 4.2% growth rate for July 2015 “modest growth”?

    • Sorry Andrew but “cobblers ”

      RPI was not Adam Smith’s gift to Economists maybe

      but CPI or correctly termed CREATIVE price Index, is an outright FRAUD

      if you have to “impute” anything these days you must be using an abacus , todays connected , CPU powerful , resource rich computer connected to everywhere society can have upto the minute inflation index – if we want it

      shelter , food fuel and consumer goods

      HMG want us to live of an Ipad – my AR$E

      The reason is quiet simple for the Plebs inflation , wage aint going up fer god’s sake for many years , stuffed then with rising house food and fuel costs , it a wonder they dont think inflation is Higher !

      still until the problem is recognised you might as well sit back and enjoy some popcorn …


    • Hi Andrew and thanks for the link.

      It is not my contention to say that people’s expectations/experience of inflation has to be right. However it is something where the debate in the UK has gone very wrong. You see we have had CPI and CPIH rammed down our throats by the establishment which is completely different to the reasoned case you make for RPIJ.

      For the UK CPI ignores owner occupied housing costs and the rental series in CPIH was redacted….

      We know that the housing market is important for the UK and maybe those recording higher inflation have been involved in it!

      If only we in the UK were having a rational debate between RPIJ,HII and a proper CPIH…

      Oh and I was interested in this bit

      “The Consumer Price Index
      weighs the prices of various goods by their expenditure shares, which may not correspond to the
      importance people assign to these prices. ”

      Because on Statsusernet of the RSS I have noticed a few claims that this is not the case in the UK for owner occupied imputed rents in CPIH.

      As to Canada it would appear that CBC has lost its way.

  4. Hi Shaun

    As you imply the mantra is little more than myth; deflation under this scenario is significant and persistent and, as i recall, we haven’t had that in this country since the 19th century. So the contention that deflation is an evil is a straw man set up for other reasons.

    Could the other reason be that the central bankers know full well that the only way to adjust the claims of debtors and creditors peacefully is via inflation? The money illusion is very powerful and there’s no doubt that inflation makes debt effectively cheaper and, as we all know, debt is what is driving the economy and reduced inflation is to condemn creditors to face the awful truth: that they may actually have to repay their debts in “real” terms. This is no good for the economy at all, although what “the economy” amounts to under this scenario is open to question.

    I actually think that if inflation re-emerges, as it will probably do when the oil price effect disappears from the indices, and if it goes well above 2%, as it did in 2011, the BOE will still “look through” this because they dare not increase rates. As you say we have had some news that real wages may be increasing and this should set off an amber light for the BOE. I believe that even if wages went much higher, compounding the inflationary momentum, I still do not think the BOE would raise rates. I think they will only raise rates when they are forced to and that, effectively, they have lost control.

    • Hi Bob J

      The problem for the Bank of England using inflation as a reason for raising interest-rates is the fact that it ignored its rise to over 5% in late 2011. Even if we take out the VAT rise we were at say 4% as opposed to say 2% now ex oil. Awkward. If they use the wage rises no doubt a chorus will spring up singing “we are still way below pre credit crunch levels”.

      Numbers like those from the US yesterday with wages actually dipping albeit by only one cent and the participation rate falling to 62.4% remind us that we live in a bi-polar economic world. On the upside U-6 or underemployment dropped to 10%. Again,awkward.

  5. Shaun
    Surely the music most appropriate for central bankers at the moment is:
    “21st Century Schizoid Man”

    ( I trust you had the chance to see the band on their recent tour )

  6. If people delayed purchases then no one would ever buy technology equipment or electronics. It either gets cheaper very quickly or becomes replaced by something for the same price. The replacement is measurably better e.g. faster, greater storage, higher resolution etc.

    You cannot really delay buying food and although most people have spare clothes they tend to replace one for one when something wears out which of course clothing does.

    Your example of a car is a good point. The last time I bought a car I had to buy it that day as my existing one had just died. Without buying another one I couldn’t have left the dealership and got back home! Luckily the dealer did not know this or they would have been able to extract more from me.

    The same is true of white goods. You don’t normally replace them due to getting bored of them. They break or wear out and you have to replace them.

    I have seen many people have a fixed amount of spending money, so if things get cheaper they just buy more.

    Behavioural economics is interesting and still a relatively new field. I think a lot of assumptions are wrong.

    • “n no one would ever buy technology equipment or electronics. It either gets cheaper very quickly or becomes replaced by something for the same price. The replacement is measurably better e.g. faster, greater storage, higher resolution etc.”

      Only to the maximun point of utility

      video or screen resolution does not need to get any better than the point that most people cannot tell the difference

      mp3 quality compared with HiFi ? worse but its easier to copy and play on smaller devices but stops at the point that the device cannot be smaller than human fingers can use

      I agree that Behavioural economics is much under valued by HMG and economists in general but then again economist are such a fickle lot they cant agree on a set physical laws – adding the 3 (or 4 ) laws of thermodynamics would help 🙂

      For year it been obvious to most normal people that the assumptions the economists make are false – what do they do ?

      A bunch get together and we get N+1 answers !

      At least Shaun put a more rational approach but he’s outnumbered by the Ivory Tower mob


    • Couldn’t agree more.
      Most economics theories seem to view people merely as spending machines whose economic habits are determined by sterile, arithmetic logic.
      Economists seem to know nothing and care less about the human psyche, and using it as justification for dubious, master-serving purposes, is professional fraud.

  7. “Why do central bankers scaremonger about the implications of low inflation?”

    I dunno Shaun , wasn’t that long ago that inflation was the “destroyer” evil of all economies.

    Personally I think what ever goes , ie if today government want to demonize X sector and high inflation arguement will help then all jump that bandwagon

    today its deflation /disinflation

    we’d need about 5 years worth at 2-3% to get back to where we were but hey ho HMG has big debts and no-one is allowed to disinflate houses because the sky will fall on our heads ……

    Well the Banks will go bust really , and thats the same thing to them !


    Just waiting for my house to get to 3 million , so long as thats not in Lira terms 🙂

    • Hi Forbin

      You make a good point about high inflation seemingly no longer being seen as evil. Indeed in many countries including the UK central banks seem to want to generate high inflation in house prices and rents.

      Putting it another way there are articles by economists writing about catch-up from inflation lower than target ( Charles Evans of the US Fed for example) but apart for me I have seen a scarcity of ones pointing out that the UK has a fair way to go to unwind the overshoots.

    • Ooops … Curse the lack of edit function (Better that than to curse or address my own technological shortcomings!)

      “Some people might get some pleasure out of hate
      Me, I’ve enough already on my plate
      People might need some tension to relax
      [Me?] I’m too busy dodging between the flak
      What you see is what you get
      You’ve made your bed, you better lie in it
      You choose your leaders and place your trust
      As their lies wash you down and their promises rust
      You’ll see kidney machines replaced by rockets and guns
      And the public wants what the public gets
      But I don’t get what this society wants … “

  8. The reason CBs fear deflation is its potentially disastrous effect on bank balance sheets. We’ve become hostages to fortune here as the CB inspired asset bubble that was to rescue us from economic collapse in either 2001/2008,has effectively reinforced property loans dominating the asset bases of most banks.

    To my cynical eyes,it’s no coincidence that they choose to ignore rampant HPI from official measures of the cost of living.A 20% downdraft in residential UK property values would likely create a black hole in the future sustainability of most UK retail banks financial structures.

    The problem for the CBs is that whilst on the one hand they’ve managed to drive asset values higher and maintain some semblance of normality in GDP via ZIRP,QE etc,the real economy has been slowly asphyxiated and we’ve seen that in real wages and the velocity of most money supply measures.

    At some point were going to have to accept our banks are over leveraged ……..again. The results won’t be pretty…..again.

    • Hi Dutch

      The problem that is rarely acknowledged is that the new higher house prices are marginal ones or that last sale. This is very different to a price for a whole portfolio which is what the banks face and is one of the reasons all these years down the road that they are still deleveraging. So in some ways it is mostly window-dressing.

  9. After some years of reading your excellent columns I have come to the conclusion that An Economist is a person who can describe what has happened and can explain it to their own entire satisfaction. However any predictions which an Economist makes based on his explanations of past performance should, by law, come with the disclaimer that past theories can be no guide no guide to the future. It does not seem to have put stock-pickers out of business but it is at least honest.

    • Hi Peterhoole

      One of the problems I have is with economists who slavishly follow the predictions of mathematical models based on equilibrium. When I ask them exactly when we were in equilibrium some still do not get the point!

      Of course anybody with some sense would realise that themselves and apply a bit more than a pinch of salt.

  10. It’s what would scare me about Corbyn’s Rat Pack 3 of them love their excuses for QE and even lower rates and have a penchant for screaming “DEFLATION”.

    It reminds me of the corporates I have worked for the best CEOs initiatives were ephemeral and took up no one lower down’s time. Sometimes hardest thing is not to worry when there is no underlying problem.

    Number obsession is diff’ between -.1 or 0 or +.1 that great? Like the double dip rhetoric of certain politicians where a meaningless difference here or there meant a change to no recession from double dip – slow growth is slow growth.

  11. If the car you’re thinking of buying may be £500 cheaper in six months’ time” – WOW in a car market where most are priced at the £15000 mark that would be a 3.3% price fall in 6 months or about 7% annualised NOW THAT’S WHAT I CALL DEFLATION only I aint ever seen it ……

  12. Hi Shaun, all this couldn’t possibly have anything to do with the banks, could it? After all TPTB can’t scaremonger about the problems of debt and what it might do to the banks.- Again!

    As many have said before me- rescuing the banks has turned into a long one way road to nowhere, and now it’s looking like there’s no escape.

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