Much has been made in Europe about low, and now negative, levels of inflation which might prove to be a drag on consumer demand. The rationale behind this concern is that if consumers know that a larger ticket item will be cheaper in six months than it is today, they may put off their spending plans until the price has dropped. If enough people were to do this, the argument goes that consumer demand would be stifled. Since the principle raison d’être of the EU is to function as a single market for its 28 member states, this could be a significant problem constituting a drag on growth. However, this theory ignores the fact that Western consumerism is very much geared to the “now” and, often, purchases of consumer items is made on credit. If Europeans were to be more thrifty, credit card companies and the personal finance sector would be in for a bleak future. Western consumerism is built on instant gratification, so it is highly unlikely that people will wait to save a couple of percent on the price of something that they want now.
It provides an interesting contrast to look at the laid-back attitude that the Americans seem to have about (short-term) deflation. Figures just released from the Department of Labor show that consumer prices fell by 0.7% last month (January). Prices are now 0.1% lower than they were a year ago (therefore wiping out inflation seen during 2014) – a canny Scot would describe such prices as stable.
The reason underlying the price weakness is the falling cost of crude oil. Petrol prices dipped by 18.7% in the US in January and if this fall is stripped out, then inflation would have come in at 0.1%. The Fed is predicting that inflation will pick up in the coming months as the crude oil price stabilises. Cheaper energy costs will be good for both consumers and industry. Consumers will have a little more cash to spend as a result of cheaper fuel and energy prices whilst production costs for industry will also have come down.
Weak or negative inflation means that there is no compelling reason for central banks to push up interest rates which is a mechanism used to cool inflation. It is perhaps likely that tightening of monetary policy will occur through other means first.