Zero inflation is great (so long as you're not in government)

A world without inflation. A world where prices are as likely to go down as up, and where government tax revenues are as likely to fall as to rise. A world where people get increases in living standards more from lower prices than from higher incomes. And a world where the lazy excuse of “inflation” cannot be used to justify sloppy management in public and private sectors alike.

We are not there yet, for UK consumer prices are still higher than they were a year ago. But only just, and it looks as though they will dip below the waterline during the summer before climbing again. But prices are falling across most of the eurozone, and the financial markets seem to be saying that there will be no inflation in Europe ever. How so? Well, yields on the five-year government bonds of several countries, Germany in the lead, have gone negative. The Germans can borrow for 10 years at around 0.7 per cent, and 30 years at 0.9 per cent.

This is outside our experience, which for almost everyone alive today has been a world of inflation. That was extreme in the 1970s, when UK inflation rose above 20 per cent, and prices in shops were rising every month. Jolly scary it was, too. But you have to go back to the 1930s for the last period of falling prices, and that was associated with a global depression.

Yet, on a very long view, the aberration was the 20th century, with Germany and a number of other countries having hyperinflation in the 1920s and the entire developed world having very rapid inflation in the 1970s and 1980s. There is a famous study of prices in England from the Middle Ages onwards by Henry Phelps Brown and Sheila Hopkins which showed that there was no significant increase in prices from the 1300s to the 1500s, that prices then rose roughly four times as a result of the opening up of gold and silver mines in Spanish America, and there was another period of reasonable stability until 1914. Periods when prices rose, such as during the Napoleonic wars, were offset by periods when they fell, such as the long Victorian era. If you were born in 1820, you would only know stable or falling prices.

This is not to say this will be the experience of young people in Britain now, though something close to that has occurred in Japan over the past 25 years. Our sub-1 per cent inflation is a function of one-off forces, notably the plunge in energy prices, and underlying inflation is around 2 per cent. But the working assumption of most of us that inflation over the next few years will be 2 per cent or a bit more may be wrong. Our long-term rates are not as low as Germany’s, but they are lower than in Victorian times. This would suggest that inflation in the UK will be 1 per cent or less over the next 30 years. Of course, the markets may be wrong; this has been known. But the narrower point that in the short-term there will be very little inflation in much of the developed world stands. The longer that price stability persists, the more our attitudes will change.

It will change the way government interacts with the electorate. You can see an example in Britain. If Labour had expected consumer prices to be falling now, it would hardly have seized on the “cost of living crisis” as an election vote-winner. Ditto the idea of a freeze on energy prices. It may turn out that price stability makes voters even more resistant to tax increases. It certainly will not bring governments the endowment effect, whereby inflation brings higher-than-expected revenues. It is not just a question of lower oil prices cutting North Sea revenues. Asset inflation boosts inheritance tax and stamp duty.

If you want an extreme example of what a combination of very slow growth and low or negative inflation does to government revenue, look to Japan. Tax revenue has come up a bit in the past four years but in 2011 it was the same as it was back in 1991.

For the business community, a world where you can’t increase your prices is a stern discipline. “Why,” a top retailer asked me the other day, “if the statistics say the economy is booming, does it not feel like a boom to us?”

I think the answer is that, in a world of flat prices, retailers have to run to stand still. Zero inflation is obviously bad for those who have over-borrowed, countries as well as companies and people, because the value of the debt is no longer whittled away. But it is not bad for consumers. Quite the reverse. During the 19th century, living standards rose by between 1 and 2 per cent a year as prices fell. We already get a lot of improvements in living standards from falling prices: think of the way mobile communication costs have fallen while the service has become more extensive and competent.

Inflation will, in all probability, make a comeback. It is in the interest of governments to try to generate it. But the longer the period of price stability, the less, I suggest, we will like it.