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Deflation nation

With inflation heading towards deflation, Jon Moulton asks is it really 'good news'? What does it mean for investors?

All of my life, inflation has dominated the financial scene. Indeed, when I moved back to the UK from the US in 1980, it was running at 18% per annum. This was wonderful for leveraged buy-outs. As debt rapidly declined in value, equity harvested that loss. However, Retail Price Index inflation has only once been over 5% in the last 20 years. That was in 2011.

Now inflation is barely present in Britain; oil prices and weak demand have buried it. The Bank of England’s latest Inflation Report forecasts inflation has almost as much chance of being below zero as above it this year. At the end of March, Consumer Price Index inflation hit zero – for the first time since 1960.

In the days of the ‘Gold Standard’, deflation was as common as inflation. The relatively fixed amount of gold, more often than not, grew slower than demand for it, generating a very benign economic effect. Those days are long gone.

David Cameron said this zero was good news, but actually it probably is not. Modern history in the UK shows that a rate of something nearer 4% is associated with optimal economic growth. The Monetary Policy Committee (MPC) at the

Bank of England in theory has a target of 2%, but it doesn’t set the target – the UK chancellor does. There has been precious little explanation of that target.

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