Campaigning in Putney in 1978, Mrs Thatcher famously took out a pair of scissors and cut a pound note down the middle, telling her audience that the remaining stump represented what was left of the pound in your pocket after four years of Labour and high inflation.
David Cameron may soon be able to repeat the stunt — except rather than cutting a note in half he will be able to stick a bit on the end to represent the extra buying power being granted to consumers courtesy of deflation. Inflation on the government’s preferred measure, the Consumer Prices Index (CPI), has fallen to 0.5 per cent. With the price of crude oil slumping and a supermarket price war in full cry, it may well dip below zero in coming months. That is to say: the cost of living is about to fall.
There are still those who see this as a potential disaster. So ingrained is pessimism in contemporary Britain, if not in the western world as a whole, that it is hard to imagine a piece of economic news which would be treated as a positive development. If inflation were rising, we would never hear the end of Ed Miliband’s ‘cost of living crisis’. Yet falling inflation has been greeted with a new kind of gloom. The stock market has stumbled and commentators are making grim prophecies that falling prices could lead to a Japanese-style downwards spiral. That, to paraphrase an oft-repeated argument, people put off purchases indefinitely in the expectation that prices will be even lower in a few months’ time.
Deflation is feared because it is an unknown, being beyond the experience of virtually anyone alive in Britain today. But look at what’s happening in Spain. Deflation arrived last August and has intensified since. If the gloomy economists were correct, the bamboozled Spanish would be staying away from the shops, counting their money and waiting until it could buy more later. In fact, the Spanish have been delighted by the falling prices and have flocked to the shops – the Christmas retail sales were the best in seven years and car sales are up 18 per cent. In Madrid, the effect of deflation can be summed up in a non-technical word: ka-ching.
Could it happen in Britain? It could – and it did. Bouts of deflation were a regular feature of economic life throughout the 19th century, a period which saw an explosion in production and wealth on a scale never seen before. Between 1873 and 1896 wholesale prices fell by a third — and our cities continued to thrive and expand while living standards ratcheted upwards. What mattered was real incomes, which continued to increase.
Even without this historical perspective, it ought to be obvious that the pessimism of many economic commentators is overdone. If people really did put off purchases in the expectation of prices being lower in future then they would never buy electronic goods, which — regardless of high general inflation for some of the period — have been in deflation for 50 years. When inflation was nudging 30 per cent in 1975, the price of pocket calculators was falling sharply. Yet people continued to buy them, because they wanted them then, not in a year’s time — and Sir Clive Sinclair grew rich. And the deflation that Britain is now set to experience will be in food and fuel — both of which people cannot delay buying. So when they become cheaper, it is a moment for celebration.
There is one big change since Victorian times which has made deflation potentially rather less benign: the rise in consumer and government debt. When prices fall, the real value of debt rises. The £1.47 trillion national debt could rapidly become ever larger if falling prices cause a collapse in tax revenues. Yet the cost of servicing debt would fall rapidly too. If deflation persisted in Britain, it is likely that the Treasury would find itself able to do what the Swiss and Danish governments did this week, and issue bonds at negative interest rates — effectively charging investors for the privilege of lending money to the government.
The virtuous combination of rising wages and falling prices has meant that real incomes are now suddenly increasing strongly for the first time since 2008. Ed Miliband was right — if a little late — in identifying a cost-of-living crisis. Yet week by week, the crisis is abating. It is hard to believe that less than 18 months ago his promise of an energy price freeze promised to be a big vote winner. A freeze now sounds like an expensive threat to consumers now that wholesale prices are plummeting.
There lies the beginning of a political idea, if only the Conservatives are brave enough to seize it. It sometimes seems that David Cameron is more surprised than anyone when his policies work — but he can take a bow. He cut taxes on companies, which means they’re better able to compete with each other and pass the savings on to consumers. After all, companies don’t pay tax: only people can, through higher prices or lower wages. When corporation tax falls, as it has repeatedly under Cameron, people are paid better and consumers charged less.
These are the basic laws of market economics, which demonstrably baffle Ed Miliband. But can the Tories say they genuinely grasp them? The Prime Minister ought to make speeches linking his tax cuts to the surge in employment — he has made it more worthwhile for people to move into work. His restraint on tax and regulation has left British companies in rude health — which, of course, means they compete and cut costs for all. He applied some Conservative medicine, and it worked. He ought not to look so surprised.
If the Prime Minister can counter the gloomy commentators and convince the public that deflation is a boon, it may just keep him in Downing Street. Time for a couple of fivers and a roll of sellotape.