It may be counter-intuitive to consumers, but economists and central bankers believe that a little inflation in an economy is a good thing. Most of the major central banks target annual price rises of 2 to 3% as being ideal for supporting economic growth. Of course, if you are in employment, this means that unless your pay sees an annual increment above inflation or you can negotiate a significant pay award then your ability to purchase things will be eroded by the difference between your settlement and inflation.
At the moment, many major economies are experiencing low inflation or even deflation which means that consumers’ money goes a little further. Japan is the poster boy for the detrimental effects of prolonged price deflation, having had to contend with deflationary pressures for more than two decades. It is argued that deflation subdues domestic demand since consumers delay significant purchases for as long as possible on the knowledge that the goods will be cheaper in the future. Weak domestic demand hampers investment and can put pressure on jobs (however, Japan has enjoyed very low levels of unemployment despite this – current unemployment is only 3.5% which is near to practical full employment levels). Consequently, Japanese Prime Minister, Shinzo Abe and the Bank of Japan (BOJ) have made the injection of low, stable inflation a key economic policy. Japan has had to increase its sales tax from 5 to 8% to raise money for the exchequer partially, to offset rising social security costs for Japan’s aging population. This boosted inflation, but stifled consumer demand, prompting a short recession.
Current Japanese inflation data suggest that it is stalling. If the effects of the sales tax increase are stripped out of the data, Japanese inflation fell back to zero for the first time in almost two years, the data for February shows. Retail sales slipped back by 1.8 and household consumption by 2%, respectively, over where they were twelve months earlier. There is renewed speculation that the BOJ will engage in further monetary easing, but it is unlikely to start before the autumn.