Daily Dose of Deflation 18Nov2008
Economist: Debt and deflation - Depressing times
The Bank of England sees deflation as more than just a remote risk. Its Inflation Report, published on November 12th, puts the spread of likely inflation rates at between -1% and 3% in two years’ time. It is the first time the bank’s fan chart, which projects where inflation is likely to lie nine times out of ten, has encompassed deflation.
A deadly mix of falling prices and high leverage could foment a “debt-deflation” of the type first described by Irving Fisher, an American economist, in 1933. In this schema, debt-laden firms and consumers rush to repay loans as credit dries up. That hurts demand and leads to price cuts. The deflation in turn increases the real cost of debt. It also means that real interest rates can’t be negative, and so are undesirably high. That spurs yet more repayment so that, in Fisher’s words, the “liquidation defeats itself.”
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