ben broadbent : the economics of deflation speech by mr ben broadbent, deputy governor for monetary policy of the bank of england, at imperial college business school, london, 27 march 2015. * * * the cpi in february this year was no higher than in february 2014. this is the first time the uk has failed to record positive annual inflation for over 50 years. inflation was briefly negative in late 1959 and early 1960. before then, you have to go back to the early 1930s, and the agonies of the great depression, to find a period when uk consumer prices fell over a sustained period ( chart 1 plots three - year rolling averages of inflation ). because of the depth of the economic downturn at that time, and the more recent stagnation of japan, the weakness of price inflation today has raised fears in some quarters about the risks of sustained deflation in this country. the mpc ’ s objective is not simply to prevent prices from falling : it is to ensure they rise at the target rate of 2 % a year. because of the attention it ’ s been getting, however, i ’ m going to focus today on negative inflation specifically. i ’ ll divide the substance of my remarks in two. one part will discuss the basic economics – how and why it matters if prices decline over a protracted period – the other, the frequency and implications of deflation in the historical data. chart 1 deflation last seen in 1930s source : ons and hills, thomas, dimsdale ( 2010 ). within that first section there are two points i ’ ll try and get across. one is the distinction between the price of what we buy ( consumer prices ) and the price of what we sell ( mainly wages ). for the moment it ’ s the first that ’ s fallen not the second : the drop in inflation has been driven largely by something that has significantly boosted real incomes ( the sharp decline in commodity prices ). it is what some have termed “ good ” deflation and, while it is unlikely to go on for that long, it is positive, not negative, for demand and output. there is a risk that the fall in prices becomes more generalised and more sustained. if so – and this is the second point about the economics – what matters is not deflation per se but the capacity of monetary policy to respond to it. there are circumstances, in particular when the appropriate or “ neutral ” real interest rate is clearly positive, and when

is likely to rise quite steeply in early 2016. i ’ m also struck by the rarity of persistent deflation in the past 15, particularly amongst countries with an independent monetary policy. as we ’ ve seen, long periods of falling prices were perfectly common during the gold standard. that ’ s inevitable under a commodity peg if, over any period of time, the commodity itself is in fixed supply. the same was true in other countries at the time and, infamously, during the great depression. it was only when britain came off gold, in 1931, that its nominal income started to accelerate 16. and since the second world war, and the abandonment of commodity standards, positive inflation has been the norm – so much so, in fact, that the commonly cited example of the japanese deflation is almost unique. chart 12a deflation episodes are rare chart 12b even rarer in countries with floating exchange rates source : bordo and eichengreen, imf and oecd source : bordo and eichengreen, imf and oecd note : sample 1960 - 2010 ; 3300 observations note : sample 1960 - 2010 ; 3300 observations. a very recent paper by claudio borio and co - authors at the bis makes the same point ( borio et al. ( 2015 ) ) ; see also broadbent et al ( 2010 ). for more on the contractionary effect of the gold standard during the great depression, see eichengreen ( 1996 ). bis central bankers ’ speeches the international data on consumer prices are relatively rich : we have annual numbers for over 70 countries, most of them back to 1960 17. in all, across countries and years, there are 3, 300 separate post - war observations. in only 70 of these – barely 2 % of the sample – has inflation actually been negative ( chart 12a ) ; the majority of these “ deflations ” ( 46 out of 70 ) have lasted no more than a year, many of these shorter episodes coinciding with falls in oil prices ; of the 24 deflations lasting two or more years, 20 have been in economies with fixed exchange rates, most of those emerging economies ; among countries with freely floating exchange rates, only bahrain and – somewhat more famously – japan have experienced protracted deflations, both of them twice ( chart 12b ). this is not a common occurrence. a credible monetary policy reduces the persistence of movements in inflation why might deflation