Cheaper electricity pushes inflation to below zero: but is it deflation?

Annual inflation rate down to -0.05%, but is it deflataion?

In July, the annual inflation rate as measured by the Retail Price Index stood at -0.05 %, according to research carried out by the National Statistics Office.

Last year, the annual inflation rate was 2.08%.

The main downward impacts were recorded in the Water, Electricity, Gas and Fuels Index (-0.62 percentage points) and the Transport and Communication Index (-0.25 percentage points). This was largely due to lower electricity rates and airfares respectively.

The main upward impacts were recorded in the Recreation and Culture Index (+0.30 percentage points), the Beverages and Tobacco Index (+0.22 percentage points) and the Household Equipment and House Maintenance Costs Index (+0.12 percentage points). This was largely due to higher prices of newspapers, cigarettes and household appliances respectively.

Is it deflation?

The MIT Dictionary of Modern Economics defines deflation as “a sustained fall in the general price level” – in contrast, “disinflation” represents a period when the inflation rate is positive, but declining over time.

The key question here is whether the decrease in utility prices has quelled the energy-inflation of the past years, and if inflationary pressures will gradually resume over the coming months. Will the decrease in prices persist over the coming months? If they do, it could mean that retail commerce is doing badly that demand is not pushing the retail price index upwards.

A moderate level of inflation can push consumers to buy goods now, rather than wait and pay more later if they believe prices are rising.

But deflation could be a sign that people are hoarding their cash, refusing to spend it because they expect lower prices in the future, a precursor to low demand and lower profits for businesses. No spending is bad news for jobs, too.

The problem would be a deflationary spiral that leads to less demand and less production. The government, by reducing energy prices but at the same calling on consumers to ‘go ahead’ and switch on their lights, is hoping that people’s demand for goods and services stays healthy.