The dangers of deflation

Ireland and most western economies will find itself dealing with the problem of deflation next year. It is widely believed inflation will tumble during 2009 as oil and energy costs drop. Collapsing demand is symptomatic of poor business conditions. Those who anticipate deflation see it occurring because of people losing their jobs, and a continuation of the recession that we've been having. It occurs when the economy is in deep trouble. Irish inflation could even turn negative for the first time since 1946!

Shoppers coping with the increased inflation of late could be forgiven for welcoming the potential boost to the euro in their pocket, but they may not be so keen on the prospect of falling wages while saddled with the burden of debts piled up in the good times. The one silver lining for homeowners with inflation was that the value of their big debts such as mortgages was eaten away more quickly. With deflation the opposite is the case. A prolonged bout can lead to businesses and consumers deferring spending amid expectations that prices fall further still.

Deflation is far more difficult to control than inflation, unfolds at a faster rate and leaves more havoc in its wake. So what are the consequences of deflation?

• Along with deflation we get a contracting economy and badly run businesses will fail as will others that use old methods and technology.
  
• Business activity will decline, resulting in lower sales and profits, and many companies will declare losses.
  
• Commercial property will fall in price due to lack of demand and lack of credit.
  
• House prices will continue to fall and housing turnover will continue to remain low. This will be due to people seeing houses as a place to live, rather than an 'inflation hedge' or investment.
  
• Rising unemployment and the possibility of lower pay levels will also hit house prices.
  
• Commodities will fall in price, particularly base metals, as the production of goods that contain them will drop.
  
• The price of antiques and works of art could fall dramatically as the contraction in the economy and the difficulty in obtaining credit would make this market come to a virtual standstill.
  
• Benefit payments such as the state pension are also pegged to the cost of living. A period of deflation next year could herald much smaller increases for many people.