This week's edition of Money Week has a very good editorial by Merryn Somerset Webb as well as a lengthy article with input from four economists, two in the inflation corner and two in the deflation corner.

Merryn acts as the impartial referee in the verbal boxing match. The inflation corner is represented by Liam Halligan, chief economist of Prosperity Capital Management and Peter Warburton, Director of Economic Perspectives Ltd. The deflation corner has James Ferguson, head of strategy for Arbuthnot Securities and Thomas Wittenborg, partner of Wittenborg Capital Management.

As Merryn points out in her editorial, the debate between inflation and deflation is "the most important one in economics".

The main outcome of the debate was that both sides are agreed that the economy will not rattle on with inflation at about 2.5% and that everything will be fine in the end.

The inflationists point to the current gradually rising CPI and RPI rates, the expansionary fiscal and monetary policy, low Bank of England rates, the rising cost of fuel, the rising cost of imported goods and thus the importation of foreign inflation.

The deflationists point to a shrinking money supply across the West, high real interest rates that people actually pay, wage freezes, the breakdown of the credit system, rising unemployment leading to lack of demand for goods, the apparent output gap leading to spare capacity and banks still crippled by bad debt and not lending.

The one thing I don't understand is why government action / inaction is never factored in to these debates. It's as if a political status quo is assumed.

The government do not want to see anything other than gradual growth. Anything else means excessive change, which can endanger their position. It is tempting to say that the government wants hyperinflation to water its debt down to nothing. But that would trash the economy and displease anyone who currently holds our debt (and there's a lot of them at the moment).

What we may actually see though is inflation in the cost of certain goods whilst others see deflation.

There are goods that people have to have to exist: water, food, shelter and heat. As taxes rise and wages don't keep pace a higher proportion of household money will go on those costs. People may well then not upgrade such things as cars, computers, furniture etc as often as they used to.

Basic essentials will, even if prices stay the same, be inflating in price in real terms. But big ticket items will have to drop in price or companies will fail. The government effectively deflated the price to the consumer of some big ticket items via tax policy. Reducing VAT for a time will have a bigger effect on more expensive items, the car and boiler scrappage schemes and the reduction in stamp duty for houses. I therefore see a gradual ramping up in the cost of basic existence but with the overall amount of money changing hands staying about the same.

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