Stock Markets fear deflation...

On FT.com today there is an excellent article highlighting the link between the further sharp fall in stock markets and the fear that we could soon be heading for a period of prolonged price deflation ("Deflation fears drive equities sharply lower", FT.Com, 19/11/08). Before we discuss these concerns it might be worth explaining exactly what economists mean by the term deflation. Put simply, deflation equals a fall in the general price level. What is the link between deflation and the renewed weakness in financial markets. The worry is that if price inflation now starts to turn negative it will make consumers cancel their spending decisions almost indefinitely. They will be reluctant to buy any "large ticket" items always hoping the price will be lower tomorrow. For companies relying on consumer spending this could spell very bad news. This was the pattern in the Japanese Economy in the early 1990s. The Japanese Government responded by aggressive monetary policy (zero interest rates) and fiscal policy (lower taxes and higher government spending) measures. The truth was that despite this the economy remained in recession for many years. This should act as sharp warning to Governments across the World who are now employing similar tactics to fight the economic slowdown. Sometimes the consumer cannot be encouraged to spend no matter what bribes the authorities are prepared to throw at them. These are difficult times and the financial markets will remain nervous for months ahead.