Low inflation can create problems for the economy particularly in today's
interest rate environment when short-term interest rates are already
approaching zero. In these circumstances, declines in inflation pushes up
the cost of borrowing in inflation-adjusted terms which is very bad for
spending and growth. High unemployment and low demand for goods
and services tend to push down inflation. At the end of 2010 inflation
was very low and unemployment was very high, there was a risk that
prices could actually decline, which is referred to as deflation.
Falling prices may seem like a good thing but they are usually
accompanied with falling demand, falling incomes and more
more unemployment. This makes it harder for borrowers to repay
their debts - both on the business and on the individual side. This forces
business people and individuals to cut back further on their own spending,
reducing other people's incomes and potentially leading to more deflation.
Sheila McKinney
