Deflation spiral: Who would be the winners and losers?
Yesterday it was finally confirmed the embattled eurozone slipped into deflation in the final month of 2014.
Consumer prices slid into negative territory with a -0.2 per cent year-on-year inflation rate. This marked a significant fall from November when prices rose by 0.3 per cent according to Eurostat.
This has fuelled concern the eurozone could be teetering on the edge of a deflation death spiral, where people delay spending on the belief better deals will be around tomorrow. This weakens demand and eventually eats into companies' profits reducing cash available for investment, new hires and wages.
Eventually a vicious cycle emerges as depressed demand becomes more entrenched crunching companies' profits, curtailing wage and job growth and how much people are prepared to spend.
The euro area hasn't fallen into a deflationary trap just yet – the reading was largely due to crumbling oil prices and core inflation (which removes more volatile indicators like food and energy) was 0.8 per cent.
But if it does fall down the much-dreaded deflation death trap who will be the winners and losers?
Winners:
Consumers:
Initially consumers would be better off as falling prices cut the cost of everyday goods like petrol, clothing, food and even laptops.
Good deflation (or so-called benign deflation) is when technological innovation drives productivity flooding markets with more products. The surplus drives down prices while shielding people from nastier side effects like falling wages, layoffs etc.
But if it's the bad kind (or so-called malign deflation) consumers will eventually feel pinched as jobs and wages are squeezed.
Savers:
Deflation can reward savers who painstakingly cream off a portion of their paycheck each month and park it in the bank.
However while high inflation actually eats into the value of money by reducing purchasing power, in times of deflation it'll do the exact opposite.
What's more, falling prices and delayed purchases means people spend less, leaving the financially prudent with more left over to save at the end of the month.
Retirees:
Deflation can also top-up retirees' incomes by making the value of pension pots decrease more slowly.
Equally, it can depend on the kind of scheme they have, and those with a final salary pension scheme will be best off. However, if you've brought an inflation-linked annuity, then you could see your retirement income dwindle.
Losers:
Borrowers and their banks:
Endemic deflation makes it much more difficult for households (and also governments) to service their debts as the real value falls more slower than initially expected.
For individuals depressed wages mean the number of hours employees must theoretically work to pay back their debts increases. Banks also suffer as borrowers become reluctant, and at worse unable, to repay loans.
Governments will also struggle, as prices and wages fall, with a knock-on effect on tax revenue. Peripheral eurozone countries with big debts such as Greece, Italy and Spain would be particularly worse off.
Retailers:
Retailers lose out during deflationary periods as falling prices encourages people to put off spending decisions.
Why would someone pay £50 for a microwave one week when they think it'll be going for around £45 at a later date? Savvy shoppers who hold out could end up £5 better off.
What's more, weak demand can lead retailers to slash prices further, as they battle to win ever scarer custom.
The European Central Bank:
Central bankers dread full-blown deflation because, once it's takes hold, there's little they can do to stop it.
Policymakers typically stimulate inflation by raising interest rates, but with interest rates languishing at record lows, there's little room to manoeuvre.
Yesterday's inflation figures have fired-up already hot pressure on the European Central Bank to introduce quantitative easing but there's also doubts about how successful this will be.