Why Is Deflation a Worry for Governments (and Procurement People)?

After governments have spent most of my lifetime worrying about inflation, it is a bit of a shock to see deflation suddenly presented as the biggest economic threat in Europe. Deflation - where prices are declining over time rather than going up - might seem at first to be a good thing. Surely if goods and services are cheaper, we can buy more of them?

But there are real problems associated with the phenomenon. The first serious issue is for governments who have high levels of debt, which includes the UK as well as the usual suspects of European economic weakness such as Greece.

When prices and earnings are rising (inflation), debt automatically reduces in real terms. If prices and earnings doubled overnight, government tax revenues would double in nominal terms, and a debt of £100 billion (or whatever) would be halved in size at a stroke in real terms.

But the opposite applies if we enter into deflation. Government revenues drop and the debt grows in real terms. Worryingly, although the UK is not yet in a deflation situation, tax revenues this year have been well below expectations, suggesting this could be a real problem for the heavily indebted UK. Meanwhile bond yields on Greek debt have shot up recently, a sign that investors are worried about whether Greece can afford to pay back its debt if we move into deflationary territory.

The next major problem is that deflation encourages business and consumers NOT to spend money now. If you think that car, holiday or case of wine is going to be cheaper in a year's time, you might decide to delay your purchase. That has an effect on the wider economy, and can push a nation into recession along with the deflation. That's what happened to Japan during that country's "lost decade," and there is a real danger the same could happen to Europe. Hence the European Central Bank is looking at quantitative easing, to pump money into the economy and generate a bit of inflation and avoid another damaging recession.

For businesses and procurement people, deflation brings some challenges too. As we said, it might suggest delaying purchase of certain items for instance if prices are likely to fall. That will lead to some tricky discussions around planning capital expenditure and investment.

Then, measuring "savings" might become tougher if the baseline is a 1 or 2% fall rather than 2 or 3 % inflation. "I've held the price of widgets for the next two years" might not be an impressive procurement boast any longer in this new world. Changing our negotiation mindsets will be a challenge.

Finally, of course any general economic problems or issues have a number of impacts on our organisations and our work. Having seen many economies recovering in the last couple of years, are we heading back into serious economic problems? Will that put the procurement focus firmly back onto cost reduction for many organisations?

Keep an eye on economic indicators in the next few month and we might find out.

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