Discuss whether the MPC should be concerned about the risk of deflation in the UK economy

Edexcel AS Economics Paper 2 June 2016 Extract

With reference to Extracts A and B and your own knowledge, discuss whether the MPC should be concerned about the risk of deflation in the UK economy. (15 marks)

Paragraph 1

1. The MPC should be concerned about deflation as it can lead to a deflationary spiral which is difficult to control.
2. Extract B mentioned that Japan averaged an inflation rate of -0.3% across 12 years.
3. Deflation is when there is a fall in the average price level.
4. When there is deflation, consumers form an expectation that prices will be lower in the future.
5. This means that they are likely to delay spending on big purchases.
6. This means that there would be a fall in output across the economy.
7. Demand for labour is derived from the demand for goods and services, so there might be an increase in unemployment as a result.
8. In 2015, the EU also experienced deflation with a rate of -0.5%, and inflation rates in the UK also fell to around 0.5% in October 2024.
9. Extract A Line 6 also mentions that inflation rates are 'expected to be negative'.

Evaluation

1. However, UK inflation rates remained positive as of January 2015, which means there is currently disinflation but not deflation.
2. Disinflation is when the rate of inflation falls but remains positive.
3. Also, Extract A Line 8 mentions 'Britain's economic recovery'.
4. This suggests that the MPC are aware that inflation is falling but they expect it to recover along with the economic cycle.
5. The initial cause of the fall in inflation rate seemed to be lower oil prices, but as aggregate demand increases along with the economic recovery, price level should begin to rise again, without the need for lower interest rates, which are already close to 0%.

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