The overall price level in Britain and the United States was much the same in 1913 as a century earlier. The longest semi-official price series we have reports a 140 fold increase in the UK since 1750. But all the increase between 1750 and 1938 is accounted for by inflation during the Napoleonic and First World Wars (the price level roughly doubled during both these episodes).  Our perception that inflation is the normal condition is simply a reflection of the experience of people who are alive today.

     This historical perspective may offer a partial antidote to the panic in the investment community at the unprecedentedly (in recent times) low rate of inflation in Europe and North America. There is no qualitative difference between an economy in which prices are rising slightly and one in which prices are falling slightly.  The CPI is a complex statistical construct, not a physical fact.  Water is a liquid at temperatures above 0°C, and solid below it.  But the surface of a pond will be cold enough to skate on when the average water temperature is well above zero, and while you could – with a good deal of effort – compute the average temperature of the water in the pond the question of whether it is above or below zero tells you very little.

But at least you can see and feel the difference between ice and water, and you can skate on one but not the other.  Similarly, you can tell whether the price of petrol at the pump is rising or falling because petrol is a homogeneous commodity which changes very little over time.  But what has been happening to the price of cars, or smartphones, or medical services?   The evolution of prices in the modern economy is a mixture of price and quality change, and while much effort is made by official statisticians to acknowledge this quality adjustment is subjective and – it is generally conceded – too low.  Perhaps we have been experiencing deflation for years.

More importantly, however, the significance of a fall in a price index depends on the causes.   The declining price level of the second half of the nineteenth century was the result of increases in manufacturing productivity and the opening of new lands, particularly in North America.  Grain prices tumbled from the end of the Civil War until the 1890s, raising workers’ real incomes, but with effects on agricultural rents that spelled the beginning of the end for the landed aristocracy.  These nineteenth century technological developments and shifts in global trade patterns have obvious parallels today in the development of a digital economy and the rise of China, which have similarly contributed to the fall in inflation since 1980.

On the other hand, the deflation, and associated depression and social strife, which Britain experienced between the two wars was largely the result of a misguided attempt to restore the 1914 exchange rate against the dollar.  Prices in Britain fell steadily after 1920 until President Roosevelt finally wrecked the gold standard at the London Conference on exchange rate stabilisation in 1933.   This dismal economic policy and economic performance also finds modern parallels in the travails of the eurozone.  Falling prices have often been associated with economic transformations or recessions, but mostly causation has run from economic conditions to prices, not the other way round.

The development that is tipping Western economies into statistical deflation today is the fall in energy prices, which is more or less unambiguous good news for the countries experiencing it.  Raised body temperature might be an indicator of ebola, or the result of a relaxing hot bath:  it is wise  to determine which it is before you start to worry, far less prescribe remedies.