Deflation: An abject failure in the BOE's monetary policy
I tell my students that when inflation rises above 10% then people really begin to notice and start to change their spending habits. In the past double rather than a single digit attracted a lot more media attention and the effect of people bringing forward purchases increased the velocity of circulation of money. In turn this increased monetary demand and pushed up the rate of inflation even higher.
However if we move the decimal point two places to the left then 0.1% deflation tends to have a similar, though opposite, effect on peoples spending habits as they start to hold back purchases. This slows down the velocity of circulation of money as there is no rush to buy when prices are falling and the value of money is rising. Should this deflation become entrenched then even expansions in the money supply may not offset the contraction in monetary demand due to a slowing velocity.
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