Over last 18 months, the path taken by the UK economy has been easy to make out. After August 2007, financial markets froze up. Credit conditions tightened, large seemingly invulnerable banks unexpectedly failed, and in due course the economy slipped into a recession.
Some observers took this trend and followed it all the way to the bottom, suggesting that the credit contraction would be so powerful that consumer prices and asset values would to fall in absolute terms. In other words, the UK economy was on course for deflation.
For a time, the deflation story was tracking the data nicely. Inflation has moderated somewhat in the last few months, coming off a 16 year high in September. Asset prices, particularly equities took a battering, and house prices fell by just over 20 percent.
Nevertheless, recent data has gently pointed in a different direction. While the real economy continues to weaken, there are now compelling reasons to think that the risks of deflation, in the sense of falling consumer prices, were overstated. Has the UK economy approached the turning point? Will inflation begin to re-emerge? There are at least eight reasons to think so. Some of these points you have seen from me before in previous posts, but it never hurts to repeat them.
So what is the counterargument? Well, there's no denying that the world economy is spinning into the worst recession since the 1930s. Every indicator points in that direction. At the same time, monetary policy across the world is extraordinarily expansionary. There is no reason to think that a devastating recession cannot comfortably coexist with rapidly rising inflation. This was, after all, the great lesson of the 1970s.