When one of the world’s best economists warns that the global economy is sinking into a quagmire of depression and deflation, we should listen. Paul Krugman, professor of economics at Princeton, has in fact been warning of this since 1998-long before the boom turned to bust. So far, he is looking prescient. Now many economists and central bank officials have joined him in seeing deflation-a sustained decline in price levels-as a serious danger.

Growth has slowed to a standstill in most regions, and inflation rates are below 2 per cent in the US and the euro area (but not Britain). Prices fell in Japan, China and Hong Kong last year. In the countries that have experienced property booms, like the US and Britain, house prices might be starting to falter, and the fear is they will soon follow share prices in a crash. The recent depreciation of the dollar will help the US economy but will reduce import prices elsewhere and therefore fuel the deflation affecting Japan and perhaps spreading to Germany. The uncertainties added by the war in Iraq, terrorism, and Sars are also hindering any global economic recovery.

Deflation anxiety is compelling because the phenomenon is outside our experience. For all of our lifetimes, up to now, we’ve seen inflation rather than deflation, even during recessions. Inflation on a massive scale. The years from 1947 to 2000 saw a 23-fold increase in the level of prices in Britain and similar rises in other developed economies. A pound tucked under the mattress in 1947 was worth about 4p by 2000.

Inflation above, say, 5 per cent a year, is economically and socially corrosive. It discourages investment, redistributes wealth from savers to borrowers, causes instability and reduces growth. And it is hard to eliminate. It was only after 1990 that all the main central banks brought inflation down to an acceptable 2-3 per cent annual rate. (So in this country, prices have risen by “only” 50 per cent since 1…

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