For many businesses, the only remaining route to surviving what promises to be a severe recession this year is to lay staff off and to further reduce the prices of their goods and services.

It is an unedifying combination, but Britain’s economy is in such bad shape, there is little alternative. Try as it might, the Government cannot make everyone work for the state.

But are falling prices necessarily a bad thing? Well, technically, it ensures your money goes further, although only if you have rid yourself of debt and your income is fixed.

Instead, the question elicits one of those awkward facts of economic life, for if prices fall too rapidly, or for too long, then price deflation can have just as serious an impact on the economy as rampant price inflation.

In November 2002, Ben Bernanke, now head of the US Federal Reserve, gave a speech to the National Economists’ Club in Washington DC entitled Deflation: Making Sure It Doesn’t Happen Here.

His words provided a de facto manual for surviving, and ultimately defeating, this most insidious trend by monetary means.

Deflation is defined as a “collapse in aggregate demand” — a severe fall in spending which causes producers to constantly cut prices in order to tempt buyers. Its effects upon our economy are becoming increasingly evident: recession, rising unemployment and financial stress are just three of the problems.

Bernanke said: “Deflation of sufficient magnitude may result in the nominal interest rate declining to zero or very close to zero.

“Once the nominal interest rate is at zero, no further downward adjustment in the rate can occur. This . . . poses special problems for the economy (because) when the nominal interest rate has been reduced to zero, the real interest rate paid by borrowers equals the expected rate of deflation, however large that may be.

“In a period of sufficiently severe deflation, the real cost of borrowing becomes prohibitive. Capital investment, purchases of new homes, and other types of spending decline accordingly, worsening the economic downturn.”

Once a sustained period of falling prices takes hold, a self-reinforcing debt trap is created. In other words, the real cost of mortgages rise while house prices fall, a situation which Bernanke says can: “Increase the fragility of the nation's financial system, for example, by leading to a rapid increase in the share of bank loans that are . . . in default.”

But he also highlighted the restrictions which deflation places on conventional monetary policy.

When interest rates hit zero, central banks can no longer ease policy by lowering their usual interest rate targets, which means they must use other methods at their disposal.

The most likely outcome is that central banks start printing money, ostensibly to acquire assets.

The risk then is that a ‘liquidity lake’ is created which could suddenly flood the system causing the economy to experience hyper-inflation, not deflation.

For now, we must deal with deflation, a process which causes consumers to delay their expenditure and businesses to hold back on investing, as this can be achieved more cheaply in the future.

Ultimately, deflation is also bad news for equity investors because falling prices create a widening ‘gap’ between investors’ required rate of return and the anticipated growth of corporate earnings as the latter declines.

The options for escaping deflation are not palatable: Japan’s experience showed that saddling future generations with public debts running to billions nearly bankrupted the country.

Bernanke’s alternative — using monetary stimulus rather than fiscal sprees — is, under the circumstances, the least bad.

I trust the Treasury received its copy of Bernanke’s speech — and that they understand its implications.