The Bank of England said prompt action can stop Britain from experiencing the same deflationary conditions that were blamed for the depression of the 1930s.

In the central bank’s quarterly bulletin, deflation has been identified as a major risk.

“It is widely recognised by policymakers, academics and city commentators that periods of deflation can have adverse consequences,” the Bank said in the report.

“Indeed, the persistent deflationary episodes that occurred in the UK and other developed economies during the late 1920s and early 1930s were associated with depressed economic conditions,” the report added.

However, policymakers can learn from history, the report said.

According to analysts at the Bank, “deflationary episodes can be short-lived and less costly if policy responds promptly and decisively, employing the full range of conventional and unconventional monetary policy instruments.”

The Bank has already taken the base interest rate down to 0.5 per cent in an effort to help banks access cheap cash, and has now begun quantitative easing, a more unconventional way of fighting deflation.

The problem of ‘debt deflation’ was also highlighted in the report. Families with a fixed debt see their burden increase during deflation as the cost of debt will rise relative to falling prices.

“Debt deflation might magnify adverse shocks as unexpectedly lower inflation increases the burden of debt fixed in nominal terms, especially if this is accompanied by even greater real falls in asset prices,” the report warned.

“In practice, the effects of falling asset prices and lower incomes are likely to be more costly than falling prices themselves.”