Michael Burke: The deflationary trends gripping the economy are a very serious threat to any recovery and a magnification of the crisis in government finances. Michael Taft has recently highlighted the problem of deflation in a recent posting here, arguing that, "Deflation comes with a very high price – one of them is that it increases the deficit and debt burden. A comparison of the Exchequer Balance in the first quarters of 2009 and 2010 highlights this:
• Q1 2009: -11.2 percent of GNP
• Q1 2010: -13 percent of GNP
The reason for the deterioration is not the amount of deficit but rather the falling value of GNP. If GNP nominal value remains sluggish throughout the year, we may find an ever increasing deficit and debt burden".
Meanwhile, from another angle the CPI out today confirms the deflationary trend. Prices have risen in the last 5 months, but are 0.9% below a year ago and 6.7% below the September 2008 level. The starting-point of deflation is significant as it coincides with the announcement of first government steps down the long path of fiscal 'austerity'.
That rebound is not part of some fantasy of economic recovery. Disgracefully, it is administered prices that are rising sharply. So, while furnishings and household equipment prices have fallen by 4.6% in the latest 12 months, food and non-alcoholic drink prices down 5.4% and clothing and footwear prices down 11.2%; energy prices are up 9.5%, and mortgage interest up 16.5%. Housing, water gas and electricity costs combined have risen by 4.3% in the last 3 months alone. Otherwise, deflation continues to grip all the non-administered consumer prices in the economy.
In effect these are government tax increases via price rises at state and semi-state utilities and they hit the poorest hardest because they disproportionately spend more of their incomes on basic utilities. They are combined with price-gouging by mortgage lenders where variable rates now range from 2.62% to 4.6%, even though the ECB base rate on which they generally rest is unchanged. As the mortgage website says the primary reason for that is fattening profit margins at the lenders, "However we expect the [interest] rate curve to continue upwards for the following reasons:
Increasing margins required by lenders (recent increases by Bank of Ireland for example)"
So the bulk of the economy is gripped by deflation. But there is significant inflation elsewhere through increases in indirect taxes, which hurt the poor, and through gouging by lenders.
The worst of both worlds.