Monday, 25 April 2016

The Danger of Deflation

Paul Sweeney: The danger of deflation, i.e. falling prices, is that people wait to consume and so demand falls and that ultimately puts people out of work. Deflation has been hovering around for some years but so far, it has not bitten. However, it is not far off as European countries have been enduring low inflation for some time. There is also very weak demand and little growth.

Ireland, almost uniquely, has enjoyed substantial growth, with some pick-up in domestic demand (after several years of none, in addition as the strong exports which drove our recovery).

Low inflation has been driven by weak demand, which was driven by austerity policies (which have ceased here,) by low oil prices (which are now rising, up from under $30 a barrel at the beginning of the year to $43 now - but it had been at $110 for four years to early 2015), by the low euro (which may or may not continue to rise) and by lack of or low growth in most European countries.

Conversely it is argued that a little bit of inflation oils the wheels of an economy. Provided prices rise slowly, inflation can improve many peoples’ lives and help businesses, savers and, importantly, reduce national debts too.

Consumer prices in Ireland in March 2016 were exactly at the same level as in December 2008. Thus there has been no increase in prices in over 7 years. In fact there was a sharp fall of 8 per cent in the period to November 2009, and then prices rose since as the graph shows.

It can also be seen that inflation has only moved up and down within a price range of 2 percent since 2012.

It is interesting to note that inflation is low in Europe too. We are in an era of low inflation, which could become deflation. This is in stark contrast to the early 1980s when prices soared as much as by 25 percent in one period here. It averaged 18.2 percent in 1980 and followed by the peak annual rise of 20.4 in 1980 and then fell to 17.1 in 1982 and down to a more modest but still high 10.4 percent in 1983. It averaged minus 4.5 percent in 2009 and was negative at -0.3 in 2015.

Price levels (as compared to price movements) in Ireland are high compared to most other countries in the World and indeed in the EU. Price levels here are 22 percent higher overall than the EU average per Eurostat. We are the fourth most expensive country in the EU to live in after Denmark, Sweden, Finland.

This is an improvement. For we had been second after Denmark for some years. The UK is just below us at 21 percent higher than the average and Italy and Germany are above the EU28 average of 100 while Spain Portugal are a bit below it.

A period of lower inflation here than in other countries will bring our consumer price levels down closer to the EU average, but when the other states are having low inflation, this decline slows.

This is what is happening. The Eurostat data shows that last year, 2015, half of all EU countries ie 14 had no inflation (if a range of under 0.2 percent either way ie plus or minus is taken as negligible). A further nine has negative price movements. The EU28 average was 0, down from an already low 0.5 percent in 2014.

The ECB is the body entrusted to mind inflation. It has a target to contain it at around a 2 percent rise. @ percent would oil the wheels of economies nicely. With inflation so low, the ECB is clearly failing in its job. Some economists, like Olivier Blanchard formerly of the IMF, have argued that its target should now be raised to 4 percent.

Many progressives have also argued that its mandate should include employment to shift it away from its overly narrow focus on prices. But it is even failing on its key mandate of maintaining prices at or just below 2 percent. This is costing a great deal. While the ECB printed much money, (“quantative easing”) as a stimulus which probably prevented deflation and in this it was moderately successful. But overall its policies have not been successful in boosting the European economy. But it is not just monetary policy implemented by central banks but also fiscal policy which is needed. Europe needs both acting together to assist in managing this largest economy in the world.

Another benefit of some inflation is it assists in reducing both our national debt and the very high personal debts and mortgages of many citizens. Higher inflation would also mean better interest rates for savers, many of whom are getting nothing at all in the bank or post office.  So low inflation is of some benefit but a slightly higher rate would be better for all.

Finally, when there is inflation, there is strong pressure on workers to seek higher wages. This can be good for an economy as higher wages boost demand and thus create more jobs etc. However, there can be a wages /price spiral as there was in many countries in the early 1980s. This can be unproductive for both capital and labour.

In the next blog there will be a brief examination of the interaction of jobs and wages and inflation.

Paul Sweeney is Chair of TASC’s Economists’ Network

No comments: