Deflation in Advanced Economies: The Good, the Bad and the Ugly

Deflation in Advanced Economies: The Good, the Bad and the Ugly

Deflation in Advanced Economies: The Good, the Bad and the Ugly

London-Banner-2
 By Media Eghbal – Head of Countries’ Analysis

 

Since 2014, or the threat of negative inflation (falling prices for goods and services) has been a persistent problem for some of the world’s largest developed economies. Euromonitor International forecasts that 16 countries globally (at the time of writing) will register deflation overall in 2015. These include Italy and Spain, the third and fourth largest economies in the eurozone. A further 44 countries worldwide are projected to post inflation rates of less than 1.0% to zero in 2015, including France, Germany, UK and the USA.

The sharp decline in world oil prices (and the consequent fall in energy and petrol prices) since 2014 is a major driver of this trend, while in some countries such as the UK, food price falls have also contributed. A stronger pound and US dollar have made imports cheaper for domestic consumers in the UK and USA, bringing further downward pressure on consumer prices. There has been much scaremongering about the spectre of deflation but in some situations, decreasing prices can be a sign of a competitive economy. Understanding the economic context of deflation is key.

Inflation in Selected Economies: 2015

Inflation-Rates

Source: Euromonitor International from national statistics/Eurostat/OECD/UN/International Monetary Fund (IMF), International Financial Statistics (IFS)

Note: Figures are forecast

Every cloud has a silver lining

There are several circumstances where a drop in prices can be welcome, especially for the consumer:

  • As deflation essentially means falling prices, the real value of money increases. This will provide a boost to consumer spending power while confidence is buoyed by the feeling of more money in the pocket. Lower global oil prices have provided a big boost to oil importing countries in 2015. In March 2015, the average spot price for Europe Brent Crude Oil stood at US$55.9 per barrel down from US$97.1 per barrel just six months earlier in September 2014;
  • Falling prices can signal innovation and advancements. Technological innovation, for example, often results in price falls in the tech sector as goods become cheaper to manufacture, leading to price competitiveness in the end product;
  • Similarly, enhancements in productivity can also result in deflation when production and input savings are passed on to the consumer, while also encouraging healthy competition in the market;
  • Every situation provides opportunities and in the case of a deflationary climate, prospects emerge for goods and service providers with affordable, value offerings or discount products.

Entrenched deflation is a warning sign

It is when deflation becomes deep-rooted that the alarms of a deflationary spiral are set off:

  • Consumer and business spending will be harmed if purchases are delayed in expectation of further price falls. This will hurt business profits and hinder expansion and recruitment potential, thus having a wider impact on economic growth via rising unemployment and lowed demand – ensuing in a deflationary spiral;
  • Japan is often cited as of what happens when deflation becomes engrained with nine years of negative annual inflation recorded in 1999-2014. This was driven by the bursting of asset bubbles, a stronger Yen, greater economic integration (resulting in more imports) and the deregulation of the domestic economy. Japanese total consumer expenditure experienced real growth of just 0.2% on average per year in this period;
  • Deflation or lowflation also gives a headache to monetary policymakers who need to decide when to implement the inevitable interest rate hikes from their current record lows;
  • Deflation makes debt more expensive to service as it increases the real value of debt on a fixed liability. This is an issue for consumer, businesses and government debt burdens, diverting spending to debt reduction. Spain and Italy, two countries forecast by Euromonitor to have overall deflation in 2015, both suffer significant public debt burdens, with Italy’s amongst the highest globally as of 2014, at 132% of GDP.

Context is the key

A scenario where deflation becomes ugly is dependent on the economic context, as was the case in Japan. Euromonitor expects that Greece will experience a third consecutive year of deflation in 2015 (-1.4%) and the country is also at risk of experiencing a lost decade. Greece is the epicentre of the eurozone sovereign debt crisis, suffered six consecutive years of real GDP decline after the global financial crisis of 2008, and where a quarter of the economically active population are still unemployed in 2015. In this environment, deflation becomes another sign of economic malaise.

The eurozone, on the other hand, is poised to renter inflation territory when a zero inflation rate in April 2015 ended four consecutive months of price declines. Demand and prices in the bloc are being boosted by the Quantitative Easing programme launched by the European Central Bank (ECB) in January 2015, the weak euro and a slight expected rebound in global oil prices. However, Euromonitor International does not expect eurozone inflation to reach the ECB target of below but close to 2.0% until 2018.

 

Published in Euromonitor

 

You must be logged in to post a comment Login