David Blanchflower: Don’t believe those who tell you deflation is good news
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Version 0 of 1. The UK is a month away from deflation. It seems likely the UK will become the 23rd European country to catch the deflation disease. This is very bad news. Don’t believe anyone who tells you it’s good news. It isn’t. Why buy something today when its price will be lower tomorrow? Plus borrowers struggle to pay back loans. The worry is that the very low wage growth seen recently will be lowered further as prices of goods fall. There is a growing concern that deflation, including falling oil, food and commodity prices, has been caused by a collapse of global demand, especially from China, rather than a jump in oil supply. Ludicrously, both the Prime Minister and the Chancellor tried to take credit for the zero inflation which they claimed was a result of their “long-term economic plan”. It was nothing of the sort. According to their narrative the Labour Party was responsible for the global recession and the collapse of the sub-prime market in Detroit, Arizona and Nevada, while the Tories were responsible for the collapse in world oil, commodity and food prices and Chinese demand. Duh! No wonder Lynton Crosby cancelled his Q&A session last week where journalists would have asked him for details of which part of their plan caused these global movements. It is downright irresponsible of Cameron and Osborne to say that a minus 2 percentage point inflation miss is good, since it casts doubt on the monetary framework, and this is not to be taken lightly. Listen to the expert. In a now famous 2002 speech called “Deflation: making sure ‘it’ doesn’t happen here”, the soon-to-be Fed chairman, Ben Bernanke, explained why nations don’t want deflation. What is seen as good rapidly turns bad and just won’t go away. What is the cause of deflation? “Deflation is in almost all cases a side-effect of a collapse of aggregate demand – a drop in spending so severe that producers must cut prices on an ongoing basis in order to find buyers,” explained Bernanke. Oh dear. Bernanke went on to explain that deflation in Japan, which experienced a relatively moderate but long-lasting deflation, “has been associated with years of painfully slow growth, rising joblessness, and apparently intractable financial problems in the banking and corporate sectors. While it is difficult to sort out cause from effect, the consensus view is that deflation has been an important negative factor in the Japanese slump”. Bernanke also notes that the deflationary spell was largely unexpected. His view is that it is not technical infeasibility but political constraints, including the inability to implement economic reforms, rather than a lack of policy instruments that explains Japan’s chronic deflation. The first chart illustrates inflation and deflation in Japan alongside UK inflation. Over the period January 1997 to January 2015, inflation in Japan averaged 0.1 per cent, compared with 2.1 per cent in the UK. Over the 218 months plotted here, Japan experienced deflation in 125 of them, including 49 in a row from September 1999 to September 2003. In contrast, the UK experienced zero months of deflation. It appears that once a country has caught deflation it can’t get rid of it, so don’t get it. Plus even if it does get rid of it for a while, it soon comes charging back. Interestingly, since June 2013 Japan experienced rising inflation as a result of fiscal and monetary stimulus, even in the face of falling oil prices, when the UK experienced disinflation. The second chart illustrates the problem that Bernanke identified. Japanese growth over this period was lethargic. It averaged 0.14 per quarter, compared with 0.51 per cent in the UK. Of the 71 quarters, Japan had 29 that were negative, compared with 12 in the UK. So Bernanke was right: deflation appears to be a negative factor in relation to growth. What policy options are available to deal with deflation? At the outset I should make clear that the best policy is to not get the disease at all. Deflation arises because the combination of fiscal and monetary policy is too tight. But given that the pandemic has spread to the UK, what can be done? Bernanke spells out several options of what can be done when interest rates are rock bottom . The first is to do more QE. By increasing the number of pounds in circulation, or even by credibly threatening to do so, the UK Government can also reduce the value of a pound in terms of goods and services, which is equivalent to raising the prices in dollars of those goods and services. The Bank of England probably would also have to expand the range of assets it purchases, with the intention of impacting longer-term yields. It could, for example, buy foreign government debt, as well as domestic government debt, in an attempt to lower the international value of the pound. A determined government, Bernanke suggests, can always generate higher spending and hence positive inflation. Maybe. A broad-based tax cut, argues Bernanke, would almost certainly be an effective stimulant to consumption and hence to prices. Even if households decided not to increase consumption but instead re-balanced their portfolios by using their extra cash to acquire real and financial assets, the resulting increase in asset values would lower the cost of capital and improve the balance sheet positions of potential borrowers. A money-financed tax cut is essentially equivalent to Milton Friedman’s famous “helicopter drop” of money. Of course, in lieu of tax cuts or increases in transfers, the government could and should increase spending on current goods and services, or even acquire existing real or financial assets. Francis O’Grady from the TUC has colourfully called Osborne’s budget plan a “suicide note”, but she has a point – “looks almost perfectly wrong, reducing stimulus when it should be increased”. The PM and Chancellor are responsible for this economic disaster. They caused the slowest recovery ever, falling real wages and prices. Some record. |