Deflation Bigger Threat Than Inflation: AMP

Global deflation is now a bigger threat to economic stability than a surge in inflation, according to AMP’s chief economist Shane Oliver.

Since the global financial crisis, economists have warned that easing monetary policies would cause skyrocketing inflation and would whittle away at the value of currencies around the world. But this prediction “simply hasn’t occurred”, Dr Oliver said in a note published today.

In fact, Dr Oliver said a renewed plunge in bond yields over the last year — to record or near-record lows — suggests that the world may end up with sustained deflation.

He said that falling commodity prices and spare global capacity indicates that deflation is more of a threat than inflation, which has been falling in many major economies.

“December has seen falling consumer price levels in many countries and annual inflation rates are now just 0.8 per cent in the US, [negative] 0.2 per cent in Europe, 0.5 per cent in the UK, 0.4 per cent in Japan,” Dr Oliver said.

In Australia, inflation looks likely to fall below the Reserve Bank of Australia’s 2 to 3 per cent target, which will give the bank more room to cut interest rates to stimulate the economy.

As the European Central Bank gears up for a dose of quantitative easing, and as Japan buckles down on stimulus, it “should help head the threat off” but “it’s worth keeping an eye on”, Mr Oliver said.

“The proportion of countries with hyperinflation is now being matched by a steady advance in the proportion seeing deflation,” he said.

While falling prices for electronic goods are an example of the positive effect of deflation for consumers, falling prices are a concern if they are associated with falling wages and rising unemployment.

Deflation in falling asset prices can spark a feedback cycle of economic woes, and see consumer’s debt weigh more heavily with rising real debt burdens.

“Falling wages and prices would make it harder to service debts. Lower nominal growth will mean less growth in public sector tax revenues making still high public debt levels harder to pay off. And when prices fall people put off decisions to spend and invest, which could threaten economic growth,” according to Dr Oliver.

Dr Oliver said that while deflation would be a good thing for investors who hold gold stocks, or governments who issue bonds, it will make the sharemarket a more volatile environment.

“As the generally easy global and Australian monetary environment continues it will help underpin further gains in growth assets like shares, albeit with more volatility,” he said.

This news story is reprinted from www.businessspectator.com.au

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