Tuesday 9 September 2014

Deflation – déjà vu with a twist

Signs of deflation I have seen before start showing up in my neighbourhood but falling prices have been with us for a long time

Your Neighbourhood Economist has been getting a sense of déjà vu recently – to do with deflation.  My past experiences of falling prices come from years spent living in Japan and I am seeing the same things again in my neighbourhood in London.  Japan and deflation make for a scary combination considering that Japan is a byword for prolonged economic stagnation and poor policy choices.  But deflation may have already been lurking around unnoticed for a while. 

This looks familiar

The symptoms of déjà vu started with the fast food chains such as McDonald’s and KFC offering cheaper menu options.  This first started in London a few years back but it was a sign that consumers did not have much cash to spend.  It is a sorry state of affairs when even the least expensive places to eat out need to provide food with even lower prices to attract customers.  But it is the same tact that similar companies had adopted in Japan around a decade ago in the face of increasing price conscious consumers.

The other memory of deflation in Japan was from buying groceries at the supermarket.  The most notable place was shopping at my local 100 yen store (which is like a pound shop or a dollar shop).  While the prices of the products on the shelves did not change (obviously), there was a noticeable increase in the range of goods that could be brought for 100 yen.  The same trend is becoming more obvious in the UK in the success of discount supermarkets such as Lidl and Aldi.  To keep up, the mainstream supermarkets have been slashing prices but shoppers are still switching to their cheaper rivals. 

The only areas in the economy where prices are still rising are sectors where the pressures of price competition are less fierce.  UK companies such as energy providers or train operators function in imperfect markets where consumers have less choice and few other options.  Spending on energy or transport often cannot be avoided so companies do not have to try hard to sell their products.  As such, it is large energy bills and higher transport costs that are increasingly responsible for inflation.  With nowhere else to go, consumers have increasingly turned to the government to prove an answer despite there being little that politicians can do.

We live in deflationary times

Yet, for good or bad, this may be the new world that we live in now rather than just a temporary blip amid a slow economic recovery.  In a new global era, firms and consumers can scourge the world for the cheapest places to buy whatever they want.  This impacts what we buy off the shelves at our local store as well as what we can purchase off the internet.  Technology further aids this trend by providing information on what is on offer outside of our neighbourhoods and for what price.  And we are increasingly consuming services through the internet at cheaper rates than ever before.

This is great for us as consumers but the flipside is that companies in our local economies face growing pressures and will not be able to provide the same level of employment opportunities or pay the same wages as before.  This is a problem for governments who want their national economies to prosper.  Jobs are seen as the primary gauge of the health of the economy but boosting employment is tricky when competing on a global scale.

Here today and here tomorrow

Deflation is often seen as a problem in itself.  The standard economic theory goes that, if prices are falling, consumers will wait to spend as goods will be cheaper tomorrow.  Yet, globalization and technology are not something new and we have had downward pressure on prices for a long time.  Inflation has been low for the past few decades suggesting that deflation may have not been that far away.  It is perhaps only the voracious appetite for raw materials in China and elsewhere that pushed up global commodity prices and stopped deflation setting in sooner.    

If it has been around for so long, deflation by itself may not be so bad after all.  Yet, an overreaction by policy makers might be.  The European Central Bank seems set to ramp up its measures to fight off threats of deflation (and a morbid economy in Europe).  The central bank in Japan has launched a renewed onslaught against falling prices but to little avail.  Yet, the forces of globalization and technology cannot be reversed using just monetary policy.  Falling prices are something that may be with us for a while so it is better to get used to living with the potential for deflation and focus our efforts on other economic evils.

9 comments:

  1. Hi,

    (It would be good if I could subscribe to post comments. I clicked on the Subscribe to: Post Comments (Atom) button, but it only opened a new tab with a bunch of unreadable html code)

    I completely agree with your sentiments. Essentially the whole world is the market place accessible from my computer or phone. We can calculate the costs of delivery and then buy stuff where it is cheapest. I could list a whole bunch of deflationary advances, as a few examples, my telephone bill is now almost zero, I can LINE or Skype video calls to anywhere in the world, second hand stuff I can buy from across the globe rather than buy new stuff, I can educate myself free using coursera.org or wiki)

    The only inflationary force I can discern is the escalating real estate bubble. It pushes up rents as the landlords try to realise a RoI on their property.

    There are a lot of people trying to protect what they have by intervention or manipulation. And reducing the interest rates to zero is one of these misguided efforts. It creates huge distortions and malinvestments.

    Why are all the fiscal policy makers sitting on their hands and looking at the central bankers to fix all the issues? Poor Draghi has pulled all his levers and still the fiscal policy makers are doing nothing. As long as the EUR exists there will be no solution to the woes in Europe. That really has to be clear to the biggest numpty on the planet.

    I despair.

    Maybe you could comment on this observation. Possibly it might not go anywhere.

    The average UK wage is around GBP 25,000. Some average guy has toiled away for a whole twelve months, some 1,800 hours, to earn that. And out of that he has to pay taxes, accommodation and all the rest. BUT this same GBP 25,000 can be borrowed by the finance industry for far less than 1%. Yep, they can claim use of 25,000 Quid for less than 250 Quid. With no employee regulations and no blasted employee.

    That just does not seem right to me.

    It is a distortion and misrepresents the effort that most of us have to put in to earn that.

    ReplyDelete
    Replies
    1. Hello

      Thanks for your comments.

      I agree with your frustration at governments relying on central banks to do all the work in getting the economy going again. It is something that I looked at a wee while back (http://yourneighbourhoodeconomist.blogspot.fr/2013/06/the-perils-of-doing-too-much.html)
      but is still a problem and creates other issues such as financial bubbles at the most inappropriate of times.

      I am not as pessimist as you about the prospects for the Eurozone. It can be made to work if politicians commit to the cause but no one in Europe wants to take on the extra burden at a time when things are already tough.

      I am currently working on a couple of blogs to do with Germany and their role in stopping progress in Europe in terms with dealing with the issues. Your comments have got me thinking about an extra angle about how Europe can be made to work.

      Regarding subscribing to comments, it might work if you sent up a blogger account and then you might get emails when replies are posted to your comments. Worth a try...

      Thanks
      YNE

      Delete
    2. I have distilled the grand masterplan for saving Europe.

      1. Get inflation to chug along at 2% in the EuroZombiRegionArea. The premise here is that, if across the whole of Europe they can get 2%, the Germans will have much higher inflation.

      Wages will then rise faster in Germany, making their stuff more expensive and less competitive, whilst wages in the the region will remain stuck below inflation and regain the competitiveness they had before, causing firms to invest and build factories and all that good stuff.

      2. Fiscal plans will be set in motion by the courageous fiscal plan makers to ensure that things get better.

      I do, however, see a few weak points.

      1. Germany will not tolerate being singled out as the country to experience higher inflation.

      2. I am not sure the premise that Germany would indeed experience higher inflation is true. Inflation has been the national anathema for 90 years, and they are certainly not going to change that overnight, or even over the next decade.

      3. Are the rest really expected to forego wage increases when they see Germany getting richer and wealthier? Nope, the French will continue to award themselves more money. They are the only guys in Europe to have consistently given themselves pay increases in the face of terrible finances.

      4. Abe has been trying all sorts of levers and only succeeded in dropping GDP by 7.1% Does Draghi reckon he can achieve a different result? Or is he just doing things because if he stops doing things, then nobody in Europe will be doing things.

      Might as well sack the damn lot.

      5. Unfortunately Draghi did not realise he had an arch-enemy in the Highlands. That haggis-chucker Salmond has single handed reversed the losses in the GBP-EUR and made the GBP weaker against the EUR. So much for the plan to devalue the EUR against a major trading partner.

      6. I cannot see the courageous fiscal plan makers leaping around waving new and viable plans for each of their respective terrains.

      The only solution is for countries to reverse back out of the Euro. I hope that France will do the deed, they are probably the biggest chance for Europe.

      Viva la France et le Franc nouvelle!

      Delete
    3. Thanks for your comments (and your dedication to get them posted despite obvious problems).

      I do not think that creating inflation in itself is the answer. It would help real wages fall but it will take time and it is not as easy to generate inflation as is commonly thought (as in the case of Japan). A possible way out for Europe would probably involve more spending by governments on things such as infrastructure. Reducing their dependence on Russian gas is one example that would be helpful on many fronts. Another option is further loosening of monetary policy which would help a little but probably not too much. And sometimes sorting out problems just takes time.

      More market friendly governments in Italy and France may eventually push through reforms. The global economy may pick up and help Europe out. But it will take some effort on the part of policy makers in Europe. At least they have the example of Japan into scaring them into doing something.

      Delete
    4. The fiscal policy makers in Europe will not be spending on large infrastructure projects. They are all trying to curb and maintain their deficit budgets to 3% of GDP.

      The Russian gas might end up in China if the current barney over the Ukraine is not sorted soon.

      IMO there are now two massive forces ploughing their way over the economies.

      Globalisation is levelling the differences between the East and the West.

      Demographics. The aging oldies are forming an increasingly large percentage of the population. The oldies simply either do not have the cash or do not want to buy new stuff to replace perfectly serviceable old stuff.

      Japan has been showing the world for two decades where economies can end up. Massive monetary interferences have not helped. And Western governments, as I have said, are doing nothing but delegating responsibility to the Central Bankers, who have pulled all the levers and made all the "expectation setting" they can do.

      Delete
    5. Austerity is not something that is set in stone. And not all governments in Europe are having to deal with budget deficits.

      I agree with your two trends. But it does not mean that all developed economies will end up like Japan. For cultural reasons, Japan is an exception as it is one of the less flexible economies (life time employment at one firm was the norm until recently) and consensus policies may it difficult to push through reforms. Europe can avoid this fate but only if it wakes up to the urgency of the issues.

      Delete
  2. This comment has been removed by a blog administrator.

    ReplyDelete
  3. I have distilled the grand masterplan for saving Europe.

    1. Get inflation to chug along at 2% in the EuroZombiRegionArea. The premise here is that, if across the whole of Europe they can get 2%, the Germans will have much higher inflation.

    Wages will then rise faster in Germany, making their stuff more expensive and less competitive, whilst wages in the the region will remain stuck below inflation and regain the competitiveness they had before, causing firms to invest and build factories and all that good stuff.

    2. Fiscal plans will be set in motion by the courageous fiscal plan makers to ensure that things get better.

    I do, however, see a few weak points.

    1. Germany will not tolerate being singled out as the country to experience higher inflation.

    2. I am not sure the premise that Germany would indeed experience higher inflation is true. Inflation has been the national anathema for 90 years, and they are certainly not going to change that overnight, or even over the next decade.

    3. Are the rest really expected to forego wage increases when they see Germany getting richer and wealthier? Nope, the French will continue to award themselves more money. They are the only guys in Europe to have consistently given themselves pay increases in the face of terrible finances.

    4. Abe has been trying all sorts of levers and only succeeded in dropping GDP by 7.1% Does Draghi reckon he can achieve a different result? Or is he just doing things because if he stops doing things, then nobody in Europe will be doing things.

    Might as well sack the damn lot.

    5. Unfortunately Draghi did not realise he had an arch-enemy in the Highlands. That haggis-chucker Salmond has single handed reversed the losses in the GBP-EUR and made the GBP weaker against the EUR. So much for the plan to devalue the EUR against a major trading partner.

    6. I cannot see the courageous fiscal plan makers leaping around waving new and viable plans for each of their respective terrains

    7. Just how many years will it take?

    The only solution is for countries to reverse back out of the Euro. I hope that France will do the deed, they are probably the biggest chance for Europe.

    Viva la France et le Franc nouvelle!

    ReplyDelete
  4. Oh gawd, sorry about all those posts.

    I tried to use a google account and it came back with errors.

    And then tried again.

    And then, after the third time things happened very quickly.

    Please delete the redundant posts, thanks.

    ReplyDelete