Thursday, February 5, 2009

The Deflation Debate: Myth and Reality

(Peter Hall — Export Development Canada)

Concern about deflation is gathering momentum. The dreaded ‘d’ word surfaced last fall, and is now a regular in business news. It has even crept into emerging market analysis, unimaginable just weeks ago. Are we really on a deflation precipice, or is this just headline-grabbing alarmism?

Recent data are fuelling the deflation debate. Price growth is getting razor-thin in the world’s major economies, and in some cases annual consumer price increases are negative. Moreover, consumer price growth has stalled almost overnight. Recall that just six months ago, central banks the world over were fretting about runaway prices. On the surface, things look pretty grim.

From this perspective, things will only worsen in the coming months. Take Canada, for example, where CPI growth fell from 3.5% last August to just 1.2% in December. The recent monthly movements that have reduced yearly growth so rapidly virtually assure that we will see outright declines in CPI for quite a few months in the middle of this year. This will occur whether monthly growth is in line with the Bank of Canada’s inflation target or not. At that time those who heralded deflation’s imminence will likely proclaim its arrival with much fanfare. Are they right?

Whether or not they are right, they’ll have lots of company. The same phenomenon is already suppressing headline prices in most large nations, sparking the same debate. Eurozone price growth, at 4% in July, is now 1.6% and falling. UK CPI growth was 5.2% in September, and is now 3.1%. US CPI growth has tumbled even more dramatically, from 5.5% in July to -0.1% in December. In each case, the negatives are bound to deepen in the coming months. Anecdotal evidence suggests that even emerging markets won’t dodge the drop. But is it actually deflation? Read more here.