By Costas Apostolides
THE RELEASE last week of the consumer price index (CPI) data for the period January-September suggests that 2013 will be a year of zero inflation. This may be presented by many as a good sign, but that is not necessarily the case, and to some extent it depends whether you are among the losers or the gainers of recession.
By coincidence the discussion of whether zero inflation or even deflation (falling prices) is good or bad for the economy, was the subject of a major article in a recent issue of The Economist (November 9, “The Perils of Falling Inflation”). In this article I attempt to address the arguments for and against zero inflation.
The data for first nine months of the year show that in comparison with the same period in 2012, the CPI has fallen slightly below zero (-0.3%), implying that unless something dramatic occurs in the last quarter the final rate of inflation for 2013 will be zero or close to zero. This compares with an average inflation rate of 2.5 per cent over the 14 years from 2000 to 2013, with a low of almost zero (+ 0.3 per cent) in the recession year of 2009, and a peak (+4.7 per cent) at the height of the boom in 2008. Overall the average of 2.5 per cent over the period was reasonable, though a little high for the eurozone.
The table below shows that in comparison with 2012 the prices of local goods fell, and imported goods were only marginally above zero. Services also show a slight deflation, while petroleum products increased by 3.6 per cent. In local products electricity prices declined sharply (-4.9 per cent) from the peak prices resulting from the explosion at Mari in July 2011, with a favourable income on the economy and households. Agricultural product prices fell slightly, but rather surprisingly manufactured products increased in price reducing the overall price decline of local sales to just below one per cent.
The dominant sector of the economy, services, was slightly below zero (-0.2 per cent), but there was considerable variation in the various subsectors. The main fall, as witnessed by the large number of abandoned shops and “For Rent”banners, was in rents, which show a fall of six per cent, which is very much in line with the decline of GDP. Obviously this helps shopkeepers and those renting accommodation, but harms property owners who are not necessarily better off than their tenants in Cyprus. Medical care prices fell (- 2.7 per cent) with the private sector struggling to make ends meet after a decade of considerable modernisation and investment in the sector. In contrast there were increases in transport (presumably reflecting fuel costs) and in insurance, so motorists have been hit. Government service costs have risen (+2.8 per cent) which represents economic nonsense in a recession, presumably owing to the measures introduced by the troika to reduce the government deficit. Restaurants and cafes (the latter an important feature of Cyprus life) showed modest price reductions.
Zero inflation means that the unemployed do not have to suffer real income decreases, but it also reflects the recession, therefore suggesting that the prospects of getting a job are unlikely to improve and more likely to get worse. The big gainers are those with steady jobs and high incomes who may actually be better off as a result of the slight fall in prices. Shop keepers that have maintained their business are likely to be better off as they can negotiate rent reductions, but to a large extent the bleak picture of empty shops shows that the consumer response to the economic crisis is hitting the retail sector hard.
The Economist looks more at the macro picture, and surprisingly for such a conservative institution argues that in “America and Europe central bankers should be pushing prices upwards.” This reflects the views of Nobel laureate Paul Krugman who at the beginning of the recession argued that a modest inflation actually facilitates recovery by enabling consumers and businesses to deal better with their loan situation. The Economist presents a similar argument with reference to the problems of Japan where “deflation was deeply damaging and hard to escape (from) in weak economies with high debts”. This relates to both private and public sector debts. Obviously in Europe that would apply to Greece, Cyprus, Portugal, and Spain and possibly Italy also.
The Economist even goes further and states that one possible policy is to raise the inflation targets of central banks from two to four per cent, which was also the level that Krugman suggested but for which he was criticised. However, inflation can only be justified if it is related to increased economic activity that is necessary for recovery. Inflation alone will simply damage the economy by making it less competitive. So the key is recovery, and the fear is that central banks may, as prices rise, move too quickly to tackle inflation and kill the green shoots that imply the beginning of recovery.
Therefore a moderate inflation can only be justified by recovery, and serves no purpose if simply a response to oil price increases or inflationary policies or handouts.
In addition, care is needed because inflation could lead to negative interest rates which would undermine the financial sector and make nonsense of lending and borrowing. The policy should be based on real interest rates for loans and not nominal rates. For example inflation of four per cent implies nominal rates of about seven per cent, but real rates would still be a reasonable three per cent. The wheels of recovery would be greased and many things made a lot easier (repayments, ability to invest etc). It is good to see The Economist moving away from monetarist dogma, but they are still far from coming up with a policy for recovery.
Costas Apostolides is chairman of EMS Economic Management Ltd ([email protected]).