Deflation Strikes Back?
Todayâ€™s Consumer Price Index provides an important reminder that, despite expansive monetary policy from central banks and perceived â€œgreen shootsâ€ in the economy, deflation remains a more serious risk than rising inflation.
In April, the national inflation rate fell to 0.4%. Four provinces â€“ Alberta, Nova Scotia, New Brunswick and Prince Edward Island â€“ posted negative inflation rates.
While falling prices benefit consumers who have income, they also threaten to deprive workers of income. Consumers may delay major purchases in anticipation of even lower prices. Such a decrease in consumer spending would prompt businesses to reduce output and lay off more workers. A lower level of employment would further reduce consumer spending, placing additional downward pressure on prices and thereby perpetuating a deflationary spiral.
Of course, todayâ€™s numbers do not reflect such a generalized price decline, but rather a sharp drop in the price of gasoline compared to a year ago. While lower gasoline prices will probably not lead to a deflationary spiral, they rule out an inflationary spiral in the near future. In other words, even if the threat of deflation is small, the threat of inflation is even smaller.
The fact that national inflation is falling and seems likely to turn negative gives the Bank and Government of Canada a free hand to stimulate the economy without fear of accelerating inflation. Todayâ€™s Consumer Price Index validates the Bank of Canadaâ€™s (belated) decision to hold interest rates near zero until mid-2010. The central bank should keep open the possibility of quantitative easing. As suggested previously, further fiscal stimulus is also warranted.