Deflation Strikes Back?

Today’s Consumer Price Index provides an important reminder that, despite expansive monetary policy from central banks and perceived “green shoots” in the economy, deflation remains a more serious risk than rising inflation.

In April, the national inflation rate fell to 0.4%. Four provinces – Alberta, Nova Scotia, New Brunswick and Prince Edward Island – 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, today’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. Today’s Consumer Price Index validates the Bank of Canada’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.

4 comments

  • unfortunately for most of the pundits, the green shoots analogy, is but another of the fairy tales being told to all those befuddled by the seeming complexity of the economy.

    Duncan C.’s last article in Rabble resonated on the economic Richter scale at about a 8.0.

    Hope is good, but you can’t eat it, I would really like to see one of these green shoots. About the only thing right about the analogy is the green, as it to me is about the only way out of this turmoil, rebuild an economy based on green. We can do it.

    Imagine this, my uncle works part-time as a farmer out in Saskatchewan, yesterday he planted 600 acres of lentils. One man, one tractor, two types of fertilizer, one seed, 90 feet of machinery – one day- isn’t that kind of like Moses and the bread thingy? If we can achieve that after 300 years of innovation, we can transform the machine to be more green friendly.

    Print the money and instead of giving it to rich bankers who drove us into the ditch by the side of the farm, give it to those willing to green the economy.

    Imagine my chagrin, finding out that it was food prices driving up the CPI, after having such a cool lentil story. Damn stole my thunder!

    paul

  • I still don’t get how low interest rates and higher inflation are good things. they are eroding my savings and propping up the housing and credit bubbles. Why do we want to pretend that the economy of 2007 was a good, stable, viable economy? Please don’t bring it back!

  • Isn’t the real threat from deflation debt-deflation, i.e. the inability to pay back debts which causes default which causes more deflation?

  • No, everything goes haywire when the central bank can’t reduce interest rates below 0% in order to spur growth. Government options to spur GDP growth start to narrow sharply to tax cuts or increases in spending, and sustained long-term deficits. And even those would have limited long-term appeal. Also, people start to hoard cash, throwing bond markets into disarray. And people delay capital purchases like cars or housing renos So no this is not a good thing.

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