Australian unemployment rose to 5.3% yesterday in something of a surprise, but the Australian Bureau of Statistics has recast the labour force data in a major revamp, which has boosted the number of people in the labour force and the number of people working and unemployed.
But our unemployment rate is like full employment compared with Europe and the US, where a souring labour market, slack demand and sluggish economy is raising fears that deflation, and no inflation, is the fate awaiting America, just like Japan.
So is this fear real or not, The AMP’s Chief Economist, Dr Shane Oliver looks at inflation, deflation, or noinflation.
From inflation worries to deflation worries
Fears about inflation and deflation have fluctuated wildly in recent times. In late 2008 at the height of the global financial crisis the big worry was a “debt deflation spiral” dragging the world into depression.
Six months ago many were worried about inflation.
Global growth was recovering and fears abounded that major developed countries would print money to get out of their public debt problems.
However in the last few months fears of deflation have regained the upper hand, on the back of still falling inflation rates and worries about a return to global recession.
Our base case is ongoing low inflation in major countries over the next few years, but the risks are skewed to deflation rather than accelerating inflation.
But what is deflation?
Why worry about it?
Why is it more of a risk than a surge in inflation?
And what would deflation mean for investors?
What is deflation?
Deflation refers to persistent and generalised falls in prices.
Prior to last century it was common, but with the advent of paper currencies not backed by gold and macro stabilisation policies it became less common last century.
Nevertheless there was a bout of deflation associated with the Great Depression of the 1930s. Japan has also experienced deflation since the 1990s.
Why worry about deflation?
Most people would see falling prices as a good thing because it means their income and assets will buy more.
Indeed there have been periods of “good deflation”.
For example, in the period 1870-1895 in the US, deflation occurred against the background of strong economic growth, reflecting rapid productivity growth and technological innovation.
Falling prices for electronic goods are a modern day example of good deflation.
However, there can also be bouts of “bad deflation” where falling prices are associated with falling wages, rising unemployment and falling asset prices.
For example, in the 1930s and more recently in Japan, deflation reflected economic collapse and rising unemployment made worse by the combination of high debt levels and falling asset prices.
What’s more, falling prices can cause people to delay spending which in turn weakens economic activity.
In the current environment deflation could cause serious problems because household debt and/or public debt levels are high in many major countries.
A swing into sustained deflation would increase the real value of debt at the same time asset prices would be falling and nominal incomes and government revenue would be weakening.
If individuals or governments attempt to reduce their debt burden by cutting spending and selling assets, the risk is a “debt deflation” spiral may take hold.
Why is deflation a greater risk than higher inflation?
The standard arguments of those fearing a surge in inflation are that central banks have been printing money which will drive inflation up and governments will inflate their way out of high public debt levels.
More recently some fret the adverse weather related 80% or so rise in world wheat prices in the last two months signals a new bout of inflation boosting food price surges.
However, there are several reasons not to be too concerned by each of these.
First, while quantitative easing has boosted narrow money supply measures (such as cash and bank reserves) until this flows on to increased credit and spending increases to levels so the spare capacity caused by the recession is all used up there will be no threat to inflation.
In fact, there has been no increase in credit growth and excess capacity remains huge.
Secondly, while its easy to say “governments will just inflate their way out of their public debt problems like they did post World War Two” this is now a lot harder to accomplish because it is central banks which control the money printing presses and in most major countries these days they are independent of governments and firmly focussed on keeping inflation in low single digits.
Reversing central bank independence and inflation targeting will take a lot to change and so far there is no sign of it.
Finally, while the surge in the wheat price may boost food prices in the short term, weather related surges and slumps in food prices are nothing new and usually give way to a reversal in prices six to 12 months down the track as the weather returns to normal and supply responds.
So far the surge in wheat prices doesn’t appear to have led to a big flow on to other agricultural prices.
With underlying inflation rates now below 1% in the US, Europe and Japan and headline inflation rates falling again, after a brief bounce on the back of the rebound in oil prices, it is littl
