Showing posts with label deflation. Show all posts
Showing posts with label deflation. Show all posts

Thursday, March 3, 2016

3/3/16: Hitting Record Deflationary Expectations & Waves of Monetary Activism


In a fully-repaired world of the global economy...

Source: Bloomberg

Per SocGen, thus, all the QE and monetary activism have gone pretty much nowhere, as deflationary expectations are hitting all-time record levels. And that with the U.S. inflationary readings coming in relatively strong (see http://www.bloomberg.com/news/articles/2016-03-03/socgen-global-deflationary-fears-just-hit-an-all-time-high).

Which might be a positive thing today, but can turn into a pesky problem tomorrow. Why? Because U.S. inflationary firming up may be a result of the past monetary policy mismatches between the Fed and the rest of the world. If so, we are witnessing not a structural return to 'normalcy' but a simple iteration of a vicious cycle, whereby competitive devaluations, financial repressions and monetary easing waves simply transfer liquidity surpluses around the world, cancelling each other out when it comes to global growth.

Give that possibility a thought...

Thursday, April 23, 2015

23/4/15: Where the Bad of Deflation Looks Good...


You know the theory of the 'Bad of Deflation' - I wrote about it before... the story goes as follows: if prices fall, and consumers expect them to continue to fall, then rational consumers will withhold their demand, delaying their purchases in anticipation of lower price in the future. The result will be: reduced demand today, lower investment by the firms in future production, lower investment in innovation, stagnation, layoffs, recession... locust... fire balls falling from the skies and pestilence of the kind that only Central Bankers can save us from.

You also know my response to this, especially in the current macroeconomic conditions: falling prices support household real incomes and increase households' ability to finance debt and debt deleveraging, while sustaining at least some semblance of civilised demand.

But don't take my word for this. Here is a handy chart plotting... deflation in the price of hard drives:


It's source is here: https://www.thatdatadude.com/interactive-chart-hard-drive-prices-1950-2010

Do let me know if you know of any evidence that demand for hard drives has been 'delayed' by consumers or that innovation has 'stopped' in fear of lower prices/returns by companies, or if you have seen locust swarming around...

Sunday, April 19, 2015

19/4/15: The costs of deflations: a historical perspective


An interesting article from the BIS on the impact of deflation risks on growth and post-crises recovery. Authored by Borio, Claudio E. V. and Erdem, Magdalena and Filardo, Andrew J. and Hofmann, Boris, and titled "The Costs of Deflations: A Historical Perspective" (BIS Quarterly Review March 2015: http://ssrn.com/abstract=2580289), the paper looks at the common concern amongst the policymakers that falling prices of goods and services are very costly in terms of economic growth.

The authors "test the historical link between output growth and deflation in a sample covering 140 years for up to 38 economies. The evidence suggests that this link is weak and derives largely from the Great Depression. But we find a stronger link between output growth and asset price deflations, particularly during postwar property price deflations. We fail to uncover evidence that high debt has so far raised the cost of goods and services price deflations, in so-called debt deflations. The most damaging interaction appears to be between property price deflations and private debt."

But there is much more than this to the paper. So some more colour on the above.

"Concerns about deflation [are] …shaped by the deep-seated view that deflation, regardless of context, is an economic pathology that stands in the way of any sustainable and strong expansion."

Do note that I have been challenging this thesis for some time now, precisely on the grounds of: 1) causality (deflation being caused by weak growth, not the other way around) and 2) link between corporate and household debt and deflation via monetary policy / interest rates channel.

Per authors, "The almost reflexive association of deflation with economic weakness is easily explained. It is rooted in the view that deflation signals an aggregate demand shortfall, which simultaneously pushes down prices, incomes and output. But deflation may also result from increased supply. Examples include improvements in productivity, greater competition in the goods market, or cheaper and more abundant inputs, such as labour or intermediate goods like oil. Supply-driven deflations depress prices while raising incomes and output."

Besides the supply side argument, there is more: "…even if deflation is seen as a cause, rather than a symptom, of economic conditions, its effects are not obvious. On the one hand, deflation can indeed reduce output. Rigid nominal wages may aggravate unemployment. Falling prices raise the real value of debt, undermining borrowers’ balance sheets, both public and private – a prominent concern at present given historically high debt levels. Consumers might delay spending, in anticipation of lower prices. And if interest rates hit the zero lower bound, monetary policy will struggle to encourage spending. On the other hand, deflation may actually boost output. Lower prices increase real incomes and wealth. And they may also make export goods more competitive."

Note: the authors completely ignore the interest cost channel for debt.

Meanwhile, "…while the impact of goods and services price deflations is ambiguous a priori, that of asset price deflations is not. As is widely recognised, asset price deflations erode wealth and collateral values and so undercut demand and output. Yet the strength of that effect is an empirical matter. One problem in assessing the cost of goods and services price deflations is that they often coincide with asset price deflations. It is possible, therefore, to mistakenly attribute to the former the costs induced by the latter."

The BIS paper analysis is "based on a newly constructed data set that spans more than 140 years, from 1870 to 2013, and covers up to 38 economies. In particular, the data include information on both equity and property prices as well as on debt."

The study reaches three broad conclusions:

  • "First, before accounting for the behaviour of asset prices, we find only a weak association between goods and services price deflations and growth; the Great Depression is the main exception."
  • "Second, the link with asset price deflations is stronger and, once these are taken into account, it further weakens the association between goods and services price deflations and growth."
  • "Finally, we find some evidence that high private debt levels have amplified the impact of property price deflations but we detect no similar link with goods and services price deflations." Note: this means that the ECB-targeted deflation (goods and services deflation) is a completely wrong target to aim for in the presence of private debt overhang. Just as I have been arguing for ages now.


Let's give some more focus to the paper findings on debt-deflation links: "Against the background of record high levels of both public and private debt (Graph 7 below), a key concern about the output costs of goods and services price deflation in the current debate is “debt deflation”, ie the interaction of deflation with debt."


"The idea is that, as prices fall, the real debt burden of borrowers increases, inducing spending cutbacks and possibly defaults. This harks back to Fisher (1933), who coined the term.16 Fisher’s concern was with businesses; today the focus is as strong, if not stronger, on households and the public sector. This type of debt deflation should be distinguished from the strains on balance sheets induced by asset price deflations. This interaction has an even longer intellectual tradition and has been prominent in the public debate ever since the re-emergence of financial instability in the 1980s."

Yep, you got it - the entire monetary policy today is based on the ideas tracing back to the 1930s and anchored in the experience that is only partially replicated today. In effect, we are fighting a new disease with false ancient prescriptions for an entirely different disease.

To assess the link between debt and deflation effects on growth, the authors take two measures into account:

  • "One is simply its corresponding debt ratio to GDP." 
  • "The other is a measure of “excess debt”, which should, in principle, be more relevant. We use the deviation of credit from its long-term trend, or the “credit gap” – a variable that in previous work has proved quite useful in signalling future financial distress."

Per authors, "The results point to little evidence in support of the debt deflation hypothesis, and suggest a more damaging interaction of debt with asset prices, especially property prices. Focusing on the cumulative growth performance over five year horizons for simplicity, there is no case where the interaction between the goods and services price peaks and debt is significantly negative. By contrast, we find signs that debt makes property price deflations more costly, at least when interacted with the credit gap measure."

So deflation in asset prices (property bust) is bad when household debt is high. Why?

Per study: "…these results suggest that high debt or a period of excessive debt growth has so far not increased in a visible way the costs of goods and services price deflations. Instead, it seems to have added to the strains that property price deflations in particular impose on balance sheets. …Why could the interaction of debt with asset prices matter and that with goods and services prices not matter, or at least less so? A possible explanation has to do with the size and nature of the corresponding wealth effects. For realistic scenarios, the size of the net wealth losses from asset price deflations can be much larger. Consider, for instance, the 2008 crisis in the United States,... the corresponding losses amounted to roughly $9.1 trillion and $11.3 trillion, respectively. By contrast, a hypothetical deflation of, say, 1% per year over three years would imply an increase in the real value of public and private debt of roughly $1.1 trillion (about $0.4 trillion for households and roughly $0.35 trillion each for the non-financial corporate and public sector). Moreover, the nature of the losses is quite different in the two cases. Asset price deflations represent declines in (at least perceived) aggregate net wealth; by contrast, declines in goods and services prices are mainly re-distributional. For instance, in the case of the public sector, the higher debt burden reflects the increase in the real purchasing power of debt holders."

And herein rests a major omission in the study: following asset (property) busts, accommodative monetary policy leads to a reduced cost of debt servicing for households that suffer simultaneous collapse in their nominal incomes and in their net wealth. This accommodation is deflating the cost of debt being carried. If it is accompanied by goods and services price deflation, such deflation is also boosting purchasing power of reduced nominal incomes. In simple terms, there is virtuous cycle emerging: debt servicing deflation reinforces real incomes support from goods and services deflation.

Now, reverse the two: raise rates and simultaneously hike consumer prices. what do you get?

  1. Debt servicing costs rise, disposable income left for consumption and investment falls;
  2. Inflation in goods and services reduces purchasing power of the already diminished income.

Any idea how this scenario (being pursued by the likes of the ECB) going to help the economy? I have none.

Monday, March 23, 2015

23/3/15: Deflation... Dumbflation... It's Real Purchasing Power That Matters


I have written in the recent past about the bogus debate surrounding the 'threat of deflation' in the euro area. You can see my view on this here in the context of Ireland: http://trueeconomics.blogspot.ie/2015/02/27215-deflation-and-retail-sales.html and here in the broader context: http://trueeconomics.blogspot.ie/2015/02/18215-inflation-expectations-and.html.

And now Bloomberg weighs in with the similar: http://www.bloomberg.com/professional/kc-post/ecbs-failure-reach-inflation-target-blessing/

To quote: "The strengthening recovery [in the euro area] should add some inflationary pressure — although readings are likely to remain in negative territory for some months, with lower energy prices still feeding through the production pipeline. This month, the ECB revised down its 2015 inflation forecast to zero. Assuming nominal earnings grow at the same pace seen over the last few quarters, the upward trend in real pay should persist in 2015.

Households are likely to react — even if with some lag — to the purchasing-power bonus. Household consumption, which makes up about 55 percent of GDP, has been somewhat muted lately, only contributing to growth by an average 0.1 percentage point over the last seven quarters. That’s less than half what it used to bring in during the pre-crisis years. The re-emergence of this large growth driver should help to strengthen the 2015 recovery. Negative inflation is a welcome shortcut, meaning the region doesn’t have to wait for a decline in unemployment to see a revival in domestic consumption."

Bingo!

Friday, February 27, 2015

27/2/15: Deflation and Retail Sales: Ireland 2015...


Deflation harms consumer demand?


So Irish retail sales are up 8.8% y/y in volume and 5.5% in value, implying people are buying on lower prices, not delaying buying for lower prices. And...

Irish consumer prices are shrinking (deflation).

Note, the above retail sales figures are reflective of total sales. Core sales, excluding motors were down 0.1% in value and volume m/m, but up y/y by 4.8% in volume and 0.9% in value.

More granular:

Wednesday, February 18, 2015

18/2/15: Inflation Expectations and Consumers' Readiness to Spend


In an earlier post I provided a rough snapshot of the evolving relationship between inflation and consumer demand. But here is a fresh academic paper covering the same subject:

Bachmann, Rüdiger, Tim O. Berg, and Eric R. Sims. 2015. "Inflation Expectations and Readiness to Spend: Cross-Sectional Evidence." American Economic Journal: Economic Policy, 7(1): 1-35. https://www.aeaweb.org/articles.php?doi=10.1257/pol.20130292 (h/t to @CHCEmsden for this link)

From the abstract: the authors examined "the relationship between expected inflation and spending attitudes using the microdata from the Michigan Survey of Consumers. The impact of higher inflation expectations on the reported readiness to spend on durables is generally small, outside the zero lower bound, often statistically insignificant, and inside of it typically significantly negative. In our baseline specification, a one percentage point increase in expected inflation during the recent zero lower bound period reduces households' probability of having a positive attitude towards spending by about 0.5 percentage points."

In other words, when interest rates are not close to zero, consumers expecting higher inflation do lead to a weak, statistically frequently zero, uplift in readiness to increase durable consumption (type of consumption that is more sensitive to price variation, and thus should see a significant positive increase in consumption when consumers anticipate higher inflation).

But when interest rates are at their zero 'bound', consumers expecting higher inflation in the future tend to actually cut their readiness to spend on durables. Not increase it! And this negative effect of future inflation on spending plans is "significantly negative".

Now, give it a thought: the ECB is saying they need to lift inflation to close to 2% from current near zero (stripping out energy and food). Based on the US data estimates, this should depress "households' probability of having a positive attitude towards spending" by some 1 percentage point or so. In simple terms, there appears to be absolutely no logic to the ECB concerns with deflation from consumer demand perspective.


Update: a delightful take on deflation from Colm O'Regan: http://www.bbc.com/news/blogs-magazine-monitor-31489786. And a brilliant vignette on prices, markets, consumers and ... thought for deflation too: http://www.eastonline.eu/en/opinions/hobgoblin/economics-elsewhere-three-tales-that-may-rock-the-boat by @CHCEmsden h/t above.

18/2/15: Deflation and Consumer Demand: Euro Area Evidence


The key premise behind the risk of deflation is the argument that faced with a prospect of declining prices, consumers will withhold current consumption in favour of the future consumption and producers will delay current investment in favour of lower cost future investment.

The problem, of course, with this theory is two-fold:

  1. It ignores the entirety of the evidence from the modern sectors (e.g. ICT services, ICT manufacturing and pharma) where deflation (falling prices of comparable services and goods, adjusted for quality and efficacy) has been ongoing for decades and the demand and investment grew, not fallen.
  2. It ignores the totality of fundamentals that drive both demand and prices, and in particular the role of the after-tax disposable incomes available to support consumption and investment.
But never mind, the Euro area, griped by the fears of deflation is itself proving the meme of the deflation = bad, inflation = good as consumers continue to buy, because of falling prices, not despite of them.

Here's a telling slide from BBVA assessment of the European situation:


Thus, we have a question: why, then, do European policymaker fear deflation? The answer is a simple one: deflation hurts tax intake. So the real concern here is not for the wellbeing of the economy or consumers or society at large, but for the fiscal position of already over-stretched (and in some cases insolvent) sovereigns.