Deflation: The high cost of falling prices | The Economist

Okay, I have to admit this is a convoluted and difficult to read, but once you get past the jargon, you can see the price drop in things like oil have actually had a negative effect on the economy.

I took note of the unemployment rates and what they really meant. Essentially, wages are going down because of “insecure forms of employment” such as part-time work. More underemployed people in America coupled with “flexible workforces” has declined the ability of the American worker to bargain for better wages.

The drop in prices is great when you are pumping gas or buying the loaf of bread before the next snowmageddon, but can have adverse effects on the economy as a whole.

Regardless, take a look at this story from The Economist:

via Deflation: The high cost of falling prices | The Economist.

FOR central banks in the rich world, two is a magic number. If prices rise at 2% a year, most shoppers can more or less ignore their slow ascent. And a touch of inflation is hugely helpful: it gives bosses a way to nudge unproductive workers—a pay freeze actually means a 2% cut—and an incentive to invest their earnings. Most importantly it keeps economies away from deflation and the depressing choices—hoarding cash, delaying purchases—that falling prices can bring. Yet despite the professed adherence to the 2% mantra, a period of falling prices is on the cards.

The whiff of deflation is everywhere (see chart 1). Even in America, Britain and Canada—all growing at more than 2%—inflation is well below target. Prices are cooling in the east, with Chinese inflation a meagre 0.8%. Japan’s 2.4% rate is set to evaporate, as it slips back into deflation; Thailand is already there. But it is the euro zone that is most striking. Its inflationary past—price rises averaged 11% a year in Italy and 20% in Greece in the 1980s—is a distant memory. Today 15 of the area’s 19 members are in deflation; the highest inflation rate, in Austria, is just 1%.

Oil explains a lot. A year ago a barrel of Brent crude cost $110; today it is $60 (see article). This 45% price cut is trickling through economies. In Britain data released on February 17th showed that tumbling energy and transport prices had helped deliver an inflation rate of 0.3% in the year to January, one of the lowest on record. In America the price of gasoline has fallen by 35% over the past six months; the cost of diesel and heating oil is down, too.

This is not—in itself—a bad thing. Since winter energy use is a necessity, consumers are better off with cut-price fuel. Firms are cheering, too. As well as lower energy bills, the cost of inputs, from plastic bottles to detergent, are edging down. Some of the savings are being passed on: food, which is costly to transport and requires a lot of packaging, is cheapening. These are the hallmarks of a positive supply shock: cheap oil means economies can provide more goods at lower prices. In the services sector, which relies much less on energy, transport and oil-based inputs, prices are still rising (see chart 2).

For those selling durable goods, deflation may seem more worrying. The price of new cars is flat in Britain, slowly

sliding in Portugal and tumbling in Greece, where a new motor is nearly 20% cheaper than in 2005. For many industries, however, falling prices are not new, but a way of life. In the euro zone the prices of phones, computers and cameras have been falling for a decade (in Spain telephone equipment is 90% cheaper than ten years ago), so deflation is unlikely to shock shoppers. Even in Japan, which has seen years of falling prices, there is little evidence purchases are being put off.

The boost to purchasing power from a short period of falling prices is welcome. In the rich world, pay rises have been rare despite huge improvements in employment. Since early 2010 more than 10m American workers have found jobs, as unemployment, which peaked at over 15m, has fallen by 40%. Japan has seen a similarly big drop, from 3.6m to 2.3m. Britain has done even better, slashing the ranks of its jobless by 50% to just 800,000. Even the sickly euro zone has added some jobs. The puzzle is why rising employment has not led to inflation in the form of higher pay.

Unemployment rates in America, Britain and Japan—all of them at or below pre-crisis lows—would previously have triggered rising wages. But all three have seen growth in insecure forms of employment: part-time work has risen, as have the ranks of the “underemployed”, who would like more hours if they could get them. As looser contracts have helped create flexible workforces, casual work—from drivers for Uber to day labourers in construction—has boomed. Jobs may be up, but workers’ bargaining power is not.

The drawbacks of these newly flexible labour markets are beginning to prompt a political backlash. Barack Obama has urged Congress to raise America’s minimum wage from $7.25 to $10.10. In Britain, both main parties plan to clarify when insecure “zero hours” contracts are abusive. Shinzo Abe, Japan’s prime minister, recently announced that temporary workers should expect the same deals as their permanent colleagues. As these steps lift pay and firms’ costs, inflation should follow.

But even if it is short-lived, this sort of deflation can dull an economy. With inflation at 2% a boss sitting on a cash pile has a clear choice: invest it in something that returns more or give it back to the shareholders as dividends. Either step—boosting investment or investors’ incomes—is a good one. But when prices flatline, risk-averse bosses can justifiably sit on funds. With higher inflation, corporate cash piles—which reached $2 trillion in America and ¥229 trillion ($2.1 trillion) in Japan in 2014—would be more quickly put to use.

The euro zone is a different story. Apart from Germany, its members have done little to make labour markets efficient; most have masses of spare capacity. In late 2009 the unemployment rate was just under 10%, the same as America’s. But since then joblessness has risen in the euro area and is now 11%. In Greece, it is close to 25%. It will take years to overcome this: even if Spain, lauded for its 2% growth rate, carries on at its current pace it will take eight years for unemployment to reach its pre-crisis rate. Those seeking higher pay have scant hope. That makes the risk of long-lasting deflation more of a worry than elsewhere.

If falling prices endure, then debts, fixed in nominal terms, are harder to pay. A recent study by McKinsey, a consultancy, tracked total debt—government, household and corporate—between 2007 and 2014. Euro-zone economies lead the charge, with debt up by 55 percentage points of GDP or more in five troubled “peripheral” states and three “core” ones. If incomes consistently fall those debts may become impossible to pay.

Central banks are at last leaping into action. The European Central Bank (ECB) has been late to the game on quantitative easing (QE) but will begin creating money to buy government debt in March. The Bank of Japan is committed to as much QE as it takes to get inflation back to 2%. A new and radical policy—negative interest rates—is becoming fashionable, with Nordic central banks following the ECB in adopting it (see Free exchange). If these attempts fail, then the glee at cheap food and fuel will be short-lived, as debt-ridden economies find themselves using up all the savings from falling prices to keep creditors at bay.

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