From hyperinflation to deflation – whither the economy?

Inflation has been in a steady fall since August 2013, declining by an average 0,24 percent monthly – 1,28 percent in August, 0,86 percent in September, 0,59 percent in October and 0,54 percent in November. Judging by the monthly average fall, January is like to see inflation further falling to about 0,09 percent, with February leading us to the realm of deflation, which I estimate to start at -0,15 percent.

What is happening is that as the price of goods continues to fall, and because of the low income levels being earned by the majority, consumers find the incentive to delay their purchases and consumption until prices fall further. This, however, reduces overall economic activity.

Deflation is therefore not a good thing. In a recent statement to warn about the risks of deflation to the global economic recovery, IMF boss Christine Lagarde said: ‘’If inflation is the genie, then deflation is the ogre that must be fought decisively.’’

While inflation decreases the real value of money, deflation increases money’s real value. This appears to be a good thing at first glance. However this decrease is not coming from enhanced productive efficiencies and competitiveness of manufacturers, but from consumers’ falling demand, as a result of unaffordability and low incomes.

Falling demand will also result in falling productive capacity, as manufacturers streamline their operations to only meet what is demanded. Despite still incurring high production costs the manufactures realise low returns for their products, as the prices are falling down. Many producers in a free market economy are chiefly driven by the profit motive and will simply shutdown if they start making losses.

Deflation can also result in falling investment and increasing defaults on loans by companies and individuals, apart from factory closures and shrinking incomes.

The major danger of deflation is loss of jobs as companies streamline downwards their operations. The other challenge is that it increases the real value of debt, and brings down financial values such as the values of stocks, commodities and property. If not handled properly, deflation may aggravate recessions and lead to deflationary spiral.

We need to be adequately prepare to fight deflation decisively, beginning from yesterday. The monetary policy and national budget should play a vital role in fighting deflation. The budget should deliberately stimulate aggregate demand to rise up, while the monetary policy should come up with concrete strategies to increase money supply and lower interest rates.

With respect to stimulating demand, the current civil service wage negotiations can be commended to some extent as the rises will give consumers increased spending power. This will result in increased consumer demand, which will not only increase productive capacity of manufacturers, but will also see prices rising to levels far from deflation fears. Inflation should stay within the bounds of 1 – 9 percent, for sustainable economic activity.

The removal of the MoU between the central bank and banks, which has seen interest rates going through the roof, should be severely scrutinised. One vital way of dealing with deflation is to reduce interest rates and allow productive sectors to access lending at favourable rates, so that they can invest in efficiency and be able to remunerate their employees well. The monetary policy should therefore spell out concrete measures to curtail bank charges and interest rates.

Improving money supply is vital to steer an about turn from the fast lane to deflation we are currently cruising in. We are battling a severe liquidity crunch and cannot print money to abet the situation, as we are using foreign currencies.