Deflation

Theory and description

The general level of the prices is generally included/understood like the Consumer price index (IPC). Its evolution is disconnected from those of the Financial credit or real.

This situation is not inevitably beneficial for the employees, whose incomes can simultaneously decrease (wages being however often rigid with the fall).

The Economic agents having debts suffer particularly from deflation, because their nominal Créances remains constant whereas that in real terms they represent more Purchasing power.

The central banks worry about deflation because many tools of the Monetary policy become ineffective, and moreover deflation can lead by a vicious circle to a deflationary Spirale. Since the beginning of the 20th century, the violent ones episodes of deflation are related to the bursting of speculative bubbles in the actions and the real estate. The topic re-appeared at the time of the deflation observed with the Japan since 1991 following the stock exchange crash and real estate which followed the Japanese Speculative bubble. The “spectrum” of deflation was evoked in Occident at the time of the stock exchange crisis of 2001 and could re-appear at the time of a correction of the world real estate market.

A little history

At the end of the 19th century it one long period ago of deflation, but, during which the growth was constant. This deflation was due to two major technological shocks: diffusion of electrical energy and the revolution of transport. During this period the price of the credits believed continuously. This deflation there remains however an atypical case.

Another period of general deflation, to which one generally refers, is that of the Années 1930 after the collapse of the stock exchange credits of 1929. Between December 1929 and March 1933, the prices had dropped by 27% with the the United States; this Net retreat then represented a collapse of the request and thus of the activity. Employment dropped by 16% in three years and the whole of the versed wages undergoes a retreat of more than 40%, creating in the country a dramatic situation.

Some economists think that one observes big risks of deflation to the Japan, of Hong-Kong and in Germany, whereas for the the United States and the France, the risk would be limited more.

Lower prices and lowers incomes

Deflation has important effects on the distribution of income by causing painful imbalances in the accounts of the companies and by undermining the effectiveness of the Economic policies. This effect on the distribution of income was highlighted in a famous article of Irving Fisher, published in 1933 and in which it shows how, during the time of deflation, the involved in debt economic agents see their situation being degraded quickly.

If the amount of the debt is of rising fixed, deflation will have for effect to increase the weight of its refunding, this relative at the other expenditures, which then will generate, in a total way, a fall in the demand and thus of the activity. The principal recipients of a deflation are thus the creditors, on the other hand, the most important consumers, those which tend to consume the greatest part of their income, are also often those which are involved in debt, from where the highly negative effect on the economy, money going from those which spend it towards those which thésaurisent it.

Consequently, more the level of debt of an economy is large (ratio debt totale/PIB), more one period of deflation has harmful effects. During the 19th century, the growth of the credit was limited by the weak banking infrastructures and the parity gold of the currencies. In 1932 the level of debt knew a historical maximum in the United States. The debt then gradually dropped until the middle of the years 1950. It since increased strongly and is located from now on well at the top of the level reaches in 1929.

Another consequence of deflation is the fact that the consumers can be incited to defer their purchases in order to profit from price or promotions which they hope for increasingly gravitational; this phenomenon, by deferring the act of purchase is thus, also, highly negative on the general level of the activity.

Consequently, more the share of consumption in the GDP is high in an economy and more deflation makes weigh big risks. Currently the share of consumption in the American GDP is well with the top of the historical standards and this phenomenon is common to a less level for the worldwide developed.

During one time of deflation, the companies undergo a reduction of their margins owing to the fact that their selling prices drop whereas the production costs remain relatively fixed. This stability is primarily the resultant, not only, of the long-term contracts sign with the suppliers, but especially of the stability of the wages related on the work contracts and/or the collective agreements. Admittedly, with time, an adjustment takes place, but always with delay, which undermines the general profitability of the companies, weaken them and increases the risks of bankruptcies.

Limited remedies

To fight against deflation, the central banks have only the possibility of answering by a fall of the Interest rate, but there are then two major limits with this policy:

the potential of fall of interest rates is naturally limited because, if those can be null, even slightly negative (see negative Interest rates - as, for example, in Switzerland in 1979 -, they cannot very descend durably in lower part from 0%.
but especially a fall of the rates can result in deferring the problem to later by worsening it. The economic actors heavily in debt and having important credits (real estate, actions), benefit from the fall of the rates to be involved in debt a little more. One can then see appearing bubbles in the price of the real estate, the actions and or the raw materials.

The experiment shows that it is in fact very difficult to leave one period of deflation by a fall of interest rates. The Japan is limed in deflation since the stock exchange Krach and real estate which he knew in 1990. However it maintained since a policy of rate 0.

The decisional authorities which have the responsibility for the economic policies must thus be very vigilant, in order to intervene upstream possible, and to try to modify anticipations of purchases. It is for this reason, that the Monetary authorities American, European, but also the the IMF do not hesitate to stress this risk, with like objective precisely affecting anticipations of the economic agents.

A more radical proposal: the national central banks could practice the " parachutings of tickets by hélicoptère" - the expression helicopter drop is a traditional metaphor in the monetarism, where it is used to characterize a monetary creation exogenic . Concretely the central bank would directly finance the national expenditure which for example would grant financial aids to the households. This solution is politically difficult to implement because it supposes acter politically that the current debts will be refunded in " currency of singe". Such a practice is openly inflationary, it carries wrong to the private banks and other actors who live continuous rise of the debt and creation of currency by this skew. Moreover in Europe, the national national expenditure is very narrowly supervised within the framework of the rules of management governing the European currency, the Euro, and it appears not very plausible that the European Central bank deals with the national deficits.

This policy of compensation of the fall of the debt by a rise of the creation of currency by the central bank is easier when the currency of the central bank (tickets, coins, obligatory reserves) represents a percentage high of the total money supply. It should be noted that since the end of the Second world war, the central banks control a share each day more reduced of the money supply. The tickets and coins, which still represented nearly 25% of the money supply in 1950, represent some from now on less than 5% - about 1% for the developed countries. The central banks thus are less and less well placed to thwart a fall of incur debt and related private monetary creation.

Deflation in Japan

Japan knew since the end of the year 1990 a particular monetary situation marked by a deflationary serious attack.

The Japanese economy plunges in the recession after the bursting of the Japanese Speculative bubble in 1991. The Banque of Japan then decides to lower gradually the Interest rate up to 0,5% in 1995. Beginning of 1999 in the middle of 2000, become independent of the central capacity, it lowers interest rate to 0% ( Zero Interest Rate Policy ). In March 2001, it adopts a policy known as of “quantitative easing” which tries to increase the liquidity and to facilitate the recourse to the Crédit:

massive emission of Currency.
purchase of goods of the Treasure Japanese.
broad increase in the amount of the reserves of the trade banks lodged with the Central bank.

Japan joins again with the growth starting from 2003 so much so that, beginning 2006, Japan seems to have overcome deflation. The first liberal minister Jun' ichirō Koizumi declares that “one observes signs of exit of deflation”. For the first time for eight years, the prices indeed have increased for three months of sharpened and GDP of the country gained 2,8 % in 2005. However, the paid household consumption dropped in the same time of 4,7 %. March 9th, the Bank of Japan gives up the principle of the quantitative easing officially, while maintaining for the moment interest rates with zero. The Japanese currency dropped much, under the effect of the private behaviors of arbitration (curry trade) which borrow from Japan atlow rates to invest in the United States (in particular) athigher rates. Japan joined again with very important trade surpluses. These two factors indicate that Japan tended to export its deflation and to join again with an internal inflation under the effect of the rest of the world more than by internal modifications.

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