Deflation: Brace for Impact?

Deflation means a fall in prices (a negative inflation rate). There are potential problems with deflation:

·       Higher real debt burden;

·       Decline in spending; and

·       Higher unemployment

For the consumer it impacts positively in the short term but negatively in the long term. In the short term, it increases purchasing power of consumers as prices fall. Consumers may save more money as income increases relative to expenses.

In the longer term, falling prices begin to impact company sales with less purchases (with anticipation of a further drop in prices) leading to reduced pay and/or job losses. That leads to further spending cuts that feeds on to a downward spiral.

Malaysia’s economy moved into deflation in January 2019 (CPI declined by 0.7% YOY) as fuel prices dropped. Is this just a base effect or an aberration? The core inflation index actually moved up by 0.2% in January (YOY) as per Department of Statistics data.

With global oil prices creeping upwards, CPI will be impacted but not that significantly. Inflation may remain in the 2-2.5% range for the year, which is lower than Bank Negara Malaysia’s range of 2.5-3.5% forecast for 2019.

Generally, what are the options available to overcome deflation?

       I.          The traditional tool is interest rate (lowering them boosts aggregate demand);

     II.          “helicopter drop”- new money to consumers directly, especially to the lower income group;

    III.          Quantitative easing;

   IV.          Change expectations;

     V.          Devaluation; and

   VI.          An expansionary fiscal policy – government spending to kick-start the economy.

Japan went through a long period of deflation in the 1990s and most of 2000s. But Malaysia is not in that boat and none of the above policies need to be pursued in the immediate. We need not brace for impact as this January 2019 figure and will remain, at best, a base effect if not an aberration!

References:

1. Malaysia hits deflation for first time since 2009 global crisis, The Star (22 Feb 2019)

2. Deflation returns in Malaysia after nearly a decade, Economic and Financial Analysis, Global Economics, ING (22 Feb 2019)

3. Stay calm and keep spending just a bit more, economist says on deflation, Pradeep  Nambiar, www.freemalaysiatoday.com