Case :

BOX 10.5 INFLATION OR DEFLATION Where's the danger? The spectre of deflation in the early 2000s However, with the onset of recession in mid-2008, inflation The first edition of this book in 2005 stated: 'Inflation no longer started to fall and the 'China effect' seemed to have gone seems a serious worry in many developed economies. Instead, away. Once more there seemed to be a spectre of deflation. "deflation" (i.e. falling prices) has become a source of concern.' By 2009, many people were asking themselves why they should buy now when, by delaying, they might be able to get One of the main reasons for this was dubbed the 'China price an item more cheaply later on. The effect was to shift the AD effect' . The rapid growth in cheap Chinese imports into curve leftward, forcing prices down even further and also developed countries was exerting downward pressure on prices. creating further problems for economic growth. Furthermore, outsourcing of call-centre, back-office and IT work to developing countries has added to the downward pressure on But the worry about deflation was short-lived. As the world wages. The Japanese economy experienced deflation in many economy pulled out of recession and China resumed double- years since the late 1990s (see Figure 10.10) and central banks, digit growth, so commodity and other prices began rising including the US Federal Reserve and the European Central more rapidly. In the UK, inflation reached 5.2 per cent in the Bank have continued to sound warnings that deflation is a real 12 months to September 2011. This figure was significantly and present danger to their economies too. higher than the Bank of England's 2 per cent target rate of inflation. Inflation did then move back towards its target Deflation can have a damaging effect on the economy. If level in 2012 and 2013. consumers believe that prices will fall, they are likely to hold off buying certain goods, such as household furniture and Back to the spectre of deflation? equipment, hoping to get them cheaper later. This can The period from 2010 saw a slight easing of global growth, dampen aggregate demand and reduce business profits and falling from 5.4 per cent in 2010 to 3.1 per cent in 2015. China's act as a brake on investment. Firms may cut staff in an growth slowed more dramatically, from 10.6 per cent in 2010 to attempt to reduce their own costs. 6.9 per cent in 2015. At the same time, investment in shale oils A return of inflation and in many other commodities increased their supply. Slowing demand and higher supply were reflected in falls in commodity The US and other OECD economies experienced rapid growth prices. From April 2011 to January 2016, the all commodity price in the mid-2000s. Between 2004 and 2006, US economic index fell from 201.9 to 83.05 - a fall of 59 per cent. growth averaged 3.8 per cent and the OECD countries averaged 3.1 per cent. These rates, however, were dwarfed by Falling commodity prices helped to moderate consumer price China and India, which experienced growth rates of 10.1 per inflation rates. At the start of 2015, the annual rate of CPI cent and 8.4 per cent respectively over the same period. inflation in the UK had fallen significantly to just 0 per cent and remained at around zero from several months (see the The rapid growth in aggregate demand in many OECD countries blog 'Fuelling the absence of inflation' on the Sloman put upward pressure on prices and wages but, unlike Economics News site). Meanwhile, in the eurozone there was previously, the 'China price' effect was beginning to reinforce deflation at the beginning of 2015, as discussed in the blog, this upward pressure. As The Economist of 22 June 2006 stated: 'Eurozone: positive inflation', with the CPI inflation rate China's excessive growth is not only of domestic concern. standing at -0.6 per cent. Although it hovered around zero With much of the world increasingly worried about for much of 2015, it was negative again in early 2016. inflation, questions arise about what an overheating Chinese economy could do to global prices . . . After being In the long term, whether the process of globalisation will squeezed between rising input costs and falling factory- have an inflationary or deflationary effect will depend on the gate prices, China's manufacturers are starting to raise balance of two opposing forces. Higher demand for prices to rebuild margins - and getting away with it commodities from the rapidly expanding developing countries because both domestic demand and exports are still far will tend to push up prices. Increased global competition and stronger than they were two years ago. Add in higher the spread of technological advances, however, will tend to domestic food and energy prices and surging labour costs, push down prices, or at least moderate their increase. and the China price may soon be a good deal higher.' When the global economy is booming the first effect is likely to dominate. When the global economy is in recession or By 2008, the growth in China, India and other rapidly growing sluggishly, the second effect is likely to dominate. developing countries was causing significant inflation in commodity prices (see the figures in Box 2.4).| 1. What long-term economic benefits might deflation generate for business and the economy in general? From 'China's economy: exercising its pricing power , The Economist (22 June 2. Would an inflationary China price effect be an example of 2006) demand-pull or cost-push inflation