How Serious of a Threat Is Global Deflation? Nariman Behravesh Farid Abolfathi John Mothersole Dan Ryan Todd Lee Howard Archer Global Insight Teleconference December 17, 2002
1990s: A Deflationary Wave The bursting of the Japanese asset and investment bubbles The bursting of the Japanese asset and investment bubbles The Asian Crisis The Asian Crisis Deflation spreads to other parts of Asia Deflation spreads to other parts of Asia The bursting of the high-tech bubble The bursting of the high-tech bubble Worldwide manufacturing deflation Worldwide manufacturing deflation 2
Commodity Prices
Though Up in 2002, Commodity Prices Remain Well Below Recent Levels
With Prices For Many Soft Since July
Insights From Japan’s Deflation
Disinflation, Deflation
Bursting Bubbles JAPAN Stock market peak: December Inflation: rising in 1990, volatile in 1991 (with surges above 4% m/m) GDP growth: 3+% q/q through Overnight call rate peak: March United States Stock market peak: August Federal funds peak: January 2001.
Interest Rate Response
Japan’s Slow Response Due To: Unfamiliarity with slow growth. Return to “normal” (3-4%) growth rate expected. Anti-inflation bias. Post-WWII generation of policymakers. Emphasis on fiscal rather than monetary expansion. Public works projects.
Problems Peculiar to Japan Structural problems. Overly-dependent on manufacturing, construction, exports. Low productivity in services. Bad Loans + Extreme Asset Deflation Bad loans estimated at 8-40% of GDP Asset prices now 1/4 th of peak value. Money hoarding. Due to uncertainty, risk aversion. 1990: M1 = 25% of GDP Today: M1 = 65% of GDP
Japan: Causing Global Deflation?
Asia
Asia Recovery Continues (Real GDP, percent change from a year earlier)
Recovery Still Driven by Exports (Percent change from a year earlier, Q3/2002) * Private consumption represented by real retail sales; business investment from q1-q3; exports in nominal dollar terms # Exports in nominal U.S. dollar Q2 data
Consumer Demand is Cooling (Real NIA Private Consumption, percent change from a year earlier) *Real retail sales
Exports Are Sizzling (Real NIA Exports, percent change from a year earlier) *Exports in nominal U.S. dollar
Asia Exports Rely on US Imports (Percent change from a year earlier)
Interest Rates Are near All-Time Lows
Liquidity Decelerates Despite Low Interest Rates Percent change from a year earlier
Deflation Remains A Concern (CPI, percent change from a year earlier )
Deflation Remains A Concern (Percent change from a year earlier, 2002 Q3 ) * Second quarter data
Fiscal Strain in Asia (Fiscal balance over GDP, percent)
Outlook And Risks Outlook Outlook Cautiously optimistic about 2003 Inflation will remain subdued in the near-term Accommodative fiscal and monetary policy will continue US growth rebound in 2 nd half 2002 will boost exports China, India, Korea, and Malaysia will lead the pack Risks Risks Deflation Dependence on U.S. imports Non-economic shocks: Terrorist attacks, War on Iraq Rapid consumer credit expansion Fiscal strain
Real GDP Growth Outlook (Percent change)
Real GDP Growth Outlook (Percent change)
Who Is Next?
Parallels with Japan JapanU.S.Germany Weak Domestic Demand Deflation? Real Interest Rates Too High Real Exchange Rate Too High Fiscal Rigidity Financial Stress ? Heavy Dependence on Bank Financing High Debt Levels Burst Asset Bubbles Rigid Labor Markets Poor Corporate Governance
Growth in Real Domestic Demand Versus Real GDP
Debt is High in Much of the G7 Source: OECD; National statistics *Estimate
United States
U.S. - Deflation Is Not A Threat U.S. growth has been closer to trend than most other industrialized economies U.S. growth has been closer to trend than most other industrialized economies Policy has been and continues to be aggressively expansionary Policy has been and continues to be aggressively expansionary A falling dollar will help A falling dollar will help Service sector inflation is still chugging along Service sector inflation is still chugging along However, there is no room for complacency However, there is no room for complacency 34
U.S. - Growth vs. Potential Percent change from a year earlier
U.S. Consumer Price Inflation Percent change from a year earlier
Western Europe
Western Europe overall deflation risks limited Growth in Western Europe averaged near to 2% over last decade, so not a major output gap yet. Growth in Western Europe averaged near to 2% over last decade, so not a major output gap yet. Core Eurozone inflation stayed in % range through Inflation sticky in the dominant services sector. Core Eurozone inflation stayed in % range through Inflation sticky in the dominant services sector. Money supply growth strong, even allowing for distortions. Money supply growth strong, even allowing for distortions. ECB still has significant scope to cut interest rates. 50bp cut on December brought key rate down to 2.75%. ECB still has significant scope to cut interest rates. 50bp cut on December brought key rate down to 2.75%. If deflation really becomes a threat, there is ample scope for fiscal stimulus in the region, But authorities would have to at least make the Stability and Growth Pact more flexible. If deflation really becomes a threat, there is ample scope for fiscal stimulus in the region, But authorities would have to at least make the Stability and Growth Pact more flexible.
Eurozone - Growth vs. Potential Percent change from a year earlier
Eurozone Consumer Price Inflation: Goods and Services Percent change from a year earlier
Western European Latest Annual Inflation Rates CPICPICorePPICPICPICorePPI Austria1.8n.a.1.2Netherlands3.2*n.a.3.2 Belgium1.1*n.a.0.7Norway2.1*2.0*3.3* Denmark2.7*3.1*0.8Portugal4.0*n.a.1.4 Finland1.6*n.a.0.5Spain3.9*3.6*1.6 France2.2*2.0*0.6Sweden2.3*2.1* Germany1.1*0.8*0.3Switzerland Greece3.6*n.a.1.9UK Ireland4.8*n.a.-0.4Eurozone2.2* Italy2.8*n.a.1.1
Germany Deflation Risks Large output gap developing. GDP growth averaged just 1.3% over 10-years Growth forecast at 1.0% in 2003, after 0.3% in 2002 and 0.7% in Large output gap developing. GDP growth averaged just 1.3% over 10-years Growth forecast at 1.0% in 2003, after 0.3% in 2002 and 0.7% in Unemployment at 10%. Consumer confidence at 5-year low. Unemployment at 10%. Consumer confidence at 5-year low. Major structural problems - Labor & product market rigidities. Major structural problems - Labor & product market rigidities. Stock market been weakest performing of the major industrialized countries this year. Stock market been weakest performing of the major industrialized countries this year. Debt levels have risen. Bankruptcies up sharply. Debt levels have risen. Bankruptcies up sharply. Property prices have fallen, but not collapsing. Property prices have fallen, but not collapsing. Banking sector problems mounting, but not as bad as in Japan. No signs of a significant credit crunch. Banking sector problems mounting, but not as bad as in Japan. No signs of a significant credit crunch. Locked into euro at too high a rate? Will euro rise markedly against dollar? Locked into euro at too high a rate? Will euro rise markedly against dollar? Real interest rates too high. Fiscal policy restrictive. Real interest rates too high. Fiscal policy restrictive. Policy paralysis? Policy paralysis?
Germany vs. Japan Percent change from a year earlier
Reasons to Remain Worried Weak domestic demand and growing output gaps Weak domestic demand and growing output gaps Huge amounts of excess capacity in goods- producing industries Huge amounts of excess capacity in goods- producing industries Weak commodity prices Weak commodity prices Overvalued exchange rates Overvalued exchange rates Potential for policy mistakes Potential for policy mistakes 44