Tuesday, Dec 16, 2008
Is deflation a red herring?
BBC News: UK inflation declines once again
UK inflation fell in November to 4.1%, official figures have shown, less of a decline than analysts had expected.
The drop in the government's preferred Consumer Prices Index rate compares with 4.5% in October. Some economists had tipped a fall to 3.9% in November.
Posted by flintster1994 @ 09:43 AM (2188 views) Add Comment
46 Comments
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1. flintster1994 said...
Although, if AD doesn't see deflation as a significant risk........
2. paul said...
4.1% is still 100% above the target rate of 2%.
I've always thought deflation was a red herring.
3. Gary Smith said...
I suppose extrapolating backwards (I assume this is possible) a 0.4% reduction in inflation for the month is deflation of 4.8% for the year.
This kind of deflation, with a reduction in input prices such as oil and food prices is a good deflation. I always thought the reduction in interest rates was really to help with deleveraging, ie helping those with too much debt...
4. Marcus said...
Surely with sterling dropping through the floor in recent months, the effect will soon be a rise in the cost of all imported products?
5. Travisher-scorp said...
As a mental exercise try imagining the world where;
the rate of inflation is -25%.
Interest rates cannot fall below 0%
Borrowing will cost you what?
Index linked pension formulae will do what?
What strategy would you take to safeguard yourself and your wealth?
What strategy would you expect government to follow?
It may not go to those extremes but unless you can figure it out at the extreme how can you call the market when inflation is -2%.
Leaving out housing from the inflation figures means everyone is working to false figures, why do they do this? Perhaps because the figures would look so extreme all their pet theories and bell curves and standard deviations would be proven bogus at a glance.
6. techieman said...
deflation a red herring? Wishful thinking.
7. drewster said...
Petrol is under 90p in most places, diesel around £1.00. That looks like deflation to me?
8. paul said...
What we're witnessing now is disinflation, and oil is not a good marker to measure this, especially after recent speculative increases in the prices of commodities.
When bread and cars becomes cheaper and cheaper, month after month year after year, then we have deflation. It takes just as long to work through the system as inflation - you won't see it happen in a matter of weeks like the government likes you to think.
The government is using the spectre of deflation as an excuse to engage all manner of measures right now. In reality though, can you see the government allowing prices to fall over a period of years (which correctly defines deflation)?
Me neither.
9. techieman said...
Paul you are wrong that is not deflation.
10. paul said...
techieman, deflation is a fall in the general level of prices, sustained over time and worked back in to expectations of alling prices.
What do you think deflation is?
11. paul said...
disinflation is when the price level is dropping, but still positive. Like right now.
12. techieman said...
i know what it is. What you describe is a symptom. I am not trying to be a smart ar5e and am not splitting hairs but you have made the mistake that most people make. We have discussed this before.
See http://www.elliottwavesignal.com/2008/11/20/robert-prechter-elliott-wave-international-explains-the-price-effects-of-inflation-and-deflation/
13. inbreda said...
Paul is right - just because oil has fallen from a recent speculative peak does not mean that we have deflation.
I get the argument that credit (i.e. imagined, magic money) has been used to buy stuff and has therefore allowed the prices to escalate (as with houses) and that now that the credit is gone the prices will fall back. BUT there is a difference between deflation in a small number of asset classes caused by speculation, and deflation. While these speculative bubbles in asset classes have developed, britain has remained a free economy. People haven't speculated on bread - they have still pretty much bought bread at a reasonable price, and the bread manufacturers have had to compete and therefore keep prices at reasonable levels. There is no speculative bubble in bread and bread prices will therefore not come down. Some of this "deflation" that is being reported is caused by firesales - e.g. woollies selling everything at a 20% discount. But as a closing down sale there is no longevity in this. Once everything is sold, the discount ends. It has a knock on effect on other businesses which may also then have a firesale, but this is all a contraction, not deflation. The companies that survive will eventually have to pass on the increased cost of the goods that are imported because the pound is now worth nothing.
Hence - after that diatribe - I concur with the short "deflation" and medium inflation to long term hyperinflation.
Whether you buy gold depends on how over inflated you think it is. Housing - clearly over inflated. Gold? dunno, but if it was used to replace fiat currencies you could times its current value by big multiples, so I am still buying.
14. phdinbubbles said...
Agree with paul
According to my understanding deflation is a negative inflation rate (sustained over time) - so 4.1% would make that inflation then with disinflation (decrease in inflation).
But then again there's the definition of deflation being a decrease in money supply and credit.
Oil has dropped recently from a speculative high - but for how long?
15. techieman said...
The fall in the pound and the easing of monetary conditions is to fight off deflation. I agree we dont have it yet but my view is that the artillery used to fight it wont work. So the premise deflation is a red herring is.... erm a red herring. Does anyone think the government would try THIS hard if it didnt think it had to? In any case once we do have it its actually very difficult to control - people just put buying things off... such as a new car or a new house.....
16. paul said...
techieman you've dodged the question with semantics, instead of admitting that you confused simply disinflation with deflation. After all, what is the disease, if not the symptoms?
Anyway. I agree that the fall in the pound is the government's method to tackle it, however there is the law of unanticipated side effects - when the UK borrows, it borrows in its own currency, and repays in its own currency AFAIK. What happens when the UK's credit lines are withdrawn because of the falling pound? Doesn't this affect the government's ability to sell Government bonds and treasury gilts?
17. letthemfall said...
I'll throw in my inexpert view. Given that deflation, according to the technical definition, is a contraction of money supply - cash and credit - then I would say that what we have is certainly deflation: credit supply has shrunk, we know that much, and cash will presumably dwindle too as it goes to pay off debt instead of buying more stuff (which I presume is why high debt is called deflationary by the experts). I suppose we will see soon enough. Not that I'm agreeing with techieman - heaven forbid.
18. Bobajobbob said...
The rate of inflation has fallen slightly. This is not deflation.
19. paul said...
Deflation is not a contraction in the money supply and credit.
Deflation is a common consequence of that contraction, and is usually the cause of deflation (historically).
Inflation and deflation are about expectations - if you expect prices to rise, and you adjust your behaviour accordingly by buying stuff now, making prices rise. Conversely if you ... well opposite .. blah blah .. deflation.
We're muddling cause and effect.
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21. techieman said...
Paul - i am not hiding behind semantics at all. You made a statement of what deflation is....it isnt. I do agree we are not there yet (although doesnt that depend on what you use to measure - the basket is itself a manipulated basket case). You would do well to read the link i posted, and perhaps the 8 page document explainig it. I thought the way you did too - but keep an open mind.
The point of the post was deflation is a red herring. I do agree that Gilt yeilds will rise in the medium term - and i am closely watching that but assuming we follow the US , then we will have lower yeilds first and then at some point that will reverse. Thats the fundemental view - and thats the background, as to when i think that manifests , that will be the technical view. I think someone posted here that the cost of insurance on gilts has risen.
As for can you see the government allowing [deflation] - i think you have an inflated (pardon the pun) view of our less than illustrious leaders.
Letthemfall - i admire your candidness on both counts.
22. phdinbubbles said...
From my in depth knowledge of reading wikipedia there are two definitions of deflation. The first is negative inflation (which makes paul right) and the second is the classical economic definition of decrease in money supply (which makes techieman right) - the second definition can to lead to the first in time.
23. p. doff said...
If inflation falls from 5% to 4.5% it's disinflation (because we still have inflation of 4.5%). It only becomes deflation when it falls below zero.
By George, I think I've gotit! (or have I?)
24. phdinbubbles said...
Blinking economists. There aren't two definitions of the First Law of Thermodynamics that are so different. A dismal science
25. techieman said...
Paul for what its worth you are creating a circular argument... why is it that Volvos sale of trucks was down 98% between 3rd quarter 2007 and 2008? Why is it that house purchases are being put off? Why is it that new car sales are down - approx 30% since the same period last year?
"Inflation and deflation are about expectations - if you expect prices to rise, and you adjust your behaviour accordingly by buying stuff now, making prices rise. Conversely if you ... well opposite .. blah blah .. deflation" .
YES correct there becomes a tipping point when the deflation becomes more and more pronounced. You can have a technical deflation without that being translated into the common deflation (for want of a better expression) you speak of, however that is - like unemployment - a lagging indicator.
26. phdinbubbles said...
Sorry, dismal science.
Dismal html.
27. techieman said...
phDinbubbles - yea i like that!
28. Poacher said...
Gary Smith, I think you are right. This is what is called a fat margin rescue - the central banks drop their target interest rates, but let the banks know that they can lend at higher rates - albeit not without apparent carping and criticism from the government, which is just PR and not heartfelt - so that they can recapatilise via the spread. Good chapter on it in Charles Koo's book 'Balance Sheet Recession' about the Japanese lost decade (out of print).
29. paul said...
techieman, disinflation is a fall in the inflation rate. Deflation is a negative inflation rate. p.doff go straight to the top of the class.
Those sales volume drops that you quoted show a dropoff in demand because of decreased purchasing power not because of deflation. Sales of trucks, cars and widgets can decline till the cows come home, but if the price stays the same, it is not deflation.
A change in sales volume is not the same as a change in long term prices. When the price drops, the manufacturers are adjusting their outlook of the status quo purchasing landscape.
You see it? I'm sure you do. I think most others here do.
30. drewster said...
phd, techie,
It's asset price deflation and wage deflation that matters. If bread and petrol and razor blades fall 15% a year you aren't going to wait a year to buy them, you still need to eat and drive and shave. But if house prices fall 15%, you wait. That slows down the economy, causing unemployment and depression. Unemployment leads to civil unrest (c.f. Greece). That's what governments want to avoid.
31. Digbypenguin said...
I don't believe in a deflationary spiral. Or rather, I believe it can happen to a limited extent but that eventually the reinforcing behaviour reaches some equilibrium.
The spiral is supposed to work like this: people put off buying stuff today because prices are falling. Because less money is circulating, businesses are forced to cut prices and sack staff to get money quickly to fund their business and prices fall.
I have two points: firstly, we have been living in an inflationary economy, where the tendency is to spend now and not put it off (i.e. save), and yet people still save. Similarly, I think that in deflation, the tendency is to save, but some people will still spend.
Secondly, as businesses fail, the reduction in supply of goods should increase prices. This counters the expectations of lower prices.
At some point the supply and demand will even out. The bad or higly leveraged companies will be dead. Prices for luxury and large items will have crashed. Prices for necessaties will have increased.
Is there anything unreasonable in this explanation?
On a separate note, the inflationary "spiral" is exponential and so the rate of increase, er, increases until the pop, whereas deflation is inverse exponential so the (absolute) rate of decrease slows over time. Which is why delfation can take ages to work out of the system, but tends to have less sudden effect. There is no delfationary bubble to burst - it is just the long wait for the little specks of foam to finally die off.
32. techieman said...
Paul - so what do most people do when their sales decrease? one of 3 things their either deeply discount or they put off workers or similar - eg vauxhall, or they go out of business and default meaning they sell assets at reduced prices to satisfy the creditors. If this was a single company then yes it would not be deflationary but when its industry wide (eg for cars) then thats a different scenario.
Discretionary spending has been hit quite hard we know this, and that and new car sales are, im afraid, lead indicators. If everyone has decreased purchasing power then what does that lead to exactly? you can underline and bold things all you want but I am not talking about headline rates and where we are now. I have no interest in that, its where we are going that interests me.
So yes its easy to say there will be no "deflation" under your definition, since historically this has rarely happened, but thats not to say it wont - and that per the technical definition it has already. What you do with that information is up to you.....
33. paul said...
Okay, deflation can only be seen in retrospect - there are no defined leading indicators. There's the gap in understanding.
There are many indicators that can lead to deflation, but there are no established lead indicators, where you can say "because this has happened, deflation will occur". I underlined stuff to point out that deflation is about long term general price levels, not sales volumes, bankruptcy indicators, discretionary spending levels, unemployment or anything else.
Just prices, and their feedback indicator of expected prices. The government will print money to avoid deflationary expectations becoming ingrained.
That's why deflation is a red herring.
I think drewster has it. We have house price deflation already. We may yet have deflation in the new car market (aha! that's why General Motors are worried).
Deflation of bread is, I suppose, less relevant although when you have people lowering their spending, a multiseeded organic fairtrade dolphin friendly brown loaf, at £1.50, may look pricey, and while people can adjust their purchasing behaviour quickly, there is little point making that special breadmaking machinery redundant, so the price even of those loaves may be depressed.
34. sold 2 rent 1 said...
M3 is clearly dropping like a stone - but it did this in 1976 too, and back then it turned around and a possible depression was turned into an inflationary blow-off.
Notice we are in Elliott Wave 4 of M3 growth. Maybe 1 final blow-off for wave 5 where M3 goes to 30-40pc before a deflationary collapse.
35. mrmickey said...
If Robert Mugabe can create inflation I'm sure Crash Gordon is up to the job. The only reason you would have deflation is if you can't expand the money supply for some reason, for example if your currency is backed by something like Gold, and I suspect that's why deflation has been experienced in the past. As our currency is backed by nothing what is the problem just create more out of thin air you don't even have to incur printing costs in our digital age then spend the money into the economy by employing more tree police or building a few more roads.
36. techieman said...
Drewster you are right, but not 100% right. If people become poorer they substitute so you end up with less Tesco finest and more tesco value, less waitrose and M&S and more Lidl and aldi, less Gillet mach sensor power pulsometer 3 braun whatever and more bic. In any case that then has an effect on the producers, isnt that why when people get rich they buy baby bentleys and when they get poorer they have to sell them and get something more economical? So yes you have highlighted the headline but similarly if money is tight you arent gonna buy a nice shinny new car but keep with what you already have. If you do have to buy a new car you are probably gonna get one with less bells and whistles or a brand that isnt so expensive.
So yes asset price deflation matters. But other things matter too, because of the decrease in wealth translates to less wages - eg overtime bonuses etc.
37. techieman said...
s2r1 - do you have a cumulative money supply growth chart rather than a rate of change?
38. andrew said...
Here's my definition of deflation, it doesn't exist. As far as I can remember things are either very expensive or only slightly expensive, either way we always pay more for end products than they are actually worth, so what if you get a 20% discount if the original sh!t was overpriced. Prices go one way over the long term, up.
Hasn’t anyone noticed that money flow is controlled so that the average person has somewhere between ‘just enough to scrape by’ to ‘able to buy a few luxuries’.
39. mrmickey said...
Andrew your correct over the long term everything always goes up in price the pound buys a small fraction of what it did 100 years ago, the fact is there isn't much left to inflate away.
40. sold 2 rent 1 said...
TM,
It is in green
41. inbreda said...
house prices can fall. that is not deflationary, because most of the "value" was just BS and bluster. There is no such BS and bluster (speculative) cushion in the price of bread. We need bread and will not stop eating it because we suspect the price will be less in a few months time. For the price of bread to drop, the price of the raw materials or the production/labour costs also need to drop. this will not happen without a contraction in the money supply which is simply NOT going to happen. The government can mix up the inflationary basket all they want to fiddle the figures, but genuine deflation is NOT going to happen. It is nothing more than the effect of removing bullsht and bluster (credit and speculation) from the economy. Printing money does not make the country richer. High perceived house prices does not make the country richer. House prices down. Everything else up. Value of the GBP = 0.
42. techieman said...
sorry s2r1 - am a bit under the weather today! [flu] - still no excuse really, just when you said 3rd wave of growth thought you meant ROC - Duh!
43. rumble said...
Simplifying things, I thought disinflation was the reversal of the preceding inflation, back to average, and deflation when moving down from average.
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