Jump to content
House Price Crash Forum
Sign in to follow this  
Bland Unsight

Deflation - Why Not?

Recommended Posts

Was really struck the this headline:

UK economy poised to welcome deflation for first time since 1960

Usual blah-blah about oil, but the article also included this graph.

b43d7830-2083-4ca4-bc6c-2ee1f37af2bb-620

I'm way out of my element here, but as the oil price was steady till summer 2014 the oil price move can contribute towards the leg down between then and now, but not the earlier leg down from the 2012 peak. Why is everyone so bloody certain that we are not slipping into persistent deflation that we won't be able to get out of?

My knowledge of all this is very superficial, but as I recall when commentators poured scorn on the the Japanese for not returning to a modest inflation, modest growth path after their credit-fuelled asset bubble burst there was all this talk about what they should have done, but didn't. Haven't we essentially pursued the same strategies? I've read some to and fro on the boards, some of which has gone over my head.

Where are we with this now? Are we about to see persistent CPI deflation and when KB's 2008.2 turns up a debt-deflation spiral centred on assets bid up with credit? Are there any good threads I should read/re-read?

Surely if CPI turns negative and stays there for a quarter that will play into wage settlements and in turn into the ONS AWE statistics? How can we have a tight-labour market when so much of the labour market is crappy service sector work that can done on the phone in Bangalore or by a migrant from the EU accession states? In specialist manufacturing, surely a tight labour market would just mean that a UK company could not compete with an overseas supplier who wasn't feeling any pressure on wage? Surely if we want to solve the the threat to off-shoring of jobs caused by rising labour costs, we have to trash the pound even more, giving us a currency crisis at some point which we could only arrest by pushing up rates, setting off the debt-deflation spiral in assets, which would put the economy into recession as marginal borrowers stop spending, and so on...

TL;DR version: What are the compelling arguments that lead people to believe that inflation will return?

Share this post


Link to post
Share on other sites

Was really struck the this headline:

UK economy poised to welcome deflation for first time since 1960

Usual blah-blah about oil, but the article also included this graph.

b43d7830-2083-4ca4-bc6c-2ee1f37af2bb-620

I'm way out of my element here, but as the oil price was steady till summer 2014 the oil price move can contribute towards the leg down between then and now, but not the earlier leg down from the 2012 peak. Why is everyone so bloody certain that we are not slipping into persistent deflation that we won't be able to get out of?

My knowledge of all this is very superficial, but as I recall when commentators poured scorn on the the Japanese for not returning to a modest inflation, modest growth path after their credit-fuelled asset bubble burst there was all this talk about what they should have done, but didn't. Haven't we essentially pursued the same strategies? I've read some to and fro on the boards, some of which has gone over my head.

Where are we with this now? Are we about to see persistent CPI deflation and when KB's 2008.2 turns up a debt-deflation spiral centred on assets bid up with credit? Are there any good threads I should read/re-read?

Surely if CPI turns negative and stays there for a quarter that will play into wage settlements and in turn into the ONS AWE statistics? How can we have a tight-labour market when so much of the labour market is crappy service sector work that can done on the phone in Bangalore or by a migrant from the EU accession states? In specialist manufacturing, surely a tight labour market would just mean that a UK company could not compete with an overseas supplier who wasn't feeling any pressure on wage? Surely if we want to solve the the threat to off-shoring of jobs caused by rising labour costs, we have to trash the pound even more, giving us a currency crisis at some point which we could only arrest by pushing up rates, setting off the debt-deflation spiral in assets, which would put the economy into recession as marginal borrowers stop spending, and so on...

TL;DR version: What are the compelling arguments that lead people to believe that inflation will return?

All I know about Japan is that my unit trusts held in Japanese sectors performed very well, before the bust. During the 70`s (I didn`t have unit trusts back then) the unions seemed to have a stranglehold and wages rose nearly every week ( obviously not only due to the unions) but back then you couldn`t just pop on to the internet, order something from nearly anywhere, and have it in your hands three days later. My simplistic take on the deflation that we have today is that demand has decreased due to negative sentiment ( especially about HPI) In the "boom" years you could get a credit card in 15 minutes from answering a few questions on a website, jobs were plentiful (after all people had plenty of credit to spend) rent was cheap (as mine still is) and those with mortgages or owning their house saw that the magic HPI fairy was taking a sparkly piss over everything, even the grottiest ex-council hovels. All was wonderful....then it wasn`t, people are just wiser to the fact that a house, or a credit card, isn`t going to be bailed out by HPI or wage inflation if you get in too deep. That is may take on one section of the puzzle anyway.

Edited by dances with sheeple

Share this post


Link to post
Share on other sites

I think a lot of the inflation predictions are based on the oil futures market, but you have to bear in mind these are physical goods not stocks and shares. I think the current low price is currently due to many companies being unable to take delivery because their oil storage is full (due in turn to a slow market/reduced demand) so they sell their oil futures and buy new ones that mature in 6 or 12 months time hoping that demand will have have recovered by then, and of course it should do - just look at the futures market!

In other words we could be in the bull trap phase of oil prices:

ar118945826163681.jpg

Share this post


Link to post
Share on other sites

The partial unwinding of China's monstrous construction ponzi in 2012 was the proximate cause, transmitted almost instantaneously to the other BRIC economies via intra-industry trade. The price of crude is just one manifestation of the tsunami of industrial deflation that's swept around the world since (the shale bubble was also partly responsible ofc). Iron ore, copper and coal have been similarly eviscerated. To the shadow banking system a shortfall in demand for industrial commodities is shortfall in demand for dollar denominated credit derivatives and synthetic loans, ergo a decline in demand for the dollar overseas. This in turn has contributed significantly to the dollar's recent strength.

Absent the enormous post-GFC fiscal and derivative stimulus provided by the BRIC economies the world is pretty much back where it was in 2008 i.e. in a debt de-leveraging depression.

iron-ore-vs-copper-june-2014.jpg

Share this post


Link to post
Share on other sites

I'm on a BIS-kick at the moment (emphasis added):

The costs of deflations: a historical perspective

by Claudio Borio, Magdalena Erdem, Andrew Filardo and Boris Hofmann

18 March 2015

Concerns about deflation - falling prices of goods and services - are rooted in the view that it is very costly. We test the historical link between output growth and deflation in a sample covering 140 years for up to 38 economies. The evidence suggests that this link is weak and derives largely from the Great Depression. But we find a stronger link between output growth and asset price deflations, particularly during postwar property price deflations. We fail to uncover evidence that high debt has so far raised the cost of goods and services price deflations, in so-called debt deflations. The most damaging interaction appears to be between property price deflations and private debt.1

JEL classification: E31, E32, N10.

Concerns about deflation - falling prices of goods and services - have loomed large in recent policy discussions. The debate is shaped by the deep-seated view that deflation, regardless of context, is an economic pathology that stands in the way of any sustainable and strong expansion.
. . .

The bottom line is that, whether deflation is seen as symptom or cause, its cost is ultimately an empirical question. As a symptom, it depends on its underlying drivers; as a cause, on the relative strength of various channels.

Moreover, while the impact of goods and services price deflations is ambiguous a priori, that of asset price deflations is not. As is widely recognised, asset price deflations erode wealth and collateral values and so undercut demand and output. Yet the strength of that effect is an empirical matter. One problem in assessing the cost of goods and services price deflations is that they often coincide with asset price deflations. It is possible, therefore, to mistakenly attribute to the former the costs induced by the latter.

. . .

A preliminary assessment of the link between deflations and growth does not suggest a negative relationship. Price deflations have coincided with both positive and clear negative growth rates (Graph 2). And a comparison of all inflation and deflation years suggests that, on balance, inflation years have seen only somewhat higher growth (Table 2). The difference in average growth rates is highest and statistically significant only during the interwar years, particularly in the period 1929-38 that includes the Great Depression (some 4 percentage points), and much smaller at other times. It is the experience of the interwar years that influences the full sample results. Indeed, in the postwar era, in which transitory deflations dominate, the growth rate has actually been higher during deflation years, at 3.2% versus 2.7%.

A shortcoming of this analysis is that it lumps together inflation and deflation episodes of very different durations, regardless of the economic backdrop. A finer test is to compare output performance before and after the price peaks that usher in persistent deflations.

This comparison indicates only a weak association between deflation and slower growth (Graph 3). While mean growth rates are mostly lower in the five years post-peak, the difference is large, 3.6 percentage points, and clearly statistically significant (ie cannot be attributed purely to chance) only in the interwar years, when the Great Depression took place - the subperiod that appears to drive also the results for the full sample. The difference during the classical gold standard period is 0.6 percentage points but it is not statistically significant. In fact, in the postwar era, average growth was even 0.3 percentage points higher in the five years after a price peak, although the difference is not statistically significant.7 Moreover, only in the interwar years did output actually fall post-peak. The benign output performance during the classical gold standard period is what has led previous researchers to characterise such deflations as "good" (Bordo and Redish (2004), Atkeson and Kehoe (2004), Borio and Filardo (2004), Bordo and Filardo (2005)). On this basis, the same could be said of the postwar deflations.

. . .

On balance, the relationship between changes in the consumer price index and output growth is episodic and weak (Table 3).10Higher inflation is consistently associated with higher growth only in the second half of the interwar period, which is dominated by the Great Depression - the coefficients are positive and statistically significant. At other times, no statistically significant link is apparent except in the postwar era, in which higher inflation actually coincides with lower output growth, with no significant change in the correlation during deflations. In other words, the only sign that price deflation coincides with lower output growth comes from the Great Depression and its immediate aftermath.

By contrast, output growth and asset price changes are significantly positively correlated over the full sample and in most subsamples (same table).11 The only exception is the classical gold standard period: this may reflect the comparatively high volatility of yearly changes in the various variables, which weakens the precision of the estimates as it inflates the standard errors. The relative performance of equity and property prices varies across subperiods, but they all have a positive relationship with growth in the postwar era. That of property prices is especially sizeable during this period. Moreover, the positive and statistically significant coefficients on the interaction terms suggest that, postwar, the link with asset price declines is stronger than the link with increases. In particular, the coefficient of the change in property prices more than doubles when these prices decline.12

. . .

Once we control for persistent asset price deflations and country-specific average changes in growth rates over the sample periods, persistent goods and services (CPI) deflations do not appear to be linked in a statistically significant way with slower growth even in the interwar period. They are uniformly statistically insignificant except for the first post-peak year during the postwar era - where, however, deflation appears to usher in stronger output growth. By contrast, the link of both property and equity price deflations with output growth is always the expected one, and is consistently statistically significant.

. . .

Against the background of record high levels of both public and private debt (Graph 7), a key concern about the output costs of goods and services price deflation in the current debate is "debt deflation", ie the interaction of deflation with debt. The idea is that, as prices fall, the real debt burden of borrowers increases, inducing spending cutbacks and possibly defaults. This harks back to Fisher (1933), who coined the term.16 Fisher's concern was with businesses; today the focus is as strong, if not stronger, on households and the public sector. This type of debt deflation should be distinguished from the strains on balance sheets induced by asset price deflations. This interaction has an even longer intellectual tradition and has been prominent in the public debate ever since the re-emergence of financial instability in the 1980s (see eg Borio (2014a)).

. . .

The question we seek to address, however, is quite ambitious given the data characteristics. We are trying to establish the intensity of the link between post-peak output slowdowns and the debt outstanding at the outset of persistent deflation episodes. This is different from what we did before, when we simply measured whether output growth was significantly lower post-peak, without looking for a relationship between the intensity of, say, the price decline or its pre-peak increase and that of the slowdown. Data limitations also get in the way . . . For this reason, we focus on the full sample, which provides a larger set of observations to draw inferences.

The results point to little evidence in support of the debt deflation hypothesis, and suggest a more damaging interaction of debt with asset prices, especially property prices (Table 4). Focusing on the cumulative growth performance over five-year horizons for simplicity,21 there is no case where the interaction between the goods and services price peaks and debt is significantly negative. By contrast, we find signs that debt makes property price deflations more costly, at least when interacted with the credit gap measure.22

Overall, these results suggest that high debt or a period of excessive debt growth has so far not increased in a visible way the costs of goods and services price deflations. Instead, it seems to have added to the strains that property price deflations in particular impose on balance sheets. Since other work has found that property price collapses tend to follow protracted surges in those prices alongside credit, this evidence is consistent with the view that such financial booms and busts - or financial cycles - deserve close attention (Drehmann et al (2011), Borio (2014a)).

. . .

The evidence from our long historical data set sheds new light on the costs of deflations. It raises questions about the prevailing view that goods and services price deflations, even if persistent, are always pernicious. It suggests that asset price deflations, and particularly house price deflations in the postwar era, have been more damaging. And it cautions against presuming that the interaction between debt and goods and services price deflation, as opposed to debt's interaction with property price deflations, has played a significant role in past episodes of economic weakness.

Inevitably, our results come with significant caveats. The data set could be further improved. We have focused on only a few drivers of output costs. We have only a few episodes of persistent deflation in the postwar period. And present debt levels are at, or close to, historical highs in relation to GDP. This should caution against drawing sweeping conclusions or firm inferences about the future.

Even so, the analysis does suggest a number of considerations relevant for the current policy debate. First, it is misleading to draw inferences about the costs of deflation from the Great Depression, as if it was the archetypal example. The episode was an outlier in terms of output losses; in addition, the scale of those losses may have had less to do with the fall in the price level per se than with other factors, including the sharp fall in asset prices and associated banking distress. Second, and more generally, when calibrating a policy response to deflation, it is critical to understand the driving factors and, as always, the effectiveness of the tools at the authorities' disposal. This can help to better identify the benefits and risks involved. Finally, there is a case for policymakers to pay closer attention than hitherto to the financial cycle - that is, to booms and busts in asset prices, especially property prices, alongside private sector credit.

How best to address financial cycles is a broader policy question that the specific analysis in this article obviously cannot answer. As discussed in detail elsewhere (see eg Borio (2014a, b ), there is a case that policy should first and foremost constrain the build-up of financial booms - especially in the form of strong joint credit and property price increases - as these are the main cause of the subsequent bust. And once the financial bust occurs, after the financial system is stabilised, the priority should be to address the nexus of debt and poor asset quality head-on, rather than relying on overly aggressive and prolonged macroeconomic accommodation through traditional policies. This would pave the way for a sustainable recovery. The idea would be to have macroeconomic policies that are more symmetrical across financial booms and busts so as to avoid a persistent bias that could, over time, entrench instability and chronic economic weakness as well as exhaust the policy room for manoeuvre. This article simply presents one small piece of additional evidence in a much bigger jigsaw puzzle.

Something which isn't made clear in the article and which I personally think is very important is that although real GDP per capita consistently drops off immediately post property price peak it also consistently takes off again whilst property prices are still deflating:

ch3-gra4.jpg

Edited by Neverwhere

Share this post


Link to post
Share on other sites

I'm on a BIS-kick at the moment (emphasis added):

Something which isn't made clear in the article and which I personally think is very important is that although real GDP per capita consistently drops off immediately post property price peak it also consistently takes off again whilst property prices are still deflating:

It's difficult to suffer these 'new' possible solutions - 'keeping lid on hpi' - 'non aggressive reflation measures after market tops out' - when that's what we've experienced.. QE/FLS/Project Merlin etc... and values rocketing up another 40% on 2007.... with btlers rewarded, older owners rewarded, more victim doubling down... then into HTB.

They don't seem to realise it's damaging for many young (to 40s) professionals ponzi-protecting the asset values with reflation... it's just the blessed (and too frequently idiot low earners who've had long wave stupid HPI galore) owners that matter, counting their HPI, in so many news-articles... "Average house price to be worth £1m in 2040. Comments: Of course it's possible.. bought for £18K, now worth £500K - you do the math'.

I think some of that rebound in GDP comes because the bust is healthy... it reaches a stage where it breaks up the Serpico's with 4 companies... with all of his complacent luxury overspending at top of the layer-cake, and 4 new entrants apply for debts to get a share in the breakup of the business. More house transactions (at lower prices) to get a lot more mortgage debt onto all that overvalued outright owned low-mid-high prime houses... people into shops buying for their new homes.. not landlord tightness.

Since the mid-sixteenth century there have been nine of these depressions. All followed periods of excessive debt, all involve a credit crisis, all lead to a collapse of property values, all ruin independent businessmen, all have serious political consequences, and all cause high unemployment and social distress. They do have some positive results, however, in releasing energies from the businesses they destroy.

Share this post


Link to post
Share on other sites

...I think some of that rebound in GDP comes because the bust is healthy... it reaches a stage where it breaks up the Serpico's with 4 companies... with all of his complacent luxury overspending at top of the layer-cake, and 4 new entrants apply for debts to get a share in the breakup of the business. More house transactions (at lower prices) to get a lot more mortgage debt onto all that overvalued outright owned low-mid-high prime houses... people into shops buying for their new homes.. not landlord tightness.

Yes, my reading of that graph is certainly that quality of life is increasingly better once the bust is firmly established.

To be fair to Borio et al. I think the idea of a more uniform monetary policy - as opposed to the current modus operandi of failing to place any real constraint on the boom and leaning aggressively into the bust - would imply quite sensible measures such as raising base rates to counteract excessive HPI and not attempting to postpone a HPC with endless ZIRP and government props.

Creative destruction is all well and good but I don't think there's any need for asset price booms to get this out of hand in order to achieve it!

Share this post


Link to post
Share on other sites

Create an account or sign in to comment

You need to be a member in order to leave a comment

Create an account

Sign up for a new account in our community. It's easy!

Register a new account

Sign in

Already have an account? Sign in here.

Sign In Now
Sign in to follow this  

  • Recently Browsing   0 members

    No registered users viewing this page.

  • The Prime Minister stated that there were three Brexit options available to the UK:   72 members have voted

    1. 1. Which of the Prime Minister's options would you choose?


      • Leave with the negotiated deal
      • Remain
      • Leave with no deal

    Please sign in or register to vote in this poll. View topic


×

Important Information

We have placed cookies on your device to help make this website better. You can adjust your cookie settings, otherwise we'll assume you're okay to continue.