Inflation, predictably, plunged in the last quarter. With the international prices of oil and other commodities coming off their record highs following the super-spike last year which pushed the world into recession, it was inevitable that inflation would be lower than it had been when those mammoth price rises were underway. This was compounded by falling domestic demand and house prices. The only question was whether there would actually have been deflation (ie a decrease in the general price level) in the three months to December. My figurative money was on that happening, but I didn’t pick such a big drop. Inflation was -0.5% in the last quarter.
Total inflation for all of 2008 was 3.4%, above the Reserve Bank’s 1-3% target range but, because that includes the quarters when oil was surging, it is of little concern now. The risk now for the world economy, and it is a risk that various economists have been discussing for years, is deflation as the global recession sees incomes fall and people batten down the hatches, increasing saving over spending.
High (ie double figure) inflation is bad because it encourages spending now over investment by rapidly decreasing the purchasing power of a dollar over time. Deflation, on the other hand, is generally regarded as much worse. It discourages spending now – you only have to leave your money under your mattress and you will be able to buy more with it tomorrow. Once an economy is in a recession and a deflationary spiral it can be very hard to break out of, as Japan has evidenced over the last decade and more. Deflation increases people’s pro-cyclical response to recession, which is to increase their savings pulling more demand out of the economy. Governments can try to counter that by increasing their own spending but Japan has tried with years and at great expense (it’s government debt is worth 170% of GDP now) with limited effect. New Zealand is in a slightly better position than most major economies because our higher interest rates mean monetary policy can still be used to try to inject life into the economy with further cuts in the official interest rate. Other countries, like the US and Japan, have already opened up the throttle to maximum by cutting their rates to near-zerowith no effect.
We are potentially entering a very scary economic situation. If deflation gets a grip on the major economies, the bleak outlook will worsen further; the recession will be deeper and longer. And whether or not deflation does take hold, whenever the global economy does manage to return to growth, the next oil shock will be waiting to clobber us again.
These are extraordinarily tough conditions for any government to face. We need the Government to have the vision to deliver a Green New Deal, investing heavily in energy efficiency along with the kinds of programme Irish outlines here, to both get the economy moving again and insulate us against further oil shocks.