Recently, the Bank for International Settlements (BIS) released a study spanning 140 years and 38 countries aiming to assess the economic impact of deflation. Their findings? The widely feared deflationary spiral is actually very rarely seen. Here is their more technical lingo:
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 almost reflexive association of deflation with economic weakness is easily explained. It is rooted in the view that deflation signals an aggregate demand shortfall, which simultaneously pushes down prices, incomes and output. But deflation may also result from increased supply. Examples include improvements in productivity, greater competition in the goods market, or cheaper and more abundant inputs, such as labour or intermediate goods like oil. Supply-driven deflations depress prices while raising incomes and output.
As a matter of fact, the BIS found “bad” deflation was mostly limited to the Great Depression. The rest of the time, there was no correlation between deflation and contraction. The deflationary spiral, said differently, is mostly mythology.[i] The fact the Great Depression—a singular experience—has so colored and biased many analysts and economists to deflation’s more benign overall history makes sense, considering this was the watershed economic event in modern history. The BIS did find “asset price deflation” (think: bear markets) typically precedes economic downturns, but that didn’t really need substantiating, in our view. And remember: Bear markets don’t beget recession, they foretell it.
We point this study out because deflation fears have been widespread in recent months, largely based on falling, slowing, low or no inflation in various countries as measured by headline Consumer Price Indexes and other gauges.[ii] The point to the BIS’s report is you cannot automatically assume deflation is bad. You must dig deeper. And that is important today, too! With an oil output surge playing a major role in recent unflation™, there is little reason to think falling prices will forestall consumer spending. Two major countries—the UK and Spain—illustrate both trends well. Exhibits 1 and 2 show UK and Spanish retail sales volumes accelerated as unflation took root. Now, two data points and one study probably won’t eliminate deflation concerns forever and ever. Nor should they! Again, bad deflation is possible, particularly if it is underpinned by central banks causing money supply to crater. Or, we guess, if you are not a fan of the New England Patriots.[iii]
Exhibit 1: UK CPI, Core CPI and Retail Sales Volume (All Year-Over-Year Percent Change)
Source: FactSet, as of 03/27/2015. All data are from 03/2013 – 02/2015.
Exhibit 2: Spain CPI, Core CPI and Retail Sales Volume (All Year-Over-Year Percent Change)
Source: FactSet, as of 03/27/2015. CPI data are 03/2013 – 02/2015. Retail sales data are 03/2013 – 01/2015. That is a data availability thing, as February retail sales aren’t out yet.
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[i] Insert New England Patriots joke here. Then sigh audibly.
[ii] We are hereby coining a new, all-encompassing term for a slow, low, no, dis- or deflation: unflation. You’re welcome.