Beware The Big D

There are some words one dreads uttering in fear they will become a reality if spoken aloud. In economics, one of those words is deflation. The kind of economic downward spiral that has plagued Japan for the last two decades is sometimes referred to as The Big D, as cancer is The Big C.

Deflation occurs when consumer prices fall while the economy flatlines. According to the International Monetary Fund, deflation is an economic state when prices hover at zero percent or below for two consecutive years and depress the economy. Why are economic slowdowns accompanied by low inflation so dangerous? Because the double whammy casts a lengthy pall on an economy and triggers a deflationary spiral.

One of the most severe cases was the Great Depression that began in 1929. The catastrophe that wreaked havoc on the global economy cannot be matched by more recent disasters - the oil shock of the 1970s, the Asian financial crisis starting in 1999, the global financial meltdown in late 2008. The Great Depression’s deflation was the worst kind - a demand shock in a highly indebted economy accompanied by oversupply, contraction of credit and a liquidity crunch. The Double D (for depression and deflation) left a lasting trauma.

The specter is back in many parts of the world. Ominous signs came from the euro zone after it failed to defeat the malaise of its debt-ridden member economies. Inflation in the euro zone fell to a 5-year low of 0.3 percent. The rise in consumer prices fell below zero percent in Italy and Sweden. The European Central Bank brought the key interest rate to a record low and banks pumped out low-interest loans but they have been unable to fight it off.

Japan, which went into quantitative easing on an unprecedented scale as part of Abenomics - a mix of aggressive monetary and fiscal easing - fears that inflation could fall back below 1 percent amid an economic slowdown following a hike in its sales tax in April. The U.S. economy, which has been doing relatively well, is losing steam and prices started to fall from August. China, the industrial powerhouse that helped drive the global economy, has sharply slowed and its consumer price rise in September was a five-year low of 1.8 percent. Producer prices fell for the 31st consecutive month. Economic slowdowns and falling prices have become common in just about every part of the world.

Fear of deflation is behind falling stock prices and rising government bond yields. Some criticize Japanese and European authorities for spreading deflationary pressure to other parts of the world by weakening their currencies. The epidemic may have even reached our shores. Our economy is certainly anemic and inflation is hovering in the neighborhood of 1 percent, well below the Bank of Korea’s 2.5-3.5 percent target range. The product price index has been falling since late 2012. The consumer price index in September fell 0.1 percent from the previous month. Those signs are alarming.

Real economic growth data just adds to the fear. Real economic growth is a measure of the rate of change in gross domestic product adjusted for inflation. South Korea’s real economic growth rate has remained in the 3-5 percent range since 2011. This is because inflation has been falling while the economy grew just mildly.

The real growth rate best reflects economic reality because it incorporates the real amount of money companies and households end up with. The slowdown in real economic growth means that industrial activity and consumer prices have slowed. The slowdown in the real growth rate owes more to a fall in inflation than a decline in the GDP.

For the economy to genuinely recover, real economic growth must return to over 6 percent. Interest rate cuts and revivals in property prices can spur inflation. Some may criticize short-term stimuli actions. But in desperate times, desperate measures are needed.

JoongAng Ilbo, Oct. 22, Page 28

*The author is an editorial writer of the JoongAng Ilbo.

by Kim Jong-soo