Confronting the Spectre of Deflation
Deflation is the nasty stepsister of inflation. It is a sustained fall in general prices in an economy. This includes the prices of goods and services, rents, wages and salaries, shares and property prices. Conflicts over commercial rents between tenants and landlords are already evident.
We must be realistic about what is happening to our economy. A huge chunk has disappeared literally overnight. This could be around 20 -25 percent. Hopefully much of that is temporary, but it is still a huge hit.
That means our economic output is down by about 20 to 25 percent in the short term. That means a large drop in incomes and employment in our private sector. This is the dynamic part of our economy. It is the wealth generating part of our economy. The Prime Minister has announced a 20 percent pay cut for politicians And top public servants. She is indicating the pain will be shared.
But there is a core issue in all of this. As our GDP slumps and incomes fall and unemployment surges, debt levels still remain. They just become much harder to service.
Debt is the big killer when an economy enters a deflationary spiral. New Zealand's debt levels are ugly. We have borrowed a lot of money from the banks in recent decades to bid up our house prices . This is about to be exposed. This can't be allowed to happen in the short term. It will make things much worse.
Our house prices are likely to fall as deflation sets in. Despite the public proclamations of real estate agents and mortgage brokers.
Large scale unemployment and falling incomes lead to few other options. The fabled overseas buyers are a distant memory. But we can't allow our private debt mountain to implode. We need to manage any decline very carefully.
Deflation is particularly nasty for debt holders. Their incomes and asset prices fall, yet their debts remain,
We can reduce the nightmare of widespread debt defaults and mortgage foreclosure. If we don't then we will all lose. This includes the banks as their collateral disappears and their bad debts mount.
Our Reserve bank is already acting to prevent this. It is flooding the banks with newly created money credits. The banks must pass this on in the form of extended mortgage holidays. They seem to be doing this.The banks are in a no-win situation. They must extend the debt holidays otherwise their collateral will collapse.
We need to park that debt as we deal with getting our real economy back on its feet. The real economy means actual output, incomes and jobs.
Deflation feeds on itself. As incomes and prices fall, people cut their spending. This further reduces total demand and incomes and employment. A nasty downward spiral. We must avoid this scenario otherwise we have learned nothing from history.
We can't do this as individuals. The key players are the government, the Reserve bank and the banks. Reflationary policies include quantitative easing, parking debt and providing a living allowance for those who have taken the hit to maintain demand in the economy. We are already moving in that direction. We are being well led in an extreme time.
Peter Lyons (M.Comm) is a regular columnist for the Otago Daily Times, teaches scholarship-level Economics and an author of several New Zealand economic texts. His inspiration often comes after a dram of whiskey. Just one mind you. So if you're ever stuck in a room full of economists, grab the seat next to him. For a conversation peppered with wit, wisdom and weirdness.
Please subscribe to receive his next opinion piece.