January 17, 2014 7:22 pm
If Christine Lagarde were a cartoon character, she would be Jiminy Cricket. Just like Pinocchio’s top-hat-wearing companion, the head of the International Monetary Fund has a penchant for acting as the talking conscience of global policy makers. This week Ms Lagarde took central bankers to task for not acting decisively enough against the “ogre” of deflation. The IMF chief believes that falling prices could be “disastrous” for the incipient global recovery.
Ms Lagarde’s warning is timely. Most rich economies – including the eurozone, the US and Japan – have inflation rates substantially below the targets that their central banks are set to achieve. In Britain the outlook is less worrying, since the consumer price index was at the Bank of England’s 2 per cent target in December. However, with producer price inflation rising as slowly as 1 per cent, there are legitimate fears that consumer prices could begin to decelerate more markedly at the start of 2014.
Deflation carries two equally significant risks. First, shoppers have little reason to spend their money today, since they can reasonably expect goods to be cheaper next year. This has a damping effect on consumption, pushing prices further downwards. Second, deflation makes it much harder for governments and individuals to pay back their debts. As prices drop, the nominal value of loans stays the same while revenues decline. Debtors are therefore forced to use a larger proportion of their income to service their borrowings.
The conclusion reached by Ms Lagarde – that central banks should do more to support prices – is correct. However, there are sizeable differences in the scale of the challenges facing different countries.
For a start, the threat of deflation remains very much a rich-world problem, with many emerging markets, such as India and Brazil, grappling with the opposite threat of rising prices. Even among developed countries, the picture is far from uniform. After nearly two decades of deflation, the monetary authorities in Japan are finally succeeding in making prices rise again thanks to an ambitious programme of quantitative and qualitative easing. Even excluding energy, inflation in Japan picked up to 0.6 per cent in November, the highest in 15 years.
Where the IMF’s warning appears most relevant is the eurozone. The European Central Bank looks exceedingly relaxed about the currency union’s 0.8 per cent inflation rate. Ms Lagarde is right to call for a new injection of liquidity into the system, for example through a further round of cheap loans to the banks.
The mistake to avoid is assuming that securing the recovery is exclusively a matter for the central banks. Alongside disinflation, there are other equally disturbing trends at play in the global economy, which the monetary authorities can do little to change.
The most disquieting development is what is happening to productivity. A report by the Conference Board think-tank out this week showed that, for the first time in decades, there was a decline in the world’s ability to turn capital and labour inputs into goods and services. Were this slowdown to continue, the consequences for living standards would be gloomy: efficiency and innovation are the most important drivers of economic growth in the long run.
It is up to the governments to take steps that can help productivity rise again. The solution lies in structural reforms aimed at allowing the most innovative sectors to expand. The list – which includes investing more in physical and IT infrastructure, as well as increasing competition in the labour and product market – is a well-known one. The challenge, for both the developed and the developing world, is to ensure these changes are finally implemented.
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