World faces the risk of deflation
Updated
Less than a year ago inflation was a major concern for many of Asia's economies. Now its opposite, deflation is emerging as the latest threat which could make the global recession worse if it takes hold. Japan with rapidly falling prices and rising consumer fear, is bracing for years of economic turmoil. The global recession means others could get caught in the deflation spiral as Karon Snowdon reports.
Presenter: Karon Snowdon
Speakers: Brian Redican, Senior Economist with Macquarie Bank; Ben Bernanke, US Federal Reserve Chairman
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SNOWDON: The International Monetary Fund has joined the recession club. Managing Director Dominique Strauss-Kahn warns the world faces 'a great recession' and the developing world especially Africa will need help - lots of it.
In addition the IMF says the risk of deflation is the highest in a decade and can only be avoided if the financial crisis is resolved. Deflation is a product of recession and makes matters worse. It's a long period of falling prices, everything from house prices to food to oil. And the problem is it doesn't make consumers feel good - it makes them feel worse.
Brian Redican, Senior Economist with Macquarie Bank says deflation will deepen the economic downturn.
REDICAN: So it really does undermine consumer spending and is generally associated with a rising unemployment rate and very weak economic activity.
SNOWDON: Deflation makes monetary policy - the management of interest rates by central banks less effective in their battle against recessionary pressures.
Even if rates are cut, people feel it's better to keep their money under the bed or in the bank when the value of their house is falling. Like home owners, businesses feel the weight of their debts increasing too. Banks cut back lending, bankruptcies rise, demand and prices fall further. It's a nasty spiral. One being felt in Japan where wholesale prices fell by their biggest mark in six years in February.
Brian Redican.
REDICAN: Well probably the major economy in the world that really is prone to this is Japan. It has been battling deflation over the entire 1990s, and again it does seem very vulnerable to a new bout of deflation.
SNOWDON: Some estimates say Japan could be facing two per cent deflation a year for the next decade. But the United States is even worse with perhaps four per cent deflation this year and not much improvement for ten.
Even in India where last year inflation was the problem running at 13 per cent, it's fallen to just 3 per cent - a good thing in normal circumstances but a sign according to some economists that deflation will inevitably follow.
Brian Redican says much of this is too pessimistic.
REDICAN: People aren't really expecting prices to continue falling for the next couple of years and that's what you really need to see to see these deflationary fears really grab hold. And I think India is even probably less vulnerable than China is at the moment.
SNOWDON: Bad news continues though. There have been more worrying signs that China's economy is yet to feel the full force of the global slowdown.
The country's exports fell by 26 per cent in February from a year earlier, the fourth month of decline.
And as the numbers get bigger the solutions seem further away, perhaps most of all in the United States.
US Federal Reserve Chairman Ben Bernanke told the Council on Foreign Relations in Washington, forceful coordinated action is needed to combat the worst financial crisis since the 1930's.
This means banks must be kept afloat and new financial regulations written.
BERNANKE: Until we stabilise the financial system a sustainable economic recovery will remain out of reach.
SNOWDON: He remains upbeat however saying if governments can get financial markets to operate normally again, there's a "good chance" the US recession could end this year.
Macquarie's Brian Redican says more stimulus spending might be necessary.
REDICAN: Really it was only in October when most policy makers reacted to the recession, it was only after the collapse of Lehman Brothers for example that all these fiscal policy announcements were made and interest rates were cut aggressively. And that will only really start to impact the economy from mid-2009. So I think things will actually look much better by the end of the year than they are now even though things will be very weak.
