Inflation or Deflation – what does it mean for your business.
At the beginning of 2008 we were all worried about inflation. This was the case in Australia as well as all of the other developed economies. We were concerned about interest rates rising to curb inflation and what this would mean to business. Now at the beginning the concern seems to have flipped to that of deflation.
Deflation refers to falling prices. The CPI (consumer price index) would decline. Deflation occured in the 1930′s and more recently in Japan. Deflation can be good but if it is connected with falling wages, rising unemployment and falling asset prices it can be very nasty.
With our high household debt levels, deflation could be ugly. If the house prices fall at the same time as incomes are affected then consumers will cut their spending and try to sell assets to reduce debt.
US inflation has fallen from 5.6% to just 1.1% and it’s still falling. So far, Chinese inflation has fallen from a peak of 8.5% in April to 2.4% in November. Also based on the Reserve Banks comments inflation in Australia is falling.
The CPI has been signficantly affected by the falling oil and food prices. However if businesses increase their discounting of goods to sell more then further reduction of inflation will occur. Also a recession normally leads to spare capacity. This is happening in China now. This means they reduce their prices to keep production going leading to deflation in the trade partners of China. Our fall in the exchange rate will push up import prices and this will lessen the impact on Australia. Still inflation is likely to fall in Australia.
But a rerun of the deflation of the 1930′s is unlikely because the central banks have means to continue to prime the economy. Our Reserve Bank like the other central banks of the world have shown a capacity to drop interest rates significantly in an attempt to keep the economy moving. Lastly our weak exchange rate will help to keep prices of imported goods higher.
So I believe that in 2009 inflation will tamed and deflation is a concern but should not be significant concern in Australia. It may be more of an issue in the US where they are in a severe recession.
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