Stephen Toplis, BNZ economist comments on the current situation in his latest Economy Watch posted on the BNZ website
Global spare capacity, oil and the exchange rate driving prices lower
ï‚· But no excuse to cut rates
ï‚· As spare capacity limited, housing market rampant
ï‚· Rate hike postponed
ï‚· Monetary policy largely powerless
By the end of the March quarter the level of prices, as measured by the Consumers Price Index, will almost certainly be lower than where it stood in the September quarter. We are now forecasting two consecutive quarters of price declines (December and March) with a cumulative drop of half a percent. Annual CPI inflation, as a consequence, falls to just 0.2% in the March quarter 2015. With petrol prices doing what they are, annual deflation is now a real possibility too.
Deflation as a "good" thing…
Traditionally, deflation has been seen as a "bad" thing. If prices are dropping consumers delay buying things in order to capture lower future prices. As a consequence, economic activity slows – retailers reduce sales, manufacturers supplying to those retailers reduce production and transport requirements diminish. Lower activity sees lower employment which leads in turn to reduced demand and more downward pressure on prices. And so the vicious cycle continues.
Nice in theory, but this couldn’t be further from the truth in New Zealand at the moment. There is absolutely no evidence whatsoever of a retrenchment in activity due to the pressure on the general consumer price level. Indicative of the contrary, real retail sales in the September quarter 2014 were 4.9% higher than year earlier levels.
How we think about deflation needs to change – for this particular cycle at least. If domestic prices are falling because there is insufficient demand then the normal vicious deflationary spiral might still hold. If they are falling because of a perfect storm of external shocks – some cyclical, some structural – then the conclusions reached are quite different.
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