The Sunday News
Dr Bongani Ngwenya
Preamble
THIS week’s Economic Focus is a continuation of last week’s focus: “Stimulating Economic Growth and Domestic Product Competitiveness through Internal Devaluation”. To give a clear background of this week’s focus, I am quoting Governor of the Reserve Bank of Zimbabwe Dr John Mangudya’s January 2016 Monetary Policy Statement.
“The strategies and prudential policy measures in this statement are intended to transform the economy through rebalancing it away from being a consumptive or supermarket economy to a productive one, and away from the high incidence of capital flight characterised by the externalisation of export sales proceeds to one that safeguards its hard-earned foreign exchange resources. This is necessary in order to give impetus to effectively deal with the negative inflation (or deflation) environment besetting the economy”.
Dr Mangudya went on to highlight that, “. . . reflecting the constraining effect of tight liquidity conditions, inflation has remained in the negative territory since the fourth quarter of 2014. In this regard, annual headline inflation decelerated from -1,3 percent in January 2015 to a lowest rate of -3,3 percent in October 2015, before accelerating slightly to -2,5 percent in December 2015. Annual headline averaged -2,4 percent for the period January to November 2015. The persistent negative inflationary mode is underpinned by the continued deflating effects on both food and non-food prices, against the backdrop of waning aggregate demand due to significant externalisation taking place in the country.”
I have always advised my MBA students in our Business Environment lectures that a cautious approach has to be taken against quick conclusions that there is “real inflation” phenomenon in the Zimbabwean economy pos-dollarisation or multi-currency regime.
During the pre-dollarisation era, yes we could talk of inflation, even hyperinflation, that is, in the presence of a sovereign currency, the Zimbabwe dollar, not in its absence. Dr Mangudya in his monetary policy statement vindicates this economic line of thinking.
Economic deflation
Deflation is an economic theory, which deals with the general reduction in the price levels, such as what is obtaining in Zimbabwe since dollarisation or in the prices of a type of good or asset. The effects of deflation could be immense on the economic conditions of a particular country. With respect to the effects of deflation, we should not mix-up the concept with that of a temporary decrease in the prices, that is, a slow-down in the inflation rate — when inflation declines to lower levels (disinflation).
Deflation affects the general price fall in a sustained manner, exerting more or less permanent influence on a country’s economy. Of all the financial pathologies to afflict an economy, too much debt combined with simultaneously falling prices, can tip an economy from recession into depression, from which it may be extremely difficult to escape.
Different ways in which deflation may impact the economic condition of a country
Naturally, deflation affects an economy by decreasing the velocity of money or the number of commercial or business transactions more or less permanently. When that happens the result is an emergence of a remarkable contraction in the supply of money (liquidity).
Deflation is considered to be a natural phenomenon; as far as hard currency economies are concerned —dollarised economies like Zimbabwe. Usually, and in this scenario, the rate of increase in money supply cannot be maintained in proportion to population growth and the general growth of the economy, ie in the absence of monetary policy sovereignty of seneiorage. Under such circumstance, the per capita availability of the hard currency — US$ in our situation for example, reduces. The purchasing power of each unit of currency would escalate, creating a generally negative impact on a country’s economic condition.
An increase in the purchasing power of one’s money benefits some, it amplifies the sting of debt for others: after a period of deflation, the payments to service a debt represent a larger amount of purchasing power than they did when the debt was first incurred.
The longer Zimbabwe takes to clear its sovereign debt with spiraling deflation the more amplified the sting of debt can be.
Consequently, deflation can be thought of as an effective increase in a loan’s interest rate. This is because the advent of deflation acts as a tax or levy on the borrowers and the liquid asset holders simultaneously — the amount borrowed does not reduce or deflect by the way, when potential incomes and revenues deflect.
However, a benefit, as far as the creditors are concerned. Thus, deflation is just the opposite economic situation to inflation, levying tax on money lenders and holders, in the interest of short-term consumption and that of the borrowers.
As per the contemporary economic school of thought, the concept of deflation is associated with certain amount of risk. To hedge against this risk, the motivation is to gather money, rather than investing it in the productive sectors of the economy or solid and assured investment securities or assets-hence the concern by RBZ to plug out the leakages of liquidity in our economy. When not checked this can lead to the formation of a theoretical condition known as “liquidity trap”. Liquidity trap is regarded as a critical condition as it stagnates the economy, where the nominal rate of interest becomes zero or close to zero.
On a more server impact deflation discourages both investment and expenditure. In fact, deflation brings with it, a fall in the aggregate demand. Emergence of deflationary spiral is considered to be one of the primary impacts of deflation. In this case, there is fall in the prices, resulting in the creation of a vicious circle.
This makes a problematic situation to worsen, rather than reaching any amicable solution. With the emergence of deflationary spiral, the solution to the decreasing collective demand acts as an incentive to the central bank of a nation, asking for the expansion in the supply of money. It also stimulates the country’s fiscal authorities to increase demand, as well as lend money at low interest rates than those available with the private commercial bodies.
On a lighter and positive note deflation can result in the improvement of production efficiency, due to lowering of the overall price of commodities. The production efficiency of a country develops at a time when the economic producers of goods and services are propelled sufficiently by a promise of enhancing their profit margins, by improving the overall standard of their products. At this point, the consumers are required to make low payment while buying those goods. This increases the purchasing power, and culminates into an economic condition called deflation. Hard money economies claim that the economy involves no rigidity. Hence deflation is a most welcome phenomenon here, for the economy to make diversified ventures in other fields as well, owing to the lowering of prices. This is always a good deflationary effect, as far as economic growth and development is concerned. However, there is very little advantage and economic benefits that can be derived from deflation, as compared to the potential economic damage that deflation can cause.
Overcoming deflation
To overcome deflation and revitalise the economy, the Government through the Reserve Bank and the Ministry of Finance has to implemented an integrated and unprecedented policy packages approach-aggressive monetary policy to dispel the deflation mindset that is now entrenched among businesses and households. The aggressive monetary policy for example can aim at achieving a certain percentage price stability target, say three percent at the earliest possible time with a time horizon of, say about two years.
In addition, implementing flexible fiscal policy that will create effective demand in order to exit from deflation quickly and focus on policy fields that better contribute to private-demand-led growth, placing the economy on steady growth path, raising productivity by boosting domestic private and foreign investment. These growth strategies should be aimed at the improvement of employment and incomes, such that the benefits of economic growth are widely spread.
In conclusion, deflation is a different and more dangerous phenomenon than disinflation. It has rarely been seen (except in theory) in the past two years for example Zimbabwe has suffered from deflation and it can literally cripple the economy, if not managed prudently. Deflation is when the rate of inflation goes negative — less money will buy more value — and buyers wait to buy, expecting that the longer they wait, the lower the price goes.
Dr Bongani Ngwenya is a Bulawayo-based Economist and Senior lecturer at Solusi University’s Post Graduate School of Business. Feedback, [email protected]/ [email protected]
