Lower prices from productivity gains and lower import prices relative to export prices are a good thing.
Yet many overseas commentators worry about price deflation. They see it as a bad thing, the harbinger of stagnation, recession or even depression.
Price deflation is an ongoing fall in the general level of prices – the opposite of inflation.
New Zealand’s consumers price index fell 0.2% in the December 2014 quarter. For some, this raised the spectre of deflation.
However, the fear is unwarranted. For a start, a one quarter decline is not an ongoing decline in the general level of prices. The consumers price index actually rose by 0.8% in the calendar year.
Second, the proximate cause of the decline in the December quarter was something that made us better off: petrol prices fell 4.7% in the quarter and 4.0% in the year. How could that be a cause for alarm?
Lower prices from productivity gains are also a good thing. Such gains allow prices to go down and wages to go up – permanently. Contrast the price and quality of today’s electronic products with that of only a decade ago.
Nor does it hurt workers if wage rates fell but prices fell by more. That is like seeing wages rise faster than prices.
So what counts for wage workers is what wages can buy. That is neither an inflation nor a deflation thing. It is primarily a productivity thing.
Productivity gains that reduce prices are good for savers too. Lower prices increase the purchasing power of accumulated savings.
More generally, deflation increases the purchasing power of interest income from savings and inflation reduces it – if interest income is unchanged. (Interest income is unchanged for those who have long-dated fixed interest investments.)
High government debt is a real threat to savers and taxpayers. Governments commonly get into debt because they succumb to the temptation to spend up in good times. New Zealand did that between 2005 and 2008.
When the crunch comes, governments seek to minimise their debt burden. One option is to default.
Greece has a history of taking that option. High inflation is a slightly more reputable option. It drives taxpayers into higher tax brackets when thresholds are fixed. Unexpectedly high inflation destroys the value of savings invested in long-dated fixed coupon government bonds.
Currently, the preferred option internationally is for central banks to keep interest rates abnormally low relative to price inflation. This helps borrowing governments and hurts savers.
The government bias in favour of inflation is very strong. The consumers price index in New Zealand today is 58 times higher than in 1934 when the Reserve Bank was established.
When it gets to 64 times higher, it would have doubled 16 times. Before 1934 New Zealanders had never experienced even one doubling of the price index.
The bias in favour of inflation was evident in New Zealand when the Reserve Bank’s inflation target range was increased, dubiously and peremptorily, from 0-2% to 1-3%.
Commentators are pointing out that the 0.8% rise in the last year was below the bottom end of the 1-3% range. The implication is that the Reserve Bank should now keep interest rates abnormally low for longer.
However, fear of deflation is not a good reason for doing so currently.
Price deflation can be, but need not be, associated with falling output and productivity and rising unemployment. But so can price inflation.
The important thing is to identify the causes of a recession and deal with them in a way likely to generate a sustained rise in productivity in the fullness of time.
The December quarter consumer price outcome is not a recessionary risk for New Zealand. Nor is it a threat to productivity growth.
Productivity growth remains the key to improving New Zealanders’ wellbeing.
The government is right to recognise that the Resource Management Act is a major impediment to higher productivity (not to mention the environment). It is right to make that a major focus for this parliamentary term.
Bryce Wilkinson is a senior research fellow at The New Zealand Initiative.