Why are the acceleration and the deceleration of inflation is equally harmful for the Russian economy
Experts alarmed: the prices in Russia are falling, the country faced the threat of deflation and economic difficulties associated with the sharp slowdown in inflation. The population moved to saver mode, reduced consumption that could start a deflationary spiral we experienced in the U.S. during the great depression.
The prices in Russia, according to official statistics, fall. According to Rosstat (published 23 March), the week inflation rose 0.1 percent. From the beginning of 2016, prices increased by two percent. For comparison: for the similar period of 2015 we had inflation at 7.4 percent.
In February 2015 the growth of consumer prices was 2.2%, in February this year — 0.6 per cent. Inflation continues to decline on the back of rising oil prices. Moreover, the actual slowdown of consumer prices was worse than expected, the Central Bank. On 14 March the annual inflation rate was 7.9 percent, while the regulator had expected the rate to 8.9 percent by the end of the first quarter. However, the data fall squarely within the policy of the Central Bank. By 2017, the regulator plans to pin down inflation to four percent.
The slowdown in inflation has alarmed many analysts. So, the leading expert of the Russian public opinion research center Oleg chernozub, analyzing the results of the survey conducted on February 20-21, among 1.6 thousand people in 130 settlements of Russia, said that the economy is beginning to take shape deflationary risks. “For the first time in a long period of observations at the same time has deteriorated all indicators signalling growth factor that John Maynard Keynes called “liquidity preference”” — he said, commenting on the survey results.
With the beginning of the year prices of goods and services rose by two percentage points. For comparison: during the same period of 2015 inflation exceeded seven per cent
Photo: Alexander Chizhenok / Kommersant
The threat of sliding into a deflationary spiral, the expert sees that for fear of losing a job, people try not to spend money. This leads to the fact that the turnover in the economy is reduced. As a result, enterprises will not be able to sell their goods and reduce production, which would entail dismissal. This will force the citizens to ensure that their concerns about the development of the crisis, and they will continue to save. The circle is closed.
Bank of America analyst David honer also warned that Russia will face long-term risk of deflation. According to the expert, reduction of prices may occur because of severe budget constraints, reduce debt levels, demographic factors, surplus of current account and high real interest rates.
A classic example of economy entered into a deflationary spiral, is the situation in the USA 30-ies of the last century, during the great depression. Then a decline was observed simultaneously in different areas, from goods in shops until the prices of the raw materials. In those circumstances, a fall in their prices meant that firms simply stopped working. And if the goods are not needed and the plants are not needed and the workers: this led to layoffs, mass unemployment and the impoverishment of the population.
Then, the economists have shown deflation, on the one hand, overproduction due to industrial development and the emergence of new types of goods, on the other hand is binding in the money supply to gold reserves. Products have become more and money in the economy remained the same, and this has led to falling prices. Hence, loan default, bankruptcy and the downturn in the economy.
People withdrew money from Bank deposits, because he was afraid of a wave of bankruptcies of credit institutions. Of course, in the current Russian situation, the deposits are insured, and this makes the liquidation of banks is not so terrible. Nevertheless, regular reviews of licenses do not add to confidence in the financial system as a whole, especially for those who want to save some significant amounts of. The surviving banks, in turn, avoid issuing new loans, preferring to keep their money in the most liquid form.
Demonstration of novelties in the Central Department store, 1948
Photo: Anatoly Garanin / RIA Novosti
Another example of the damaging effect of deflation is the USSR 1940-1950’s, but it’s not about the normal economic laws, but rather political action. Because all enterprises were state-owned, to reduce prices by the Directive was not so difficult. The state reduced the already non-market prices in terms of commodity deficits in 1947, 1949, 1953 and 1954, but then more than compensated for population issued the original loan. Government bonds, the purchase of which it was impossible to refuse, the increase in taxes and other payments to the state — such was the cost of a planned deflation. All this not only allowed us to return money to the budget, but also helped to mobilize significant resources.
The phantom menace
In a classical capitalist economy GDP growth accompanied by a modest increase in prices, and a recession to reduce them. The current state of the European economy just assumes the risks of deflation, and to fight recession, the European Central Bank pursues a policy of quantitative easing-to stimulate lending through low interest rates.
In history was an example, when inflation was followed by a recession in 1974 to 1976 the growth rate of prices in the U.S. amounted to more than 10 percent, and unemployment reached 7.6 percent. The economic crisis was caused by the oil crisis, when the countries-oil producers raised the price from three to twelve dollars per barrel due to the embargo against the United States. That’s when the British Finance Minister Iain Macleod coined the term “stagflation” (stagnation plus inflation).
The main objective of the Central Bank — decrease in inflation to four percent. Photo: the Chairman of the Bank of Russia Elvira Nabiullina
Photo: Gleb Schelkunov / Kommersant
But what about modern Russian economy? Head of international capital markets IMEMO Yakov Mirkin believes that the price decrease is not what you should be wary of Russian citizens. “It is difficult to expect deflation on the model of the EU. Of course, reducing consumption reduces the pressure on rates and prevents cooling of the economy, but here come into play other factors. Russia in the long term will face the fall of the ruble, and that always means higher prices. In addition, the dollar will strengthen against the Euro”, — the expert believes. According to him, Russia’s economic downturn will combine with inflation — in other words, our country will face unpleasant and paradoxical phenomenon of stagflation.
The head of the Russian Central Bank Elvira Nabiullina on March 18 following the meeting of the Board of Directors of the Central Bank stated that credit institutions additional funds not needed. This confirms that the risk of deflation does not exist, otherwise the regulator would have injected financial resources into the economy by the example of the ECB. But inflation risks for the Bank of Russia are obvious: it is because of them the key rate remains at 11 percent.
What is so special in the Russian economy, causing the decline of production combined with the increase in consumer prices? The fact is that in Russia many types of services and production is monopolized, and so-called natural monopoly regularly increase the tariffs — that is, doing the positive contribution to the acceleration of inflation. Thus large government agencies actually save the country from deflation. And the Bank of Russia meanwhile continues to fight rising prices. Four percent by 2017 — to reach this level, is a tight monetary policy. Its flip side — the economic slowdown.