Bernard Hickey: Deflation is the real target in economic battle for growth

If your income is rising or flat then your real purchasing power has increased, particularly if buying imports with a strong currency. Photo / Thinkstock

Who could possibly be against falling prices? Over the past few years, consumers have relished walking into the electronics store or car yard to find prices have fallen.

Statistics NZ figures show total import prices for consumer goods fell 8 per cent in the last three years. Import prices for consumer durables, such as mobile phones, computers and clothes, fell 24 per cent. Passenger car prices fell 4 per cent in the three years to September, and a close reading of the motoring section shows European, Japanese and Korean carmakers have slashed prices again in recent months.

Total prices for imported services, including banking and travel, have also fallen 6.6 per cent in the last three years, and travel prices fell 18 per cent.

Production capacity, across Europe and Asia in particular, has expanded massively over the last decade and at a lower cost per unit. Demand in Europe, and the United States to a lesser extent, has also slumped. That means too many products chasing too few buyers, which creates deflation.

It hasn't helped that central banks in the UK, US, Japan and China have been printing money at nearly $200 billion a month for the last year. That depresses the value of printed currencies and increases the value of those not being printed, such as the kiwi.

If your income is rising or flat then your real purchasing power has increased, particularly if buying imports with a strong currency.

But deflation encourages consumers to wait before buying something, knowing it will be cheaper in future. If everyone delays purchasing then demand falls and prices are cut again. One dangerous consequence is the fall in profits, which encourages employers to lay off staff and cut wages.

In our part of the world there seems to be less worry about inflation, although it's been below the bottom of the Reserve Bank's target of 1-3 per cent for most of the last 18 months. On Friday, the bank warned it needed to be careful to "anchor" inflationary expectations. The bank is expected to warn again this Thursday that it will have to increase interest rates next year to contain consumer price inflation.

Economists have warned about higher interest rates over the last five years, yet have been surprised by the sheer weight of the deflationary forces of ageing, globalisation and new technology. Our policymakers are still fighting inflationary battles of the 1970s, 80s and 90s, when the real battle is with deflation.