- Political stability
- Fiscal affairs
- Monetary policy
- Regulated markets
- Privatisation
- Macroeconomic developments
Inflation, deflation, stagflation
submited on 16.10.2008 in category Political stability | Fiscal affairs | Monetary policy | Regulated markets | Privatisation | Macroeconomic developments
submited on 16.10.2008 in category Political stability | Fiscal affairs | Monetary policy | Regulated markets | Privatisation | Macroeconomic developments
The central bankers have put themselves in very uncomfortable situation, in order to defend the latest cutting of the key interest rates. A consensus has formed that the financial crisis increases recession risks, and therefore – inflationary pressure will inevitably decline. If central bankers look only at consumer prices, this will hardly happen soon.
This is not necessarily true and it is visible through the existence of the notion stagflation – which in the 70’s marked a period of steady price growth combined with stagnation in the economy. But even 2008 showed that the global economy fell into crisis, which tends to produce effects in the real sector together with unprecedented consumer price growth.
In order to understand what is happening, we must differentiate between consumer prices and prices of investment goods, commodities and assets. When the monetary policy is loose, in other words the credit is easy and cheap, investments in fixed capital grow. This, on one hand, increases the production capacity and allows for “supply” of consumer goods to increase so that there is no growth in consumer prices. On the other hand however, the demand for energy, commodities and real estate is growing, which under slight changes in supply results in higher prices. This is exactly the experience in the period 2000 – 2006, when the central banks eased the monetary stance – consumer prices did not surge, but prices of metals, oil and real estate were growing at fast pace. In line with this the market value of the companies was growing – they were valued with regard to longer time horizon due to the lower value of money in time, with excessive expectations for continuing investment growth.
The new valuation shows that some of the investment projects are not profitable when the access to capital is more difficult. The expectations are now for restraining investments. This would mean less new production capacity, less construction and infrastructure, less growth in transport. Therefore, decline in the prices of the basic commodities and oil – they are following the market expectations for future investments. In the same time, consumption even in the economies, potentially entering a recession, could not contract too much. Even if income is being lost, household budgets in the mature economies far exceed the purchases of food, clothing, basic entertainment. Limitations will come again via limited demand for long-term assets and commodities – fewer houses, cars, furniture and so on.
In Bulgaria the situation is similar. The contraction of investment opportunities will affect projects, which are far from the consumer and have the longest payback period. Meanwhile, these activities, which were directly dependent on investment growth in other sectors, could expect reduced demand. The value of the companies on the stock exchange already illustrated this – when expectations were of continuing growth of the fresh capital (in 2007), they were growing at fast rates, in 2008 declined sharply despite the high consumer inflation. Hence, if there is deflation it will affect asset prices to a much larger extent than consumer prices. But if there are fewer starting projects for new industrial projects or holiday communities, the value of the land will also decline.
This is not necessarily true and it is visible through the existence of the notion stagflation – which in the 70’s marked a period of steady price growth combined with stagnation in the economy. But even 2008 showed that the global economy fell into crisis, which tends to produce effects in the real sector together with unprecedented consumer price growth.
In order to understand what is happening, we must differentiate between consumer prices and prices of investment goods, commodities and assets. When the monetary policy is loose, in other words the credit is easy and cheap, investments in fixed capital grow. This, on one hand, increases the production capacity and allows for “supply” of consumer goods to increase so that there is no growth in consumer prices. On the other hand however, the demand for energy, commodities and real estate is growing, which under slight changes in supply results in higher prices. This is exactly the experience in the period 2000 – 2006, when the central banks eased the monetary stance – consumer prices did not surge, but prices of metals, oil and real estate were growing at fast pace. In line with this the market value of the companies was growing – they were valued with regard to longer time horizon due to the lower value of money in time, with excessive expectations for continuing investment growth.
The new valuation shows that some of the investment projects are not profitable when the access to capital is more difficult. The expectations are now for restraining investments. This would mean less new production capacity, less construction and infrastructure, less growth in transport. Therefore, decline in the prices of the basic commodities and oil – they are following the market expectations for future investments. In the same time, consumption even in the economies, potentially entering a recession, could not contract too much. Even if income is being lost, household budgets in the mature economies far exceed the purchases of food, clothing, basic entertainment. Limitations will come again via limited demand for long-term assets and commodities – fewer houses, cars, furniture and so on.
In Bulgaria the situation is similar. The contraction of investment opportunities will affect projects, which are far from the consumer and have the longest payback period. Meanwhile, these activities, which were directly dependent on investment growth in other sectors, could expect reduced demand. The value of the companies on the stock exchange already illustrated this – when expectations were of continuing growth of the fresh capital (in 2007), they were growing at fast rates, in 2008 declined sharply despite the high consumer inflation. Hence, if there is deflation it will affect asset prices to a much larger extent than consumer prices. But if there are fewer starting projects for new industrial projects or holiday communities, the value of the land will also decline.
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