Ever since the Global Financial Crisis, the world has experienced low inflation. Despite periodic warnings of inflationary pressures, inflation rates globally have been tracking well below historic averages. Central Banks have deployed loose monetary policy and quantitative easing at an ever-increasing rate to try and inflate global markets and in some cases to avoid outright deflation, but these interventions have been increasingly ineffective.
There have been many theories for the persistently low inflation, from hidden labour market slack to globalisation, but one theory that is gaining increasing attention is the deflationary impact of new technology. Technological advancements, from iPhones to Uber, are inherently deflationary as their whole purpose is to enable goods and services to be produced and distributed more efficiently and at a lower cost. Yet these powerful deflationary forces are not captured in official models. This is particularly important now as COVID-19 has increased the pace of digital disruption, enabling the rapid, widescale uptake of technology in many sectors from education to healthcare.
Inflation in NZ
According to the Reserve Bank’s inflation calculator, a basket of goods and services worth $1.00 in 1980 would have cost $3.54 twenty years later. By contrast, a basket worth $1.00 in the year 2000 only increased by 53 cents by 2020. There was a big drop in inflation when the Reserve Bank began inflation targeting. However, since the GFC, inflation has been easily contained below the “safe” 2 percent bound, despite low levels of unemployment and a tight labour market which are normally associated with higher prices.
From scarcity to abundance
Technology entrepreneur Jeff Booth recently published a book on the subject of technological deflation titled The Price of Tomorrow — why deflation is the key to an abundant future. In it, he argues that our economic models were not designed for a digital world, but rather for an environment where labour and capital were inseparable, where growth and inflation were a given, and where people created wealth by exploiting scarcity and inefficiencies.
Booth contends that because technological progress allows us to do more with less we are moving from an environment of scarcity to one of abundance. Meanwhile, technological advancements like artificial intelligence will impact almost every part of the economy, driving down inflation to such an extent that ultimately it will be impossible for Central Banks to counteract the effects through monetary policy. He points out that we can already see this happening given in the last two decades it took $185 trillion of debt to produce just $46 trillion of GDP growth.
What is the solution? Booth argues the answer is to let deflationary forces take effect and to deal with the consequences now rather than facing worse consequences of unwinding an ever-increasing debt burden down the track.
Tsunami of debt
Global debt has grown to an eye-watering level over the last 20 years with the Institute of International Finance predicting total global debt would reach $277 trillion or three times global GDP by the end of 2020. In 2020 alone the level of debt increased by $15 trillion. The rate of global debt accumulation is so large the IFF has warned it will be difficult for the world to reduce the debt without adverse economic consequences.
In New Zealand the public debt burden is tipped to rise to 50 percent of GDP in 2024, a comparatively modest level compared to the advanced country average of close to 100 percent of GDP.
While the full impacts of a deflationary post-COVID world are not yet clear, such high levels of debt combined with prolonged deflation will make it much harder for the world’s economies to recover from the pandemic.
The costs of not addressing the ongoing impact of deflation may mean Central Banks and governments will be trapped into an endless cycle of inflating the market through monetary and fiscal stimulus. What is clear is that the resulting ultra-low interest rates coupled with rising asset prices will only exacerbate the existing structural inequalities — and not to mention civil unrest — that are evident in many parts of the world today.