The opposite of a bad thing is not necessarily a good thing. Sometimes it is an appalling nightmare. Inflation is a perfect example.
When prices are generally rising, those on fixed salaries are in pain. Without a pay increase, rising prices will eat into their real purchasing power and add to their already heavy financial burdens.
Taiwan’s real salaries have retreated to the level of 16 years ago. Any increase in the cost of living would be intolerably heavy. Hence people in all income brackets are earnestly hoping that inflation will stop, and if prices drop overall, it would be seen as a godsend.
Last year, Taiwan’s wholesale price index was -2.43 percent for the full year. For manufacturers this means that unit sale prices decreased and profits declined. But the consumer price index was 0.79 percent, while for most consumers real incomes fell, making the hard times seem even tougher.
This year, CPI was 0.4 percent in January and February, but the positive number still represented an increase. If CPI could immediately fall to zero or even turn negative, it would mean a real-income rise, and people would feel relieved.
On the other hand, however, CPI only has to approach zero, coupled with the long-term trend of negative WPI, the prospect of deflation would become a real worry. Deflation is historically the most fearsome economic disaster, which would take more than a decade to reverse. While inflation may be unwelcome, deflation is a catastrophe.
In fact, mild inflation, although superficially deleterious to fixed-income earners, has a stimulus effect on the economy as a whole because entrepreneurs can only benefit from it.
As prices rise, real interest rates fall, reducing the interest burden on investors, manufacturers and employers. It naturally boosts profits for business operators because they buy goods when prices are low and sell as prices increase. As a result, factories actively boost output and payrolls, adding to economic growth and real gross national income. Demand for workers increases by the day, and as job opportunities rise, so do nominal wages.
Under this virtuous cycle, the rise in nominal and real income would relieve people of worries about a jump in the cost of living. Taiwan’s economy was like this more than two decades ago when inflation was often almost double digit.
Recently, because of such problems as the pig diarrhea epidemic, meat prices have risen noticeably. However, although the effect on CPI has been barely noticeable, consumers continue to complain, and the government has been working hard to stabilize prices. Combating inflation and lowering prices have become popular consensus.
A comparison of mild inflation with mild deflation of the same magnitude is illustrative. Following the analysis above, the former seems like a slightly bumpy ride but is essentially smooth sailing, while the latter is like a bottomless chasm and one false step could lead to situations beyond redemption.
Taiwan is already standing on the edge of this precipice, and most people fail to see the gravity of the situation. They rely on their feelings and demand that the government strike heavily against minuscule inflation, pushing the nation slowly toward the chasm.
The ROC Central Bank, which is responsible for keeping prices stable, plays a crucial role in the picture. In recent years, the bank’s mantra has been to keep CPI below 2 percent, so it seems satisfied with CPI figures of 0.79 percent and 0.4 percent. But what if CPI falls to zero or even turns negative, would the bank consider the figure an even better fulfillment of its target? This is a frightening prospect.
Taiwan’s per capita income has long been behind that of advanced countries, and has been overtaken in the past decade by South Korea’s, making people despondent. Last year, however, in purchasing power parity terms, Taiwan’s per capita income was ahead of such countries as France, Germany and Japan, and 17 percent higher than that of South Korea. This is the opposite of what is popularly believed.
The crux of this phenomenon is that everyone in the nation, leaders and the people alike, suffers from a severe inflation phobia. The attack on prices is non-stop, with the aim of making electricity and water prices the lowest in Asia. This has made the discrepancy between nominal rates and PPP greater by the day, concealing the vicious cycle of low prices, low investment, low production and low wages even more.
To break this vicious cycle and create a virtuous one of prices, production, growth and wages, the first thing is to immediately change the central bank’s inflation target to 2 percent or more. To achieve this, general advocacy is required to turn around erroneous public consensus. The lead of Japan and U.S. should also be followed in bravely implementing monetary policy and exchange rate mechanisms until inflation exceeds 2 percent.
Much is happening in Taiwan. The nation’s finances are in straitened circumstances, lots of plans are on the back burner, and the blind popular consensus is about to push the country into a bottomless pit. Only inflationary measures can solve all these problems and the government should not further delay over their implementation. (SDH)
(This commentary first appeared in the Economic Daily News March 23, 2014.)