Global Disinflation

The decade of the 1990s saw world inflation subside from around 30 percent to around 4 percent. More exactly, world inflation averaged 30.4 percent between 1990 and 1994 and averaged 3.9 percent between 2000 and 2004. It was a decade of disinflation (Rogoff, 2003). Inflation decelerated at a rate sufficient to arouse fears of deflation. Alan Greenspan, chair of the board of governors of the Federal Reserve System from August 1987 to January 2006, felt the need to address the prospects of deflation in December 2002. In a speech to the Economic Club of New York City, he commented that it was vital to “ensure that any latent deflationary pressures were appropriately addressed before they became a problem.”

Regardless of stage of economic development or geographical location, countries around the world watched inflation rates recede. For the years between 2000 and 2004, industrialized countries experienced inflation averaging 1.8 percent, less than half of an average inflation rate of 3.8 percent that the same countries posted between 1990 and 1994 (Rogoff, 2003). The most dramatic reduction in inflation occurred in the transition economies, referring to the economies switching over from socialism to capitalism.

These countries saw inflation melt away, averaging a mere 13.4 percent between 2000 and 2004, compared to an average of 363.2 percent between 1990 and 1994 (Rogoff, 2003). Latin America boasted similar success in the war to corral inflation. Starting at an average inflation rate of 232.6 percent for the years between 1990 and 1994, Latin America saw inflation rates slip to an average of 7.9 percent for the years between 2000 and 2004 (Rogoff, 2003). For the same time frame, developing countries around the world reported average inflation falling from an average of 53.2 percent to an average of 5.6 percent (Rogoff, 2003). In Africa, average inflation fell from 39.8 percent to 11.0 percent for the same time frame.

If the trend toward disinflation had gone on uninterrupted, the world economy at some point would have tipped over to deflation. The thin edge of the wedge of deflation had already made inroads in Japan, where inflation averaged a –0.8 percent between 2000 and 2003 (Rogoff, 2003). A minus sign on inflation numbers indicates prices are falling. Hong Kong also saw deflation, posting an inflation rate of –2.5 percent for the 2000 to 2003 time frame (Rogoff, 2003). Deflation in Japan sparked fears that deflation would spread to other countries, particularly since China and Germany were flirting with deflation. China reported inflation of 0.1 percent, and Germany 1.7 percent for the years between 2000 and 2003.

The onset of world deflation would almost certainly herald the beginning of world recession. Businesses are hesitant to invest in plant and equipment if they see the prices of their output falling. Consumers are likelier to postpone spending decisions when they learn that the longer they wait, the lower the prices that they pay for consumer goods. Japan’s deflation episode coincided with a highly stagnated economy.

Several factors may have played a role in the deceleration of inflation rates around the world. First, governments around the world have yielded more independence to central banks, shielding them from electoral pressures. Central banks in both the United Kingdom and Japan won legal independence. In the same vein, central bankers have become more adept at applying tight money policies with less cost in terms of unemployment. Another factor is a technology-driven rise in productivity around the world, increasing output and decreasing business costs. Last, globalization and increased emphasis on markets and competitiveness may have diminished any positive role that inflation plays in maintaining high economic performance. In a world where prices are rigid downward, inflation helps to maintain balances in markets where prices are free to rise at different rates, but prices are not free to fall. In such situations, market equilibriums can be achieved by some prices rising faster than others, rather than some prices rising and other prices falling. With more markets having downward price flexibility as well as upward price flexibility, monetary authorities are less tempted to elevate inflation in a bid to restores macroeconomic balance.

By 2008, a worldwide boom in commodity prices put an end to fears of world deflation. On the contrary, inflation seemed on the rise. It will be interesting to see if the current uptick in inflation rates around the world is only a temporary reprieve from a longer-term trend toward deflation.