10:56 AM Jun 10, 1996
BIS NUDGES CENTRAL BANKS ON DEFLATIONGeneva 10 June (Chakravarthi Raghavan) -- While commending medium-term policies including price stability in the industrial world, the Bank of International Settlements has indirectly suggested that central banks should be as concerned about deflation as about inflation and should use monetary policy to adjust demand Stressing that price stability, meaning very low level of inflation, has been reached or almost reached in many industrial economies and that forces bearing on the price level are now more balanced than they have been for some decades, BIS says: "This is perhaps the right historical moment to recall the advise of Keynes and Wicksell in the early 1920s. Reacting against the vagaries of the gold standard, which allowed the price level to drift for extended periods in either direction, they concluded that it was appropriate as well as feasible for central banks to resist both inflation and deflation." Despite several positive features in recent economic and financial developments in the world economy, which point to a continuation or resumption of moderate growth in the industrial world, public perceptions are less sanguine, the Bank of International Settlements says in its annual report. Global economic developments, the BIS said, were generally favourable in 1995 -- the result of cumulative benefits of more disciplined macro-economic policies and an increased reliance on market mechanisms in both developed and developing economies. Despite the Mexican crisis, the international financial system continued to operate smoothly. The President of the BIS, Mr. W.F.Duisenberg, told the annual meeting of the BIS, that while inflation has generally remained well under control, wage costs in particular have been well contained and major financial markets had remained relatively calm. While objectively these developments can be seen positively, the 'feel-good' factor is absent and a 'feel-bad' factor is present in much of the industrial world, he noted. The BIS report attributes this to the weaker than expected performance of the economy in industrial countries -with the pace of activity slowing sharply in Europe and aggravating the already high degree of job insecurity. A more important contributor to this continuing anxiety, the BIS said, has been the recognition that a number of fundamental forces, some long-standing, are now interacting powerfully in ways that, although sure to create new wealth over time, may threaten job security in the near term. Duisenberg said that strong competitive pressures -- pressures for structural change caused by continuing and rapid technological advance, and the emergence of new dynamic economies in the world trading system which has intensified competitive pressures among others to improve labour market flexibility and new management methods -- have given rise to growing concerns about whether good jobs can be preserved. The BIS says that freer trade and rapid advances in technology have put continuing downward pressure on relative price of many traded goods, implying shift of productive resources into other industries in the industrial countries. But this is occurring at a time when similar technological advances and increasing competition in many service industries, in particular financial and telecommunications sectors , seeming to be leading to less job growth. And the general decline in cost of capital has led to substitution away from labour. In this situation, the tools available for policy-makers in industrial countries seem inadequate -- monetary policy cannot offset increase in unemployment without running inflationary risks. They have to avoid persistent deviations from price stability, unsustainable fiscal positions and unrealistic exchange rates and paying greater attention to the health of the financial system. In view of the inflationary experience of the last three decades, "price stability" has been generally interpreted in the industrial world to mean a very low level of inflation. And by this standard, price stability has been reached in a large number of industrial countries as well as in the developing world. And in many cases inflation has fallen more than expected. And while an inflationary threat may still exist, "yet it remains true that the forces bearing on the price level are now more balanced than they have been for some decades." The BIS then cites approvingly Keynes and Wicksell for their views of the early 1920s that central banks should resist both inflation and deflation, and suggests that at a time of rapid social and economic change, with attendant implications for social order and relative prices, it is all the more important that price stability be pursued as an anchor for rational and forward looking decisions on all fronts. Two of the most important problems of the industrial world, it stresses, have disinflationary implications. While fiscal deficits are too large everywhere, and existing levels of health care and social security imply future level of taxes so onerous as to be implausible, the question is not whether unsustainable policies will be eventually addressed, but rather the speed of the fiscal adjustment "which must balance the spiralling service costs of delay against the often unwanted short-run effects of timely action on demand..." The second problem is the need for further structural reforms in the area of labour and product markets, particularly in Europe. As with fiscal consolidation, reforms should be embarked upon as quickly as possible, given their double-edged nature and the associated lags before full benefits are seen. The adjustment to fiscal restraint, more competitive product markets and lower structural unemployment, BIS says, can be disinflationary, but once in place it may also catalyse powerful forces which stimulate demand. Pursuit of medium-term macro-economic policies should cause interest rates to continue to trend downwards. "Finally," BIS says, "central banks have the capacity to use monetary policy to adjust demand should it fail to grow at a pace consistent with price stability and they should be prepared to do so." But the BIS does not explain how, when (it admits) that the more than expected slowdown in the industrial countries was due to weak private consumption -- caused by the reluctance of households to reduce savings in the face of job insecurity -- a mere easing of monetary policy to adjust demand will overcome this factor. Earlier, in its survey of the past year, BIS says that transitional complications may have accentuated the recent slowdown of growth in some industrial countries. The policy commitment to price stability has had disproportionate effects on asset prices. In turn weak house prices have contributed to the absence of the 'feel good' factor and low levels of consumer spending over the last few years. Concerns over underlying value of collateral has led to more cautious bank lending, while fiscal restraint - which was substantial in most industrial countries except Japan - had direct effects on spending. In reviewing developments in the non-OECD countries, BIS notes that exports was a common engine of growth last year -- with volume of exports from Latin America, Asia and eastern Europe picking up strongly, and African exports picking up after several years of stagnation. As a result there was increased market penetration, and the share of developing countries in imports of US, Japan and Germany edged up to close to one-third, while that of transition economies in western European's imports too rose markedly. Also, intra-regional trade in Asia and southern Latin America contributed to the momentum of exports. Increased FDI flows within the region helped closer integration in Asia - with nearly half of investments in Indonesia, Malaysia, the Philippines and Thailand coming from other emerging economies in the region.