Global economy on a Tripod: Deflation, Inflation and Recession in 2020
It is no news that the world economy may enter economic recession in 2020 due to the ravaging effects of COVID-19, with expectation of modest growth in 2021. While the IMF expects the advanced economies to contract by -6.1%, it expects the emerging and developing economies to contract by -1.0% and Sub-Saharan Africa is expected to contract by -1.6%. From economic theories, one characteristics of a recession is that price level of goods and services will become low. If this should go by and considering that economic theories are in favour of low inflation to boost economic growth, then the low prices of goods and services is meant to be a factor that will lift economies from contraction to boom. However, this is not always the case especially for countries experiencing deflation.
Deflation is defined as a sustained decrease in general price level of goods and services in an economy over a period. It is the opposite of inflation and any inflation level less than 0% is referred to as deflation.
The shrinking of the income of consumers coupled with the decline in production level has led to general prices recording declines on monthly basis in some countries. For example, headline inflation in Japan for the month of April was 0.1% and all items, less fresh food was -0.2% denoting that when fresh food is excluded from the headline inflation (this is done because headline inflation is heavily influenced by food prices which are affected by short term supply and demand changes in the food markets), then the Japanese economy would be experiencing a deflation. On a MoM basis, the Japanese economy have recorded decline in general prices from January to March (-0.10% in January, -0.20% in February and -0.10% in March). On a Y-o-Y basis however, the level of inflation has hovered between 0.10% and 0.69% from January to April 2020.
The effect of the deflating price levels on compounding the recession problem is that since the value of money increases in real term with deflation, it means that borrowers will have a burden to bear as the real debt is now high that is, they will have to pay more in real terms. As the price level falls during a recession, it automatically means that the income of companies will also fall. With increasing real debt (caused by increasing value of money which stemmed from Deflation), the company will be short of cash to fulfil its obligations. Less spending and high unemployment will therefore compound the level of recession of countries.
For countries such as Nigeria, the situation is different as the level of inflation is high (12.34%), rate of unemployment is also high (23% as at Q3 2018 but is as high as 35% in present times according to private research reports) and the rate of growth of the economy is low (real GDP growth of 1.87% in Q1 2020 compared to 2.1% in Q1 2019). This type of economic phenomenon is referred to as STAGFLATION- An economic situation where high rate of inflation is combined with high level of unemployment and slowdown in the economy. In a typical recession, inflation rate is not meant to be high, but low because the level of activity in the economy is low. If Nigeria enters a recession this year, the country will be battling a twin problem of recession and stagflation.
For countries with negative inflation rate, a recession is likely to be a major challenge because companies have the tendency of reducing their investments and hiring when their revenue decline as their debt burden also rises in real terms.
With contributions from Samuel Adebisi
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