Focus turns to deflationary risks

While there are fears pumping cash into the world’s central banks will lead to inflation, AMP Capital Investors chief economist Dr Shane Oliver has argued deflation is more likely to replace inflation as one of the key risks to the global economy.

“Narrow money supply measures have increased, largely reflecting increased bank reserves. But to get inflation we need the banks to lend more, so that broader credit measures increase, and we need people to start spending in excess of the economies’ capacity to produce,” he said.

“Until demand picks up there is no reason to worry about inflation. In fact, the big concern is more likely to be deflation.” He added that when demand picks up, central banks would have to “reverse their policy stimulus”.

The “depth and length” of the global recession will be crucial in determining how shares and other growth-oriented financial assets will perform this year, Oliver said.

While he acknowledged ongoing losses in global banks and said investors are in for a volatile ride in the short term, there are tentative signs of improvement as a result of the global policies being implemented.

Oliver said the world is experiencing the worst recession in the post-war period and “the Australian economy is also being hard hit and looks destined for recession”.

However, he said “a re-run of the Great Depression is very unlikely” given the more positive and quicker global policy response to the crisis.

Oliver noted the significance of the policy responses by governments, such as the rapid reduction in interest rates and measures to stabilise the financial system, including loans to financial institutions. Fiscal stimulus — spending increases and tax cuts — have also been a crucial element of the global response to the crisis.

“Were it not for the capital injections into banks and guarantees over bank borrowing, the situation today would likely be far worse,” he said.

Oliver noted some indicators of improvements, focused mainly on the US, including a sharp fall in the gap between interbank lending rates and government short-term borrowing rates, signs of stabilising consumer confidence measures and a pick-up in Chinese money and credit growth.

Oliver said “a range of other signposts need to turn positive” before we can be confident of economic recovery.

“However, the fact that some indicators have turned a bit more positive is a good sign and consistent with our expectations for a global economic recovery from later this year and/or through 2010,” he said.