Let some air out of inflated deflation worries

CONCERNS about deflation might be a little inflated. Yes, Singapore is experiencing a decline in overall consumer prices. But no, the country is not caught in a spiral of falling prices that will snuff out consumer demand and extinguish economic growth.

Overall consumer prices may have fallen in the past two months but, as the economists are going out of their way to explain, the long-term trend of prices in Singapore is still positive.

The headline consumer price index (CPI) fell year-on-year in November and December, the first time in five years that we have seen prices decline. Strictly speaking, falling prices equals negative inflation equals deflation, which would be what Singapore is going through right now.

Except that the truth is more complicated.

To begin with, the definition of "prices" is crucial. Overall prices fell in the final two months of 2014, but the headline number includes accommodation and private road transport prices - components that introduce certain problems when trying to assess long-term trends.

Those spending items tend to be volatile and their actual impact on consumers tends to be lumpy (most people do not buy and sell their homes every day). Accommodation and private road transport prices are also highly affected, in Singapore's case, by government policy. As Credit Suisse economist Michael Wan explained, price changes in those areas are "targeted at specific sectors and have not spilled over into broader expectations for prices to fall".

When we take out accommodation and private road transport, what we are left with is "core" inflation - a measure that the central bank prefers to track instead of headline inflation.

If we use the "core" definition of prices, therefore, Singapore is still comfortably in an inflationary environment. To be precise, core inflation was 1.5 per cent in November as well as December.

Core inflation is still positive but slowing, which is why the economists have taken to calling this a period of "disinflation". The belief is that there is enough upward pressure from imported food-price inflation and high wages to keep core deflation away for quite a while.

"If you look at core inflation, one driver is food, the other is services," said Standard Chartered economist Jeff Ng. "Food-wise, I continue to see some inflationary pressures because there have been some floods in the past few months . . . Services-wise, the concern is with the very tight labour market."

Why does it matter whether Singapore is experiencing deflation?

Deflation raises particular problems for the economy.

As Credit Suisse's Mr Wan explained, deflation "potentially increases the real value of debt, if wages fall together with general prices. It could cause people to defer spending today, for spending tomorrow, as the expectation of lower future prices gets entrenched. Both lead to a nasty downward spiral."

In Singapore's case, though, slight relief from the high inflation of recent years could be welcome.

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