Today I wish to reinforce a theme I established a couple of months ago, back on the 29th of January to be precise. This goes against the economic orthodoxy which tells us that consumers when faced with lower prices then expect even lower prices and defer consumption. Frankly that always looked dubious to me in a country like ours as the UK these days seems to be to be something of an instant gratification nation unlikely to be able to wait long for anything. Also even before these times of economic difficulty we had seen falling prices for many electronic goods and we saw booming sales of mp3 players I-Pads and the like rather than falls. Back on the 29th of January I reinforced the case in this fashion.
The results were fueled by all-time record revenue from iPhone® and Mac® sales as well as record performance of the App Store℠. iPhone unit sales of 74.5 million also set a new record.
This led me to this conclusion.
However if we look at the retail-sectors in the UK,Spain and Ireland we see that price falls are so far being accompanied by volume gains and as it happens by strong volume gains. This could not contradict conventional economic theory much more clearly.
And a subset conclusion about the likely behaviour of a profession that is prone to stuck in the mud type thinking.
If the history of the credit crunch is any guide many will try to ignore reality and instead cling to their prized and pet theories.
UK Retail Sales
My theory and theme received considerable reinforcement from yesterday’s UK Retail Sales data which were very strong and provided another sign that it has been a solid first quarter for the UK economy.
Year-on-year estimates of the quantity bought in the retail industry continued to show growth in February 2015, increasing by 5.7% compared with February 2014. This was the 23rd consecutive month of year-on-year growth and the longest period of sustained growth since May 2008 when there were 31 periods of growth.
Quite a powerhouse performance when we consider that UK consumer inflation was on its way to disappearing in February. But we get an even more significant implication if we look at retail price behaviour over the past year and the emphasis is mine.
Average store prices (including petrol stations) fell for the eighth consecutive month, falling by 3.6% in February 2015 compared with February 2014. This is the largest year-on-year fall since consistent records began in 1997. Once again the largest contribution to the year-on-year fall came from petrol stations, which fell by 15.5%, the largest year-on-year fall in this store type on record.
So for the deflationistas we should be seeing large amounts of deferred consumption to take advantage of expected lower prices in the future. It is not so easy to square that with year on year growth of 5.7% in the retail sector is it?! Indeed we are seeing quite the reverse as around 60% of the increase in the volume of retail sales is due to the effect of lower prices enhancing volumes. Furthermore if we drill down to the latest three months which is the period where consumer inflation has lurched down to zero we see this.
The underlying pattern in the 3 month on 3 month movement in the quantity bought continued to show growth for the 24th consecutive month, increasing by 2.0%. This was the longest period of sustained growth since November 2007
The doom,doom,doom theories of conventional economics should instead be listening to the Outhere brothers.
I say boom boom boom let me hear u say wayo
I say boom boom boom now everybody say wayo
What is happening here?
We find ourselves examining a much longer-term theme of this blog which is that the above target consumer inflation in the UK which the Bank of England “looked through” contributed to a decline in real incomes and therefore had a contractionary impact as opposed to the promised expansionary one. However now we found ourselves in an environment where even the current level of weak wage growth -let us hope that this was a one-off- is higher than consumer inflation and is much higher than inflation in the retail sector. We do not have a like-for like comparison but even the 1.1% wage growth of January will make consumers and workers feel better off when it faces the 3.6% fall in prices in the retail sector in the year to February. Put this way we have quite considerable real wage growth here and accordingly no wonder we are seeing a boom.
An International Perspective
Y Viva Espana
Back on January 29th I also established the view that disinflation was providing an economic boost for Spain too. As you can see below prices are falling in Spain.
The Harmonised Index of Consumer Prices (HICP) annual change stands at –1.2%, thus it increases three tenths as compared with January.
Indeed prices have been falling in Spain since last July, so much more time for the deflationistas doom-doom cycle to kick in. Er well not quite at least not according to the Bank of Spain…
During 2015 Q1 the economy saw a continuation of the expansionary path of the previous year. On the information available, GDP is estimated to have grown at a quarter-on-quarter rate of 0.8% in Q1, which would take its year-on-year rate of change to 2.5%. This estimate marks a slight acceleration in activity on the final stretch of 2014.
Against this backdrop, estimated GDP growth for 2015 has been revised upwards to 2.8%. This 0.8% revision of the projection.
So rather than collapsing in on itself in the fashion of a black hole the Spanish economy is for now at least showing hints of escape velocity. The Bank of Spain launches itself on a rather wordy explanation of all this but does at one point approach something of a singularity in its explanation of what is causing at least part of the expansion.
the decline in prices
Of course it is taking its part in the ECB QE effort to end this boost to the Spanish economy, but I will leave that as a matter for them and the consciences.
Ireland
It would be remiss of me to not also examine the data of the third country from my original analysis which is the Emerald Isle which is currently basking in its Six Nations rugby triumph. How is the economy doing? Well it has falling prices.
Prices on average, as measured by the EU Harmonised Index of Consumer Prices (HICP), decreased by 0.4% compared with February 2014.
So the economy has collapsed? You no doubt have guessed the answer but I doubt that you guessed the scale of it.
The volume of retail sales (i.e. excluding price effects) increased by 3.3% in January 2015 when compared with December 2014 and there was an increase of 8.8% in the annual figure.
The motor trade has surged over there. Whilst this is not quite like for like as Ireland is tardy with some of its data we see that it is certainly boom-boom rather than doom-doom.
Comment
So far the evidence is clear that disinflation is producing boom-boom rather than the doom-doom of conventional economic theory. Of course we have finite evidence and there are other factors impacting at the same time. These can offset the gains as we have seen in Greece. But we get a reinforcing note from the other side of the coin. You see Japan is the ying to this yang as it has forced consumer inflation higher via its consumption tax rise and Yen depreciation. How is that going? From Japan Today earlier.
Separate data from the ministry showed household spending dropped for the 11 months in a row since the tax hike, falling 2.9% on-year in February.
Now of course the higher tax rate had an impact but so in my view has the higher level of prices. Accordingly unlike the Bank of Japan I see the fact that its adjusted favourite measure of inflation has fallen to 0% as a benefit and not a loss.
Ben Broadbent speaks
We are in the season for Bank of England speeches and Mr.Broadbent has made a case for QE which must sound weak even to his own ears.
For one thing I think the evidence suggests that unconventional policy is effective: even if they don’t circumvent it entirely, asset purchases help soften
the constraint of the zero lower bound.
Oh and the zero lower bound is back to 0.5% Base Rates again in a version of the hokey-cokey as one speech puts it back and the next dismisses it.
Also after Mark Carney’s speech on the Euro you might think that attacks on other countries policy would be a no-no. I guess many will miss the implied criticism of Denmark, Switzerland, Bulgaria et al.
if it’s not ruled out by an exchange rate peg
Still if they complain he could take a leaf out of the lyrics of Luther Vandross.
Out of my head to say the things I said
I didn’t mean a wordAnd I really didn’t mean it
Notayesmanseconomics's Blog 
This isn’t “stuck-in-the-mud” economic theory, this is, “Fit economic theory to politicians’ needs.”
Just as mainstream politicians are the vaseline-arsed sycophantic cronies of the banks, such, in turn, is the relationship between mainstream economists and politicos.
They are lying; they know they are lying, and you do well to keep them at arm’s length.
The game isn’t professional excellence, it’s professional advancement.
“Just as mainstream politicians are the vaseline-arsed sycophantic cronies of the banks” – I do like your imagery therawbuzzin.
Hi Shaun
I think you’re being a bit hard on the conventional view of deflation in that I’ve always seen the deferment of consumption argument coming only after a prolonged period of significantly(?) falling prices which create the expectation that this will continue, that is a change in collective behavior. Clearly we don’t have that here and are very unlikely to; in Japan it is another matter.
Also is there any qualification to this theory when you introduce the distinction between discretionary and non discretionary spending? Clearly discretionary spending is just that; it can be deferred, possibly for quite ling periods but non discretionary spending can’t be deferred by definition. Even if we had a situation of prolonged and significant deflation in both categories the fall off in spending would be muted by the balance of the two types and I don’t know if any index highlights this difference in any case so it may not even be capable of measurement.
I must admit the theory has always struck me as one of those things that sounds good in any economic textbook but which fall down in real world observation and, in that, it has a lot in common with quite a lot in economics!
Hence to old joke, Bob – An economist is someone who sees something working in practice and wonders if it will work in theory!
That joke now reads: doesn’t work in practice, but will try to convince us it does with a cock-and-bull theory.
“when you introduce the distinction between discretionary and non discretionary spending? Clearly discretionary spending is just that; it can be deferred, possibly for quite ling periods but non discretionary spending can’t be deferred by definition.”
There is a further qualification which is that you then have to look at incomes and personal circumstances.
A “Well paid” person with a large family to support may be spending all their income on non discretionary food heat light etc whilst a “low paid” person with little or no financial commitments may spend a significant minority of their income on non discretionary.
As you say, the falling prices = deferred consumption has always seemed nonsense to me. If it was correct then given debt interest (nearly) always exceeds inflation why would consumers borrow for their purchases, thereby making them more expensive when they can simply save for longer and purchase at a (relatively) lower price? It’s called instant gratification – a human condition that econometrics aint goin to capture or describe.
Hi Shaun
Excellent article as always. Its a shame the MSM always toe the line with the oft repeated lie.
I also think the changes in tax allowances are having an impact. Was it £6.5k when they started the parliament, and now its 10.5k. Thats are extra £1600/year for a family with both parents working. A nice little bonus to keep our consumer driven economy ticking over.
Hi Anteos and thank you
I agree that the real income boost from the raising of the tax-free Personal Allowance has slowly edged things forwards. Actually this year’s basic State Pension rise will do the same for recipients as it 2.5% it will be considerably higher than inflation. If we could get workers wages a bit higher too then it could be not only a good 2015 for the overall economy but the individuals in it too. Long overdue in my opinion!
Yesterday an R4 an ‘expert’ (rather than the ‘man-in-the-street’ – that’s me isn’t it) said that it was well observed that high rates of deflation were the only thing to cause delayed purchases.
So why is the deferred purchase argument rolled out when we haven’t even got there yet let alone to high rates?! The answer is obvious but only to a small number of people. The specious argument is propounded by people who jolly well know the real situation. Shame on them.
Hi Chris
I wish I had been there to grill the “expert” like well observed where and when?
“it was well observed that high rates of deflation were the only thing to cause delayed purchases.”
Even Japan the oft quoted case has had lower prices but mildly lower usually so I would like to know his examples of high rates we might find it is as recent as the Industrial Revolution in the UK!
In a real grind down aka Greece then perhaps but that is rather an extreme case (of incompetence if nothing else….)
But the BBC does not cover itself in glory I am afraid. Yesterday it produced some shamefully inaccurate coverage of the Japanese CPI. When I challenged it on Twitter a crew of defenders appeared who went silent when I listed the flaws.
Great column as usual, Shaun. After reading your column I read Ben Broadbent’s speech myself. He cites the recent BIS paper by Borio et al, “The costs of deflations”
Click to access r_qt1503e.pdf
The only message he seems to have taken away from it is that persistent deflations have been uncommon in the past. Here is the abstract for the paper with my emphasis added: “Concerns about deflation – falling prices of goods and services – are rooted in the view that it is very costly. We test the historical link between output growth and deflation in a sample covering 140 years for up to 38 economies. The evidence suggests that this link is weak and derives largely from the Great Depression. But WE FIND A STRONGER LINK BETWEEN OUTPUT GROWTH AND ASSET PRICE DEFLATIONS, PARTICULARLY DURING POSTWAR PROPERTY PRICE DEFLATIONS. We fail to uncover evidence that high debt has so far raised the cost of goods and services price deflations, in so-called debt deflations. THE MOST DAMAGING INTERACTION APPEARS TO BE BETWEEN PROPERTY PRICE DEFLATIONS AND PRIVATE DEBT.”
Mr. Broadbent’s boss, Mark Carney, spent most of his public career favouring the use of an inflation indicator, the Canadian CPI, that included current dwelling price changes as an important component. Since taking over as Governor of the Bank of England he has taken to decrying any suggestion that the Bank of England should occupy itself with house prices in the manner of Savonarola. It is really disturbing that someone like Mr. Broadbent would just fall into lockstep with Governor Carney’s new views. When an important BIS paper suggests that a central bank really should make it its business to include house prices in what it targets he doesn’t provide any counter-arguments. He simply takes out of the paper a nugget he feels comfortable with, and ignores the rest.
Andrew, well of course it becomes clear now, the only deflation any of that lot care about is house prices falling because they know that will unleash armageddon.Those TVs made in China or that oil pumped out of Iraq, they really dont give a s##t if that falls off a cliff, the sellers suffer a very long way a way. So you highlights reveal the truth and why housing is never measured because their dirty deception would be in plain view.
Paul, looking at the BIS paper again, it really doesn’t say that an inflation targeting central bank should include house prices in its inflation indicator. In fact there is no specific mention of inflation targeting at all. It certainly does say that the central bank should closely monitor property prices though, and that their movements should influence policy. Thank you for your interest.
Hi Andrew
I thought that too! The reason Ben Broadbent felt he could exclude the possibility of deflation was because it is rare. Now how many things have been claimed to be “rare” that have in fact turned out to be rather common in these turbulent times? Also many of the building blocks are in place…
He seems to have confused himself…
Excellent blog as usual. I’m not surprised that falling prices is increasing volumes as falling real wages since 2008 means that many people are now playing catch-up on non-vital things that they have put off due to a lack of funds. It will be interesting to see in what sectors these volume increases are.
Hi Rods and thanks
I have argued for a long time that controlling inflation would boost the UK economy and as it falls to zero we see a boost. In economics one never really gets an outright QED like you might in mathematics or physics but the evidence in favour is building.
I wonder how much of the Spanish and Irish turn around is due to delayed necessary purchases such as replacement white goods and motor vehicles? In the case of Ireland I have anecdotal evidence from an Irish friend (who arranges motor finance) that this is most definitely the case. Folk are buying vehicles because they have to as their older ones are clapped out. He doesn’t expect this to continue for long.
Deferred spending requires an equivalent increase in saving. We can make a valid case of deferred spending in Japan, with it’s very high personal savings.
But their claim that Britain suffers from deferred purchases is nonsensical. Their theory is blown apart by British borrowing and saving statistics.
Hi ExpatInBG
I agree completely. I have regularly argued in this blog that whilst there are similarities between us and Japan there are also differences. Frankly I find it hard to believe that anyone can argue that deferred spending is anywhere near the UK right now.
Although of course at the stroke of a pen according to the UK ONS we are now a nation of savers!
“Changes in the recording of pension entitlements also raised the savings ratio by an estimated 5% on average.”
Ha ha ha. ZIRP means negative real return on pension funds, then calculate what funds the majority of post-2005 entrants to the housing market will be able to save. This signals the destruction of private pension savings, even without Gordo’s means testing stupidity removing the motivation to save.
As to the countries finances – The 80s privatizations and oil wealth rescued Britain from an IMF bailout. That was a one off, making the overspending of Brown & Balls even more stupid and reckless. They also clocked up huge liabilities in form of PPP whilst running down the generating infrastructure and adding much fat in form of useless QANGOs.
Like you noted with the 2010 political budget programs, all of our politicians are denying financial reality. Possible future music replay of Sid Vicious’s Anarchy in the UK
Great stuff Shaun, In my own case I’ve only ever deferred a purchase because I don’t have the readies. Is saving to buy a new car or kitchen classed as a deferred purchase? or … if I choose not to borrow is that a deferred purchase?
Hi Eric and thanks
I dread to think how some might define a deferred purchase right now! However for these purposes it must be that they wait to buy something because it will be either much cheaper or better or both in the future.
Whereas of course what we are seeing is major falls in things which mostly we cannot defer. For example if I had deferred putting fuel in my car last night I would not have got here! Or if I had deferred switching on the cooker I would be hungry and so on…
So we are in my view as far away from it has we are from hyperinflation which is a much nearer bedfellow to deflation than many consider.
From current experience I can assure any interested economists that deferring the purchase of a replacement for my teenage daughter’s malfunctioning MP3 player turns out not to be an option.
Hi Arrbee
Perhaps you should have let them have a go! I suspect they would have received their own reward/punishment…..
Hi Shaun, a very interesting piece today – thank you.
One question – Are the Spanish GDP growth numbers volume or value (price) based?
Hi Noo2
It is volume as shown below from Spanish Statistics or INE
“Gross Domestic Product (GDP) produced by the Spanish economy in the fourth quarter 2014., measured in terms of volume chain-linked indices whose reference year is 2010, registered a 0.7% quarterly growth. This rate was two tenths higher than the one estimated for the previous quarter.”
However the translations do sometimes say value which I believe to be an error.
NB. I have my doubts about the Spanish deflator series but that takes time to get the relevant data on.
One other thing – this is what I was predicting last Autumn and it has a way to go now but I am nowbecoming concerned at the impact of ECB QE in an already very loose monetary system. At current expansion rates I fear a big jump in GDP across the EZ in 2015/2016 followed by a big inflationary pulse in 2016/2017 as oil prices recover which, if the ECB doesn’t do something about this (stop QE) will prove disastrous.
I doubt that there will be a GDP jump across the Euro zone but it may happen in parts e.g Germany. The problem is that if the ECB reacts to prevent this it will push up the value of the Euro and therebye choke of the very growth they are hoping for. This would be a bit of an issue for Germany but catastrophic for the rest who really need a low Euro exchange rate. I note that Eurocrats were initially saying that QE takes a long time to act and then only a few weeks after it started claiming it was responsible for a turn around! The reality is that it is the fall in the Euro that has had the quick results. Long may it continue.
Hi Pavlaki, allow me to explain further. My position remains that unless the ECB stops QE in the next 3 months the EZ collective GDP (although not necessarily Greece and Portugal) will shoot forward due to immense narrow money growth commencing last Autumn and which still continues today. The second influence imo is the ECB antics with interest rates allied to QE resulting in as you say a falling Euro which will of course help EZ exports and who is the biggest exporter of them all who doesn’t need help? yep, Germany.
Normally, I would say QE has little if any effect on an economy (although it succeeds in inflating asset prices) however, the ECB is not in “normal” territory.
The ECB is charging EZ banks 0.2% on excess reserves held whilst simultaneously indulging in QE. The banks know they can get better prices for certain Sovereign bonds than they paid from the ECB under it’s QE programme, so I expect them to start selling Sovereigns back to the ECB and pocket the profit (moral hazard anyone?). Normally, the banks would then sit on their newly realised balances collecting interest on them from the Central Bank, except, in this case as outlined above the ECB is charging them 0.2% for the privilege in order to force them into lending the money thereby expanding money velocity and thus GDP. I believe the combination of narrow money growth with QE and a monetary policy that costs banks to hold balances will result in too much money being offered both in terms of narrow money and extended credit which cause a “unexpected leap” in GDP but will then result in an inflatioon leap a couple of years down the road when taken in the context of what I believe to be a steadily recovering oil price to circa $75 – $90 a barrel (brent crude).
Don’t get me wrong I positioned myself last Autumn for this increase in the EZ biut if things continue their current trajectory I am afraid that instead of remaining invested Iwill be taking profits and pulling out approximately year end or early 2016 – before the crash comes…..
Thanks for the reply
You misrepresent what mainstream economics teaches about deflation, and then claim it’s been proven wrong.
What economics does say is that in a period of deflation where people can rationally expect deflation to continue for a long time to come (a monetary phenomenon in which prices sink) people delay purchases.
What we have today is something entirely different; a few (important) commodities have become much cheaper, particularly oil, but there is no reason to believe that it will definitely continue to become cheaper; in the medium term in fact , it is generally expected to become more significantly more expensive. In other words, as people spend less on oil, they have more money to spend on other items, which they do while they’re cheap. This is the opposite of the situation in deflation.
. they have more money to sp expected to
…..and your explanation of ongoing and increasing demand for electrical items (washing machines, stereos, computers etc) which have been falling in price both in nominal and real terms since the 90’s whilst commodities have continued their inexorable rise over the same time period?