Commodity-driven CPI falls are not deflation
Simon Ward
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With a 0.1% fall in consumer prices in the year to May, Germany becomes the fourth Group of Seven (G7) country to record headline "deflation", following the US, Japan and the UK (the latter based charitably on the retail prices index, which incorporates declines in mortgage rates and house prices, as well as the December VAT cut).
G7-wide consumer prices were down an annual 0.3% in April. The fall reflects a collapse in commodity prices from their levels a year ago – see chart. The rate of change of "core" CPI – excluding food and energy – remains positive in every country bar Japan, averaging an annual 1.5%. As the chart shows, the commodity price effect will reverse in late 2009, assuming no renewed decline from current levels.
Headline inflation should therefore converge on core. Core inflation should decline in 2009-10 as global excess capacity undermines pricing power. After the last recession it fell to an annual 1.0%. Headline G7 inflation could rebound to around this level in early 2010 – higher if commodity prices continue to rally.
Deflation, like inflation, is a monetary phenomenon. The global money supply continues to grow healthily, arguing against a sustained period of falling prices.
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