If you don't like inflation, you'll hate deflation

As Canadians celebrate this month's fall in food prices and politicians join the national sport of shaking their fists at grocery store owners, it might be time to listen to a gloomier prediction, if just to help prevent it from happening.

After a two-year bout of inflation when price rises peaked at eight per cent, groceries climbed at more than 11 per cent, and the cost of housing left well-paid professionals feeling poor it is natural to be nostalgic for the days when everything was cheap.

"People hate inflation. Hate it," said U.S. Federal Reserve chair Jerome Powell on Wednesday. "That causes people to say the economy's terrible."

Powell was announcing that the central bank would hold interest rates steady contrary to the advice of some, including OECD chief economist Claire Lombardelli.

He insisted that a soft landing for the economy remains a primary goal for the Fed. And while getting inflation under control comes first, Powell repeatedly said a long and strong series of rate hikes has given the central bank the luxury of moving slowly to avoid breaking things.

WATCH | Inflation up 4% in August:

Inflation up again, raising fears of another interest rate hike

12 months ago

Duration 1:51

A rise in gas prices is driving Canada's inflation rate higher. Statistics Canada reports the annual inflation rate rose to four per cent in August, beating many economists' expectations and raising the possibility of another interest rate hike.

But just as three years ago, when most analysts assumedinflation was unlikely or impossible, a new minority view is a warning about its evil twin: deflation.

Where economists differ from many of us is when we think that a general decline of prices is a good thing. Most economists say that while disinflation the fall of inflation toward some reasonable level such as Powell's two per cent target is an unmitigated good, an actual decline in prices across the board, deflation, is perilous for the economy.

You shouldn't ask for it.

There are several reasons, but essentially, while economists see a little bit of inflation as a lubricant to help in the necessary process of price adjustment, deflation is like putting sand in the gears.

The prospect of falling prices encourages consumers and businesses to put off purchases because they will be cheaper if they wait, sucking money out of circulation in the economy.

Bank of Canada deputy governor Sharon Kozicki said this week in her Regina speech, rising interest rates have a similar effect.

"Instead of purchasing something now, you could earn interest on your savings, make the purchase in the future and end up with some money left over," she said. But with deflation that reluctance to spend becomes even more widespread.

Falling prices also mean companies must cut costs including wages or go broke. While workers will put up with wage hikes slightly below inflation as we have seen over the last few years wage cuts stoke anger and are difficult to impose, often leading to contraction and mass layoffs.

According to Gary Tanashian, an analyst with a large following for his newsletter Notes From the Rabbit Hole, the current Goldilocks state of the North American economy where things are not too hot and not too cold is unlikely to last through 2024.

Tanashian is one of those who think the surge in interest rates needed to battle soaring prices has been overdone and that its lagging effects will turn "Goldilocks into a deflationary liquidation," he said, writing on themarket website Seeking Alpha.

But he also hedges his bets, saying the result mightonly be stagflation an unusual combination of a lifeless economy and steady inflation or some other gloomy outcome.

Avoiding the vicious circle

For borrowers, while inflation gradually erodes the value of borrowed money as wages grow with inflation, deflation makes cash more valuable, making everyone's existing loans a heavier burden, discouraging borrowing. Sitting on inactive cash makes you richer.

And, as Tanashian implies in his gloomy warning, deflation can result in general market decline which can create a vicious circle of more declines.

WATCH | Poilievrepresses Trudeau:

Poilievre presses Trudeau on rising cost of living

12 months ago

Duration 2:44

Conservative Leader Pierre Poilievre demanded answers on rising inflation rates from Prime Minister Justin Trudeau in the Commons and said the PM is 'not worth the cost.' Trudeau countered that his government 'is there for Canadians.'

While most commentators agree with Powell and see deflation as inconceivable, it is useful to be reminded why we do not want it.

Powell has made it clear this week and in the past how important it is to prevent another outbreak of inflation. Raising rates sharply when inflation was at its peak was a relatively easy choice. But accidentally pushing the economy from disinflation into deflation would be an appalling alternative.

"Given how far we've come with our rate hikes and how quickly we've got there, we do have the ability to be careful as we move forward," he said Wednesday.

Much of this conflicts with the view, widely expressed in some form by commentators and political leaders of all stripes, that Canadians will benefit if the prices of things like groceries and houses would only go back to the levels they were at in the good old days, say, before the pandemic, so that people could afford them.

Conservative Party Leader Pierre Poilievre, for example, complained in a speech this week that the cost of lettuce was up 94 per cent, a price jump since 2020 approximately backed up by this week's Statistics Canada inflation data.

"Will lettuce be back down to its original price by Thanksgiving?" he asked with a rhetorical flourish, scoffing at Prime Minister Justin Trudeau's plan to cut grocery prices.

"Will carrots back to their original price by Thanksgiving?"

But despite the popular appeal of lower prices everyone likes a bargain the safe way to find that precious soft landing is not to make prices fall, but to gently coax them into a slower rate of increase.