No Reason to Fear Deflation, Economists Say

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Supermarket shoppers don't benefit from the low cost of manufacturing price-controlled bread.Credit: Daniel Bar-On

Prices in Israel have dropped for two years in a row, according to data published over the weekend – meaning the country is experiencing deflation.

After years of concern over price increases, it turned out that the CPI dropped by 0.2% in 2014 and by another 1% in 2015.

But economists say that contrary to popular belief and to concerns that this bodes poorly for Israel’s economic growth, there’s no reason to be scared. Rather, they say, this might be an opportunity to solve major problems facing Israel’s economy.

“The deviation from target inflation rates over the past two years stemmed from structural changes and a decrease in global prices. Therefore, this hasn’t had a negative impact on economic goals, but rather it has been helpful,” said Gal Hershkovitz, formerly the Finance Ministry’s budgets director.

The government’s goal for inflation rates is 1% to 3% a year, but Hershkovitz says that inflation is not actually a goal in and of itself, but rather a step toward achieving economic goals such as growth, employment and reversing economic inequality.

But deflation brought on by a recession, which is accompanied by decreasing private consumption, exports, and investments, is different from deflation brought on by structural changes on the supply side that increase competition and efficiency, thus decreasing the price of inputs and services, as well as global changes that reduce the price of energy and commodities.

“In the current situation, the economy isn’t fulfilling its full potential for growth but it’s also not in a recession. Private consumption is high and public expenditure isn’t low, and the decrease in investments isn’t a result of recession or high real inflation rates, but rather due to inefficiency in regulation and the public sector, and a lack of quality public infrastructure,” he said.

Often inflation rates are lowered to counter deflation, but Herskovitz said this shouldn’t be done now. Israel’s interest rates are already at an all-time low of 0.1%.

Prof. Michel Stravinsky, former deputy head of research at the Bank of Israel, said inflation rates in Israel are variable due to the changing prices of imports, but also due to price changes within Israel that are beyond the central bank’s control.

Deflation caused by temporary changes shouldn’t be too much of a concern, as opposed to deflation caused by long-term shifts, he said. An example of the latter would be a drop in housing prices, he said.

Forecasts indicate that this year Israel will see moderate price increases of less than 1%.

Stravinsky notes that prices increased last year only for housing (2.2%) and for fruits and vegetables (13.2%). If not for these factors, the deflation figure would have been even steeper, he said.

Prof. Dan Ben David agrees that there’s no reason to fight deflation. “We didn’t do anything bad,” he said. Rather, a lack of inflation enables the country to address fundamental problems, such as in infrastructure and education, by increasing its investments in the places that need it most, he said.

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