In the short term, consumers are satisfied as purchasing power increases. But in the medium term, “deflation can harm economic growth and the ability of families to generate more income”.
For decades, it represented a persistent threat to Latin America. But there are now two countries on the continent that have — that is, a negative level of inflation.
A Costa Rica (-1%) and the Panama (-0.3%) ended the month of September with their Consumer Price Index (CPI) in negative territory, compared to the same period of the previous year.
The main reasons differ from country to country, although there are also some common causes.
The executive secretary of the Central American Monetary Council, Odalis Marte, explains that the drop in fuel prices, along with the reduction in the value of certain foods on the international market, contributed to some countries in the region recording a very low inflation, or even negativein the last few months.
El Salvador, after five months of deflation, recently returned to a positive index, albeit with just 0.3% inflation. In this case, among other factors, the reduction in taxes on food imports also played a role.
In Costa Rica, the determining factor was the appreciation of the local currency against the dollar.
The former president of the Central Reserve Bank of El Salvador, Carlos Acevedo, currently works as an independent consultant. For him, the deflation observed at the moment is also explained by the “post-pandemic effect” — that is, the cost of living has reached such high levels that the current declines do not reflect a crisis, as happened in other countries that faced deflationary situations.
In fact, as the basis for comparison is high, deflation is not a worrying symptom.
“I consider this a stabilization of prices, a correction of prices”, comments Acevedo to BBC News Mundo, the BBC’s Spanish-language service.
Costa Rica has now had five consecutive months of falling prices. Panama, in turn, completes a year of negative CPI.
Researcher Benjamin Gedan, from Johns Hopkins University, in the United States, explains that deflation “is not an objective of economic policy, especially if it occurs as a result of economic stagnation”.
Common sense could lead us to think that the more prices drop, the better for our pockets. But in reality, it’s not quite like that.
And what about consumers’ pockets?
Marte emphasizes that, in the short term, consumers are satisfied, as deflation increases their purchasing power. But, In the medium term, “deflation can harm economic growth and the ability of families to generate more income”.
It is important to take into account that, “in many countries, when inflation is very low or negative, there are no salary increases”, consumption decreases, production reduces and the economy grows less. A kind of negative cyclein which, although prices are lower than a year ago, consumers’ purchasing power remains reduced. And, of course, without jobs or frozen wages, deflation is not beneficial for personal finances.
Deflation in Panama and Costa Rica is “not worrying”, according to Marte, because the economies of both countries are growing. Unlike other cases, this is deflation in line with economic growth. In both cases, if deflation lasts for a few quarters, “nothing happens”, he explains, as it is part of an adjustment process.
According to Marte, when observing these countries, it appears that deflation is not the result of a recession, but rather of a phenomenon associated with the evolution of external and internal factors.
To understand how this deflation influences the international context, it is important to consider that the structure of family spending varies from country to country, depending on the weight of each product in the basket used to measure the CPI.
In Costa Rica, Panama and El Salvador — which has just emerged from deflation, but whose CPI is still around 0% — Marte highlights that fuel and food prices have great weight in the general assessment of the cost of living. This does not happen in other countries, where the importance of certain imported products is not so preponderant. And, in more local terms, a given government’s decision to subsidize certain products also has an impact. In El Salvador, for example, fuel prices are subsidized. This policy makes it possible to offset the rise in prices on the foreign market.
From a broader point of view, if deflation persists for a long time in a country’s economy, its situation can become more complex, as the phenomenon affects economic activity. But for now, this does not appear to be the case in Central America.
“I don’t believe that the drop in prices in these three countries will be permanent”, says the economist.
Carlos Acevedo also does not believe that this deflation will become a problem.
However, after the sharp rise in prices in the post-pandemic period, many families do not feel that prices have really dropped. The CPI may be comparatively low, or even negative, but “life goes on dear”considering prices before the pandemic.
The best example is Costa Rica, “an expensive country, because the reduction in prices is marginal” given the high cost of living, explains Acevedo.
“People don’t feel it in their pockets,” he says. And, in fact, when talking to Costa Ricans, the first thing you hear is that life is very expensive.
What happens when deflation becomes permanent?
One of the most striking examples of prolonged deflation is the Japanese case, known as “the lost decade” of the Asian country.
In the 1990s, Japan suffered a deep economic crisis, with falling domestic demand, low interest rates, a weak yen, high levels of debt and a lack of business investment.
With a very aging population and more concerned about saving than consuming, companies reduced prices without being able to reactivate consumption, in a context of economic stagnation, bankruptcies and an increase in non-performing loans. The chronic deflation suffered by Japan constituted a serious economic problem for many years.
What usually happens is that, in a deflationary process, people postpone consumption, hoping that prices will continue to fall. This, in turn, makes it even more difficult for the economy to recover. The process creates a vicious circlein which the reduction in consumption worsens the fall in prices and the lack of investment.
Inflation levels that are too high or too low are not good news. And, although each country defines its inflation target (the level of inflation considered appropriate for its economy), the general rule is that the ideal price variation range is between 2% and 4%, according to economists. This is what is considered a “healthy level” of inflation.
In any case, economists continue to monitor what is currently happening in Costa Rica, El Salvador and Panama as a transitory phenomenon, taking into account that their economies are growing at a rate even higher than that of other countries in the region. Clearly, they are heading in the opposite direction of the recession.
Historically, Latin America has gained fame for its fight against inflation. The “painful experiences” of the past have driven reforms in many countries, guaranteeing the independence of central banks and a responsible monetary policy, according to Benjamin Gedan.
And although it remains a huge challenge to achieve the ideal level of inflation in each country, economists agree that the lessons learned in recent decades have left a positive mark on the continent.
