Footprint of Deflation in Major Advanced Economies

July 27, 2010

The fear of future inflation has ushered in an age of austerity even as prospects for sustained economic recovery among major advanced nations face substantial and unusual uncertainty.  It is feared that government deficits, which ballooned in response to a drop in tax revenues caused by the deep recession, will be monetized away by central bank policies that promote inflation.  Never mind that current consumer price inflation is very subdued now, with  of +1.1% in the United States, +0.9% in Germany, and minus 0.9% in Japan.  Each of these rates is lower than the respective 2000-09 per annum trends of 2.6%, 1.6% and minus 0.3%.  All this makes sense in light of weak economic growth during the noughties, averaging 1.9% per year in the United States, 0.8% in Germany and 0.7% in Japan.  Unemployment remains high at 9.5% in the United States, 10.0% in Euroland, 7.8% in Britain, and 5.2% in Japan.

The trend in long-term interest rates has a distinctive deflationary tilt, which disregards any danger related to present large budget deficits of higher inflation and instead reflects the substantial slack in the major advanced economies after a long period of sub-trend growth.  Overlaying this picture of continuing sub-normal growth will be mandated cutbacks in fiscal and monetary stimulus.  In the following table, period average ten-year sovereign debt yields are shown covering the past two decades.  The yields fell progressively, and that direction remains in place.  In some instances, such as the United States, the early months of 2010 saw yields climb only to settle back more recently to levels that are below last year’s means.

U.S. Germany Japan Britain
1990s 6.65% 6.58% 3.85% 7.95%
2000-06 4.71% 4.30% 1.43% 4.76%
2007 4.63% 4.23% 1.68% 5.01%
2008 3.65% 4.00% 1.49% 4.49%
2009 3.24% 3.27% 1.36% 3.60%
1H10 3.58% 3.01% 1.31% 3.85%
July 2010 2.99% 2.64% 1.11% 3.37%
July 27th 3.03% 2.77% 1.06% 3.51%

Britain had the highest long-term interest rates among the four economies in the 1990s and retains that distinction.  With considerably more CPI inflation of 3.2% in the year to June than the other three economies experienced, a 10-year gilt yield of just 3.51% at present nonetheless reflects a disinflationary mind-set.  The new Conservative Government has topped all others in the severity of fiscal austerity that has been approved.  Although British growth of over 4% annualized last quarter topped expectations, the gilt yield suggests that investors are betting more heavily on a sustained move to lower inflation.

Copyright Larry Greenberg 2010.  All rights reserved.  No secondary distribution without express permission.



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