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“Deflation may be the main policy challenge”

CHENNAI: “Deflation, not inflation, may actually be the main economic policy challenge,” the United Nations Conference on Trade and Development (UNCTAD) has warned.

Noting that international responses to the current situation that overplay concerns about inflation are “misguided,” the UNCTAD says “the risk of a prolonged downturn or depression is far more important, as the slowdown will further reduce commodity prices.” In a policy brief on the current global financial crisis, the UN agency has said: “There is not much evidence that wage-price spirals similar to the ones that triggered inflation in the 1970s are a real threat at this point.

Only in a very few developing and developed countries have nominal wage increases consistently exceeded the growth rates of labour productivity by more than what is tolerable in terms of inflation.”

Referring to the criticism about the role of the State in the present turmoil, as opposed to the play of market forces, the UNCTAD note reasons: “For purely ideological reasons, some people have criticised the emphasis that has been placed during the crisis on the rediscovered role of the State. But this is the time for pragmatic solutions, not for dogma and ideological struggle. The State is back in the limelight because financial markets in boom-or-bust phases are in no way comparable to real markets, in which independent agents supply and demand goods and services according to their individual preferences and budget constraints.”

Protecting deposit holders and creditors of imperilled banks, the brief says, deserves higher priority than protecting the shareholders. Similarly, the long-run cost for both government and taxpayer should be kept in check by giving priority to government equity stakes and not just to subsidising banks.

“In future, such institutions must be treated like deposit-taking banks and subjected to tighter prudential regulation — or forced to change their business model and adapt to more traditional banking arrangements.”

The UNCTAD has also come up with a few solutions or “regulatory quick fixes:”

1) To reassess the role of credit rating agencies, which seem to have played a negative role by making the markets even more opaque instead of increasing transparency; 2) to create incentives for simpler financial instruments, instead of the current bias in favour of sophisticated financial products; 3) to address maturity mismatches in non-bank financial institutions and limit the involvement of banks with lightly regulated agencies; 4) to limit credit deterioration linked to securitisation.

In conclusion, the brief says: “The undesirable effects of the necessary but painful unwinding of unsustainable debt can be compensated only if the surplus countries — especially Japan and the large countries in the Euro zone, where growth is already anaemic or negative — reduce their surplus positions at all levels and quickly provide policy stimuli to avoid a long recession or even a depression of the global economy.”

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