Is zero inflation a good sign?

 

Is zero inflation a good sign?

 

By Ahmed Kamel

Falling inflation rate has been a trend since May due to a decline in aggregate demand, reflecting the overall market pessimistic sentiment incurred by the Covid-19 repercussions. The monthly inflation rate was zero in September, data from the state-run Central Agency for Public Mobilization and Statistics (CAPMAS) showed.

The annual inflation rate stood at 3.3 per cent in September, down from 3.6 per cent a month earlier, according to CAPMAS. However, the decline in inflationary pressures is temporary as it might pick up in the short term in the wake of a number of determinants.

To better foresee the outlook of inflationary pressures, we should understand what happened first. The market mechanism -- supply and demand -- basically sets the pace of growth, prices, consumption, saving and investment.

A CAPMAS report showed that prices of food and beverages declined by 0.6 per cent in September, maintaining its downtrend since the Covid-19 pandemic hit the world economy in March.

However, prices of healthcare, transport, restaurant, culture and entertainment services rose. The decline in food and beverages outweighed the impact of rising prices of these services.

While the man in the street may be happy with decreased -- or at least stabilized -- prices, macroeconomists are rather concerned about serious issues, i.e. economic growth and investment.  

From a macroeconomic perspective, a certain level of inflation is desired to push growth ahead. Easing inflationary pressures have been a direct result of a stronger pound, lower aggregate demand in the wake of less consumer spending.

Here it should be well noted that falling inflation rates over the past few months were stoked by the economic slowdown caused by the partial lockdown between mid-March and end of June. Economically, a zero inflation rate is not a good sign.    

It simply means that consumers spent less cash due to the curfew hours, while producers and investors cut their spending as well. These symptoms have hit advanced and developing economies on the back of the coronavirus repercussions.

Falling consumption leads to a decline in investment. That harms the business climate, which relies heavily on consumer demand, which is psychologically driven by a pessimistic mood at times of crises.

On the other hand, supply has decline too, as producers cut their spending on imported input materials. Consequently, that decreased demand for the US dollar on the local market.

The only gainer from the Covid-19 crisis is probably the Egyptian pound. The greenback fell to LE15.7 at local banks, down from around LE16. As the economy gets back to normal, demand will rise, and eventually the US currency may strengthen versus the pound again.

The foreign exchange is a key determinant of the inflation rate, especially in import-dependent countries. In the post-Covid era, policymakers will have to focus on fiscal measures to maintain the pound’s gains to curb imports of products that could be manufactured at home.