EKIP– Expert Club for Economics and Politics A Different Opinion
Today, the National Statistical Institute (NSI) published data on the level of the consumer price index in February, according to which deflation in Bulgaria deepened to 2.6% on an annual basis from 2.2% in January, reaching a seven-month high. Maria Ivanova from Capital commented on the data as follows:
From an economic perspective, deflation is a problem because expectations of continued price declines lead to a slowdown in purchases and a decline in consumption. This in turn forces businesses to lower prices and operate at lower margins and profits. As a result, companies are forced to cut costs, often by cutting wages or laying off employees. This leads to a further contraction in consumption and, consequently, to a further slowdown in the economy.
Ivanova's conclusions about the effect of deflation on the economy are wrong even according to her definition of this phenomenon, namely - a decline in the general price level. Even if all prices fall at the same time, and even if the decline is to the same extent, the business will be able to continue to produce at a profit, because its profit depends not only on the level of prices at which it sells, but also on the level of prices at which it buys (factors of production).
In deflation, both sets of prices fall and the differential between them remains. In addition, the very premise that is supposed to trigger the process that Ivanova describes is also wrong. It is true that, all else being equal, consumers want to pay less rather than more, but this does not mean that they can postpone the purchase of goods forever (especially those that are of paramount importance for preserving their lives, but the same principle applies to "luxury" goods such as LED TVs).
Reasons for deflation in Bulgaria?
Deflation in Bulgaria is not caused by a contraction in the money supply, nor by an increase in productivity (of the local economy), nor by a contraction in lending, but by the administratively reduced price of electricity and the greater abundance of energy and food goods. What effects does this have on the economy? The intervention of the state regulator in the pricing of electricity will lead to an outflow of investments from the sector and reduced production (and in the future it may also lead to an increase in the prices of other goods, if the state decides to save the sector with taxpayer money), an increase in the purchasing power of the leva relative to food and energy goods (the consumer can consume the same amount as before at less expense).
I bet that there is no consumer in Bulgaria who has thought even for a second about what inflation figure the NSI reports each month and based on this information shapes their consumer behavior.
@Ivan Georgiev
"Even if all prices fall at the same time, and even if the fall is to the same extent, the business will be able to continue to produce at a profit, because its profit depends not only on the level of prices at which it sells, but also on the level of prices at which it buys (factors of production)."
Well, the above is not very clear. The problem is which falls first. Whether the revenues or the expenses fall first. Because profit is revenues minus expenses.
During a crisis, your income falls first. That is, you have already incurred expenses in a past period: you have purchased goods, materials for production, etc. You have already given this money and you cannot get it back. However, income comes AFTER expenses because it takes time to process the materials and actually produce the product. And that is how your income falls first, and expenses follow. The result is that profit not only decreases, but it can also lead to a loss.
In short: During an economic crisis, revenues fall first, and expenses follow with a delay. The result is bad.
However, with growth (deflationary growth; i.e. with a constant quantity of money), your costs fall first. I.e. due to economic progress, a cheaper/efficient way of production is found and the company's costs fall. However, initially the revenues are the same. The company's revenues will also fall due to competition, but they will fall AFTER the costs have fallen. I.e. the company will not be at a loss in any case.
"It is true that, all else being equal, consumers want to pay less rather than more, but that does not mean they can postpone purchasing goods forever."
The above is exactly so. For example: the prices of computer equipment. They fall or stay the same while the quality increases. And SURPRISE: people do not wait for the prices to fall further, but buy computers. How so? It should not happen if we listen to modern economic theory, namely (from the article):
"From an economic perspective, deflation is a problem because expectations of continued price declines lead to a slowdown in purchases and a decline in consumption."