Living with Falling Prices and Falling Wages

One nasty economic side effect of the COVID-19 driven lockdowns is a fall in prices for many goods and services and a drop in wages and other income.

A collapse in demand as the economy plunges into the deepest downturn since the 1930s Great Depression means that prices in many areas have to be cut to clear the market.

Witness global oil prices and the associated drop in bowser prices which are down around 40 per cent in the past few months. Filling up for well under $1 a litre might save drivers a few dollars, but as an economic indicator, it is bad news as it reflects a collapse in demand as driving falls and air travel slumps.

The same is unfolding in the rental market for residential property.

There are some large reductions in asking rents as the number of foreign university students and tourists coming to Australia has crashed due to the closing of the borders as the government works to contain the spread of COVID-19. What is also happening in the rental market is that Airbnb properties are being made available for longer term lease, meaning there is a flood of empty rental property on the market.

In this scenario, the only question is how far rents will fall.

Investment returns are also low

This deflationary impetus is also showing up in a collapse in returns on saving and investments.

With official interest rates just above zero, term deposit interest rates are around 1 per cent. Think of what that actually means. If you are lucky enough to have saved $100,000 and you get that 1 per cent interest rate, at the end of a year you will collect just $1,000 in interest payments.

At the same time, the return on investing in the stock market has taken a blow, not just because of the loss of wealth with the sharp falls in share prices over the past three months, but also because of cuts or cancelling in dividend payments from many large companies.

At the same time, if you are lucky enough to have a job, wages in many sectors have been reduced as workers accept the harsh reality that the only way for many businesses to stay afloat is to trim wages and / or the number of hours worked per week. In both instances, the take home pay of many workers is down compared with just a few months ago.

The problem with deflation

If the community expects an extended period of falling prices, they will defer making their purchase. This is entirely rational as every consumer knows it is usually better to pay, say, $98 for an item in a few months than it is to pay $100 today.

Which is why the post-COVID-19 economic policy framework will be so important. It will be vital that demand from consumers and the business sector are both strong. Strong, so that most or all of the jobs lost during the lockdown come back, giving workers an income that they can spend, which in turn helps the business sector to produce more goods and services which in turn helps to boost employment – and so the virtuous cycle goes.

When this happens, it will see deflation pass and hopefully, as the Reserve Bank of Australia is wishing for, inflation to return to the 2 to 3 per cent target.

If or rather when this happens, it will mean the economy will be humming along with strong growth, unemployment will be low and wages growth back above 3 per cent. Happy days.

Unfortunately, the end of deflation and the return to these good times is still a reasonably long time away and it does require economic policy to be pro-growth when the COVID-19 health crisis has passed.

The post COVID-19 economic policy
framework will be so important!

Stephen Koukoulas, Managing Director, Market Economics Pty Ltd

Published with permission, first seen on Yahoo Finance AU 5 May 2020