By Kim Jae-kyoung
Staff Reporter
With financial malaise spreading throughout the world, there is a broad consensus among global investors and economists that the global and U.S. economies will undergo a long, painful recession.
However, they are widely divided over what form of recession the global economy will follow. Some say that it will slip into so-called ``stag-deflation,'' in which the economy barely grows amid falling prices, while others claim that such a scenario is unlikely as inflationary pressure will stay with us.
A year ago, everybody thought that the problem was inflation. Now, a plunge in oil prices has changed the global outlook, tipping the balance in favor of the stag-deflation scenario.
Korea also needs to be alert over the development of the global economy, as it isn't fully insulated from stag-deflation. Korea is now experiencing asset deflation amid the economic downturn, with its stock prices and home prices falling.
``It is nonsense for us to worry about deflation when inflation stays around 5 percent,'' a Seoul-based global investment bank economist told The Korea Times, asking not to be named.
``However, the government needs to be wary over how global market conditions will unfold, as the economy is especially susceptible to external shocks,'' he added.
Stag-deflation, as opposed to the stagflation of the 1970s when the economy had no growth and rising prices, is a term recently coined by New York University (NYU) Professor Nouriel Roubini.
This is the worst-case scenario where stagnation, recession and deflation take place at the same time, and the economy falls into a vicious cycle where falling prices put further constraints on the stagnant economy by dampening consumption and investment.
In an article in Forbes, Roubini, who recently came into the spotlight for his accurate prediction of the ongoing crisis, said that in the short- to medium-term, stag-deflation seems the most likely scenario for the world economy.
He pointed out that stag-deflation is being driven by four factors, which are a slack goods market, a ``recoupling'' of the rest of the world with the U.S. recession, a slack labor market, and a sharp fall in commodity prices.
``The four forces would reduce inflationary forces and lead to deflationary forces in the global economy,'' he said. ``Aggregate demand is now collapsing in the U.S. and advanced economies, and sharply decelerating in emerging markets.''
Several indicators supported his view. Yields on 10-year U.S. treasury bonds have fallen sharply since Oct. 14, while gold prices, a typical hedge against rising global inflation, are now also dropping precipitously.
Roubini's fears over global deflation ― annual falls in consumer prices ― are also backed by The Economist, a British economic weekly.
In its latest edition, the magazine reported that central banks, recently fearful of inflation, are now slashing interest rates to stop it falling too far.
``Deflation is increasingly likely next year. But recalling the 1930s, policymakers will be anxious to ensure that it does not take hold and turn crisis into catastrophe,'' it said, citing falling crude oil prices. It forecast that if raw material prices remain at current lower levels, the year-on-year change in the retail prices of food and fuel will turn sharply negative in 2009.
``The year-on-year fall in oil prices is likely to be steepest in the third quarter next year, when the base will be this summer's peak,'' it reported.
A global wave of rate cuts across the globe indicates that fears of deflation are gaining ground, which gives central banks a lot of leeway to cut rates.
Many economists said that concerns over stag-deflation are not implausible but chances are low that the global economy will go that way, citing economic stimulus packages in the offing around the world.
``I agree with Roubini that the risk of such a scenario is there. I think it is less likely than he does,'' Stijn Van Nieuwerburgh, a finance professor from the Stern School of Business at NYU, told The Korea Times.
``First, inflation is still high and has a long way to fall before it reaches zero. Second, there will be large fiscal stimulus in both the U.S. and Europe late this year and early next year,'' he added. ``Combined, I expect the world economy to grow much slower in the fourth quarter and the first quarter in 2009 and inflation to come down, but I think we will avoid a Japan-like scenario.''
Mauro F. Guillen, director of the Lauder Institute at the Wharton School of Business, echoed the view, saying, ``I think Roubini is correct in his reasoning, but he is making the assumption that growth will be negative all over the world. I am not sure that is the case.''
Some economists claim that stag-deflation scenario is out of the question, as Asian countries will remain resilient during the global recession.
``We do believe that inflation is way off the agenda in terms of policymaker concerns. However we are not expecting to see deflation,'' David Mann, head of Korea Research at the Standard Chartered Bank, said.
``Even with further economic de-leveraging in the West, China and India will continue to push on with their industrial revolutions,'' he added.
Morgan Stanley Asia's chief economist Sharon Lam also discounted stag-deflation scenario, saying, ``Commodity prices are not likely to go back to low levels, with secular growth from big economies like China and India.''