“Deflation: is it really a problem; if so, what should be done?” by Tony LATTER
University of Hong Kong
Deflation was benign during the late nineteenth century, but pernicious during the Great Depression. It has been extremely troublesome in Japan of late, but seemingly not seriously damaging in China. It has prevailed in Hong Kong for the past five years but, despite the pain it may have inflicted in certain quarters, notably in relation to the property market, real GDP this year is expected to be 20% higher than it was in 1998. Therefore, deflation need not necessarily spell disaster. However, it is likely, if it persists, to lead to sub-optimal macroeconomic outcomes, in particular because nominal interest rates cannot be negative. In Hong Kong, the Financial Secretary is for the first time forecasting no prospective resumption of positive inflation in the medium term; a non-negligible risk of continuing deflation can be inferred. Meanwhile, he projects the underlying potential growth rate of the economy as 3% pa. In such circumstances, it may be desirable to operate an active monetary policy, targeted at achieving modest positive inflation, but this would only be advisable if confidence in the new monetary order could quickly be established among markets and the international financial community. The present institutional framework within which the Hong Kong Monetary Authority operates may not be adequate to secure such confidence. Thus, Hong Kong may have little choice for the time being but to stick with its pegged exchange rate under the currency board arrangements.