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The real implications of declining inflation rates

Mar 27,2021 - Last updated at Mar 27,2021

The level of decline recorded by the inflation rate in Jordan deepened in 2020, measured by the relative change in the consumer price index, to reach 0.3 per cent, compared to an inflation rate of 0.8 per cent for the year 2019. This rate continued to decline in the first two months of the year 2021, with inflation registering an insignificant increase, at just 0.02 per cent.

Undoubtedly, this rate mainly reflects the decline in price levels of a large number of goods and services included in the citizen's consumption basket due to the decline in demand resulting from the closures that occurred as a result of the spread of the coronavirus pandemic during the year 2020.

As an economist, I do not only care about explaining the reason for the decline in inflation significantly, but what matters to me most is that this decline is a reflection of the worsening decline in economic growth rates. It is an indication that the state of contraction in the economy will last for a longer period, which will raise unemployment rates further.

In countries that target specific inflation rates — Jordan is not one of them — at a level of 2 per cent, for example, the goal is to avoid the costs of higher inflation level that exceed the target, and at the same time to avoid the difficulties of deflation, in the case of recording negative inflation rates.

When inflation is low and stable at 2 per cent, for example, companies will have more confidence and will be more likely to attract investment, which leads to increased production capacity and enables higher rates of economic growth in the future. Moreover, consumers will also feel more confident about their long-term financial plans because they know that the purchasing power of their money is preserved.

Low inflation at rates of 2 per cent in normal times also leads to a decrease in the nominal and real interest rate, which basically reduces the cost of borrowing and increases the demand for credit, and thus contributes to achieving greater economic growth rates.

When analysing inflation, regardless of its levels, one cannot ignore looking at market interest rates, economic growth rates, and most importantly unemployment rates. Interest rates in the Jordanian market decreased significantly following the decision taken by the Central Bank in March of 2020 lowering monetary policy’s interest rates.

Under normal circumstances, low interest rates require a minimum period of time of not less than nine months, to be reflected in the rates of economic growth.

The rate of economic growth, which is expected to record a decline of 3 per cent in the year 2020 in Jordan, has direct effects on the unemployment rates, which rose to 24.7 per cent in the fourth quarter of 2020.

It is clear that the relationship between inflation and unemployment in Jordan has been negative and stable for many years; this indicates that the Phillips Curve has been operating effectively in the case of the Jordanian economy for at least 10 years and not, as the experiences of the developed countries indicate that it only works in the short term. Although the original concept of the Phillips curve was disproved due to the stagflation of the 1970s in the developed countries, the reality of the Jordanian economy proved the opposite.

The downward trend in inflation rates for the past 26 months in Jordan, which strengthened in the first two months of this year, deepens the fear that the inflation rate will slide to a negative level, as happened in 2015 and 2016; this increases the possibility that the economy will remain in a state of deflation (recession) for a longer period.

Therefore, it might be worthwhile, at these times, for the Central Bank of Jordan to seriously discuss transitioning to inflation targeting policy.

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