Deflation continues: Prices down 0.8 percent in 2nd quarter

Consumer prices in the Cayman Islands have fallen for the past 18 months. The Consumer Price Index, which measures prices changes for a select basket of goods and services, dropped 0.8 percent in the second quarter compared to the same period in 2015.

It was the sixth consecutive quarter prices in Cayman have fallen when compared with the same period in the previous year, a report by the Economics and Statistics Office shows.

Commenting on lower unemployment figures, economic growth and prices, Minister of Finance, Marco Archer, said, “Currently, inflation is under control, more persons are being employed and there is increased spending and investment within our economy.”

Falling prices mean “that generally the cost of living has decreased and persons have a bit more disposable income that they can choose to spend as they wish or increase their savings,” Mr. Archer said.

Lower fuel prices, in particular, have pushed down the average charges for electricity, water and related services, gas and other fuels, as well as transport costs, he noted.

Economic theorists normally consider a wholesale drop in prices, also called deflation, as dangerous for the economy. This is because deflation is often an indication of slowing demand and consumers putting off purchases in the expectation that prices will fall further. This could result, according to traditional economic theory, in a vicious cycle of ever lower prices that in turn leads to a reduction in output, ultimately causing unemployment and a further reduction in demand.

In Cayman, however, the period of declining prices was accompanied by economic growth and falling unemployment. The unemployment rate dropped to 3.9 percent and the economy expanded by 2.4 percent in the first quarter of this year.

RBC economist Marla Dukharan says persistent deflation is indeed a problem when it reflects weak aggregate demand and consumption in countries that produce most of what they consume. But this is not the case in most Caribbean countries.

“As a result, deflation and growth are somewhat divorced in the Caribbean. So we can’t judge these phenomena through the lens of countries in the developed world whose economic structures vary significantly from ours,” she explained.

“We import 80 to 90 percent on average of everything we consume, with very few exceptions. When international commodity prices fall, as is currently the case with oil and gas and some other agricultural commodities we import, the lower cost of the imports is reflected in domestic prices falling once the retailers pass on the cost savings, and this is recorded as deflation.”

But deflation in Cayman is not a result of structural problems, she noted.

Local economist Paul Byles agrees and points out that in addition the Cayman Islands is primarily a service based economy with many of its clients overseas. “Clients in tourism and financial services won’t be impacted much, if at all, by a fall in prices locally in Cayman. So they will continue to set up their hedge funds, for example, or travel for vacation and, of course, this activity is what contributes to our continued economic growth,” he said.

“For example, a family looking to travel to Cayman will not normally postpone their vacation because they believe that local prices may drop even further. Similarly, a hedge fund manager will be driven by the need to act quickly in the financial markets and won’t delay the launch of a fund because of a potential drop in the fees of local service providers at a later date,” he added.

“This may explain why we are seeing both a fall in prices and continued economic growth in Cayman.”

Compared to the first quarter of 2016, prices fell by 1 percent overall. In addition to lower costs for electricity, gas and other fuels, down by 10.1 percent, and water, down by 5.7 percent, the Consumer Price Index highlighted a quarterly fall in food prices, such as fruit and vegetables, which declined 5.9 percent and 5.6 percent respectively, as well as 2.4 percent lower cost for meat products.

Even if deflation was perceived to be a structural problem in Cayman with negative consequences for the economy, there is little policymakers could do.

Traditional mechanisms such as fiscal and monetary stimulus would not be effective if the source of deflation is external, Ms. Dukharan said. A policy response to deflation would have come in the form of customs duties or in the direct control of domestic prices, which is not widely practiced and difficult to impose.

There is nonetheless a statistical effect that deflation has on gross domestic growth figures. Real GDP is calculated by deducting inflation from nominal GDP numbers. In the case of deflation, the inflation number is negative and effectively adds to real GDP growth.

This may explain partly the phenomenon of deflation occurring alongside growth, the RBC economist said.