|Type of paper:||Essay|
|Categories:||Economics Macroeconomics Inflation|
Why is Deflation Bad?
Bulgaria is one of the European countries that has been experiencing sharp deflation since 2013 besides Cyprus and Greece. Its inflation level has been negative reaching almost that of the lowest inflation country (Zimbabwe) in the world with -2.2% in April 2016 (Mihaylov, 2016). Many factors have contributed to the increased low inflation in Bulgaria since late 2012. Among them is administered commodity prices, fixed exchange rates and the rise in the share of foreign value added domestic products (Goretti & Zhan, 2015). The deflation problem which has become a chronic phenomenon in Bulgaria is driven by both internal and external factors. As such, the country is experiencing reduced investments and innovation and consequently lowered revenue for the government.
Most of the Bulgaria deflation problems seems to be emanating from the political influence. For instance, just before the country experience negative inflation in 2014, it had serious political turbulence and social protests in 2013. The economy recovery may take longer considering that the coalition government that was formed experiences frequent political differences. The political chaos led to the increased government debt ratio increasing to 27% of the GDP from the previous year 18% (Peltier, 2016). Although the coalition government with the help of World Bank, International Monetary Fund (IMF) and the European Union are working together re-establishing banking system stress test, bank recovery, asset quality review and resolution directives, and Bulgaria country stills remains the poorest country in the European region with the GDP of 47% of the mean EU (Peltier, 2016).
The government of Bulgaria has made some efforts to curb the negative inflation in the country. Towards the end of the year 2013 and the beginning of the year 2014, the government of Bulgaria lowered the administered prices with the hope of reducing deflation. The electricity prices were reduced by 15% for the households. After the first cut of the administered prices, the strategy seemed to work towards positive inflation dynamics. However, after the second and the third cut, the administered prices offset the positive contribution that was obtained during the first cut and started contributing to deflation.
In September 20016, the deflation rate of Bulgaria was registered to be increasing by -0.6% (Eurostat, 2016). Lower food and oil prices are the major contributors to this deflation regardless of the increased chances of welcoming investors into the country. As such, the government of Bulgaria is taking major steps to welcome investors and to offer them adequate security convenient for business growth. For instance, in June 2016, the Parliament of Bulgaria passed an anti-corruption law as a major step in overcoming corruption which has been a primary hindrance to the investors (Riga, 2016). Additionally, the Bulgarian government is working with the members of the Eastern Committee of Germany Economy as a way of encouraging trade between Germany and Bulgaria. These steps could play a significant role towards stabilizing deflation in Bulgaria, especially if the government of Bulgaria remains committed to them.
Evaluation of Monetary Policies
Evaluation of monetary policies is another major step that can help stabilize deflation in Bulgaria. The Bulgarian banking systems were shaken tremendously in 2014 during the inflation that affected most of the European countries. Most people lost confidence in the banking sectors within the country, thus affecting the economy adversely (Woodford, 2009). Since then, the Government of Bulgaria has attempted to restore the public confidence by re-establishing the banking system with the help of the European Central Bank, the Bulgarian National Bank (BNB) and the Financial Supervision Commission (Country Transition Report Assessments: Bulgaria, 2016). Although no fruitful results have been indicated so far, the Bulgarian National Bank has set up strategies that will lower the deflation in the country. For instance, BNB has set policies that will govern local banks in the development of institutional framework for crisis management, improve internal organization and banking structure. The policies will also promote supervision and adoption of information technology in the banking sector in Bulgaria to promote communication, supervisory, exchange of information among the institutions and coordination (Mattich, 2014). Despite these efforts, economists argue that although the Bulgarian Bank has reduced its main rate to 0.00%, the county will continue experiencing deflation due to the falling oil prices that cause the lower price growth (Country Transition Report Assessments: Bulgaria, 2016).
According to the BTI Bulgarian Country Report 2016, the country is also regulating and tightening the policies for the retailers to disclose their turnover in accordance with the law (Bulgaria Country Report, 2016). The government took these measures following the reduction of taxes to the extent that it had the lowest tax rates in the European Union and to a level that it could no longer lower the rates. The government adopted these measures during the economic crisis to include bus transport offices, filling stations and vending machines into the revenue agencies (Bulgaria Country Report, 2016).
A critical analysis of the sources of Bulgarian deflation indicates that the inflation in the country is quite different from that in other Eurozone countries. It is not caused by specific policy instruments in the country but rather the protraction of economic stagnation. As has been indicated, the government of Bulgaria has played its role in curbing the deflation, but still, there are external forces that seem to be driving it. Historically, Bulgaria had higher inflation rates than most of the European countries before the economic crisis. By 2009, the inflation rate in Bulgaria was 3% after a serious drop. In 2013, the rate of inflation in Bulgaria had dropped to almost 0% but later fell below 0% in 2014. Following the deflation in 2014, Bulgaria had to meet the Eurozone convergence inflation criteria, although the deflation persisted.
Considering the negative inflation situation in Bulgaria and the attempts the Government of Bulgaria with the help of world financial institutional have made, it would be wise for the country to adopt the quantitative easing technique. Bulgaria would benefit from the quantitative easing method because the deflation already in the country’s economic system would lead to more losses in the already fragile financial institutions. Quantitative easing involves the purchasing of bonds and collateralized loans. However, the adoption of this technique will pose some challenges due to the structural systems of the financial institutions in Bulgaria.
Considering that some countries such as the US and Japan had previous applied quantitative easing and were able to rise from deflation, then it could be the only option for Bulgaria to get back to the normal functioning of its economy (Polak, 2016). The adoption of quantitative easing will help Bulgaria to reduce the pressure of long-term loans and interest rates. The reduced interests and pressure of long-term loans can encourage both internal and external investors to start new enterprises in the country. Consequently, the efforts that the government of Bulgaria is making to encourage trade between Germany and Bulgaria will stand higher chances to be successful and more Germans are likely to invest in Bulgaria. As a result, the country’s economy could be back to normal inflation rates in the near future.
Secondly, the use of quantitative easing policy has both direct and indirect impacts on the assets that are at a higher risk (Reith, 2016). For instance, buying of mortgage-backed securities can play a crucial role in stabilizing the housing market prices. Consequently, the value of the financial institutions in Bulgaria can stand firm against future economic waves (Polak, 2016). In line with this, the Bulgarian government efforts to work with the World Bank, IMF and EU to restore the stability of the financial systems in Bulgaria will receive an upper hand streamlining the strategies made. The local financial institutions in Bulgaria will also be in a position to work in collaboration with the Bulgarian National Bank to implement the proposed financial policies.
Lastly, quantitative easing is a technique that has been seen to work and stabilize the inflation in economies especially during a critical condition (Hausken & Ncube, 2013). Considering the fact that Bulgaria deflation was almost reaching that of Zimbabwe (the lowest in the world), it is important to employ quantitative easing policy in an attempt to restore the deflation to the normal rate. Employing quantitative easing can help to bring stability in the prices of oil in Bulgaria, the price growth and the overall financial sector. Bulgaria is also likely to reap other advantages from using quantitative easing such as increased GDP growth, inflation rate and lowered chances of immediate liquidity constraints and financial crisis.
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