Deflation of the world economy
Self-reinforcing contractionary economic spiral
Deflationary tendencies impede the efforts of developing countries to improve resource allocation and efficiency, thus jeopardizing the success of such efforts. Deflation thus prevents many developing countries from reconciling debt-servicing with growth, despite the vigorous adjustment efforts and painful sacrifices they must make. It also obstructs the adjustment of the massive and unsustainable current account imbalances of certain developed-market countries. In the absence of more buoyant demand in the world economy, national trade and exchange rate objectives remain in conflict, damaging the prospects for exchange rate stability. The adverse consequences are not confined to the short-term. High real interest rates add significantly to structural budget deficits in both developed and developing countries. Low levels of investment harm the development prospects of developing countries by limiting capacity expansion and structural adjustment. The persistence of slack may also turn the cyclical rise of unemployment and fall in commodity prices into structural and secular problems.
The world economy now displays a wide variety of symptoms indicative of strong deflationary pressures: (a) In real terms international interest rates remain high, both by past standards and compared to rates of growth; (b) Commodity markets remain glutted, with a tendency for prices to weaken even more. To the extent that inflation is negligible, further drops in commodity prices tend to widen profit margins and lessen aggregate spending, while increasing interest rates for debtors; (c) In many developed-market economies, unemployment rates remain extraordinarily high. Poor sales prospects are deterring firms from enlarging capacity despite higher profit margins. Consequently the use of labour and raw materials is especially sluggish; (d) Markets for numerous products, including some of the most advanced technologically, are slack; this is reflected both in price movements and in a variety of practices that further close up the trading system; (e) Export markets in developing countries remain depressed, denying sales top businesses in both developed and developing countries.
(D) Detailed problems