When will it ever end? The latest consumer price index report shows prices still dropping. We have now been in deflation since May 1998; how much further do we have to go?
It is a question that many economists looking at Hong Kong have asked and, as usual for economists, there is very little agreement between them. Why not add to the disagreement? Here we go.
Let us start from the assumption that the biggest governing factor is the currency link to the US dollar. This assumption says that there is open and free trade between the United States and Hong Kong and, if the exchange rate is fixed, then there should not be much difference between them in prices of consumer goods.
If there were, then clever traders would take advantage of the disparity and their arbitrage of these prices would bring inflation rates back into line.
It does not work quite as neatly as that and certainly not as quickly but it must clearly be an influence on prices in Hong Kong and the deflation we are now experiencing is evidence of it.
So let us go back to January 1984, three months after the peg to the US dollar was adopted and assume that prices then were pretty much at the same level in both the US and Hong Kong. We shall thus restate the CPI of each on a basis of January 1984 equals 100. What does the picture look like now?
The first chart shows you the answer. We still have a long way to go, years in fact, before our consumer prices come back in line with those in the US. If this chart tells the story and differences with US inflation are the most important determining factor of Hong Kong consumer prices, then tighten your belts. The end of deflation is not yet in sight.