Don’t know how to end deflation? Ask a medieval king.

I may not post much for the next week, but if you are interested you can tune in to my debate with Lee Ohanian at

I just posted my first column, and three more are planned.  Professor Ohanian will also provide three responses.  I should mention that I was restricted a bit by the format.  I did slightly run over the 500 word limit, but I was also asked to take the side that “deflation is a currently a bigger risk than inflation.”  As you may know, I am more worried about prices rising at too slow a rate than too high a rate.  However I also think that outright deflation is less likely than “disinflation.”  In any case I don’t have much fear of high inflation, so I decided to take the “deflation” side of the debate.  It also needed to be written at a level for the average educated reader, not economists, so it wasn’t always possible to quickly sketch out these subtle distinctions.  In any case I did the best I could under those constraints, and will have two more shots.  There is much more I would have liked to say (and have said throughout this blog.)

Today’s news was full of reports that Japan just experienced its worst deflation in modern history.  I don’t have any specific complaints about news stories like this one:

“It looks like Japan is heading for another lengthy period of deflation,” warned Macquarie Securities economist Richard Jerram.

Against this backdrop, the Bank of Japan looks set to hold its key interest rate at the current low level of 0.1 percent for “a lengthy period,” he added.

What bothers me is the sort of implicit assumption in many of these stories that deflation is some sort of mysterious malady that simply fell on the poor benighted country of Japan.  And we don’t know what sort of medicine will solve the problem.  BTW, since deflation causes low interest rates, if I was Japanese I would not be reassured by the forecast that rates will remain low for a long time.

One thing that is so interesting about these news stories is that the finance ministers of medieval kings have laughed at the claim that deflation was a difficult problem to solve.  The “foolproof escape from a liquidity trap” (to borrow Princeton Professor Lars Svensson’s term), was to debase coins.  In the modern context, that would mean devaluing the yen.  This could be done by gradually making the yen a smaller and smaller fraction of the dollar.  Unfortunately, not only has the yen not been debased, its value has actually increased in the past few years.  BTW, I am not recommending that Japan target exchange rates, it’s just that I find it amusing to read press reports written as if the BOJ had somehow lost the mysterious secret known to all medieval finance ministers.  I’m pretty sure they know how to generate mild inflation, but they don’t want to.



9 Responses to “Don’t know how to end deflation? Ask a medieval king.”

  1. Gravatar of Alex Alex
    26. June 2009 at 13:43

    You don’t need a medival king. Jose Luis Machinea is still alive and kicking. You can asked him about how to create inflation… although he will probably tell you that Argentina in 89 was increasing the money supply to keep up with the soaring prices. In any case, if they want inflation just let me incharge of the BOJ for a while. I’ll charge a fee of a millon dolars per inflation percentage point. It’s a bargain if you think that it will save your country from another lost decade. That being said, I’m not responsible for any damage I might inflinct over the BOJ’s reputation…

  2. Gravatar of Bob Murphy Bob Murphy
    26. June 2009 at 14:41

    Scott, do you think the medieval kings get a bad rap for “debasing” their subjects’ coins? Weren’t they just providing for healthy economic growth?

  3. Gravatar of Lorenzo (from downunder) Lorenzo (from downunder)
    26. June 2009 at 20:19


    The coins belonged to the king (that is why his head was typically on them). “Clipping” coins was a serious offense because you were stealing the king’s silver. (Nowadays, coins are ridged to stop that.)

    So if it was wrong for subjects to debase the king’s coins, why would it be OK for the king to do so? Debasing the coinage was really about monarchs levying a surreptitious tax on their subjects. Trying to get the same amount of goods and services while expending less precious metal. The later Roman Empire seems to have debased the coinage because its ability to raise taxes were highly constrained.

    Debasing the coinage discouraged saving and longer-term transactions (and more transactions were “longer term” since communications were so slow). Debasing the coinage would discourage commercial activity, not encourage it. (This seems to have been part of what happened with the later Roman Empire, for example.) Mercantile states such as Venice realised the value in having a reliable coinage. As did the Eastern Roman (“Byzantine”) Empire, possibly in reaction to the experiences leading to the collapse of the Western Empire.

    So, the bad wrap for debasing the coinage was not unreasonable.

  4. Gravatar of Bill Woolsey Bill Woolsey
    27. June 2009 at 01:38

    At some point, disinflation is done.

    Why not accept a new long run growth path for prices?

    Nominal GDP still remains below an adjusted growth path,
    accounting for a disinflation.

    And, of course, if the Fed really wants to move to a lower
    inflation rate, they should say so.

    If they really just want to move to a lower growth path of
    nominal income at the same growth rate–well, what a bad idea.

  5. Gravatar of ssumner ssumner
    27. June 2009 at 05:08

    Alex, I have often had that feeling, and I recall James Hamilton once said in his blog something like “if the Fed can’t create inflation, let me have a try.”

    Bob, As long as the medieval kings were targeting NGDP growth at 5%, I’m OK with their debasement.

    Lorenzo, I agree (and obviously my reply to Bob was half joking.) Thanks for the history, as I don’t know much about that era.

    Bill, That’s a good point. A few responses.

    1. I don’t think the Fed wants a lower rate, as they are even more scared of liquidity traps than before. I think a well run forward looking policy could even get us your 3% NGDP target w/o liquidity traps, but their current procedure is susceptible to traps.

    2. I have advocated 5% from the point I started the blog (Feb, 2009) so I actually have a more conservative target than if I had picked mid-2008. I have a “let bygones be bygones approach.”

    3. I am OK with 2% inflation going forward, but we are still looking at less than one percent in the TIPS market for 2 years, and less than 1.5% for 5 years.

  6. Gravatar of Bill Woolsey Bill Woolsey
    30. June 2009 at 02:08


    If we moved to a 3% growth rate for GDP (nominal) in the third quarter of 2008, we were $481 billion below target in the first quarter of 2009 (as opposed to $705 billion with the 5% growth path.) The target for this quarters GDP (nominal) should be $14,688 billion as opposed to $14,986 billion. Of course, this quarter is about over. For next quarter it would be $14,798 billion as opposed to $15,174 billion.

    And.. last but not least…

    The target for third quarter 2010~

    On a 3% growth path it is.. $15,134 billion.

    With your current 5% plan it is $15,754 billion.

    I am unsure why you are telling me what “The Fed” wants. They question is what monetary policy is best. Taylor rule thinking has failed. We need inflation all the time so that backwards looking short term interest rate targetting using open market operations in T-bills will allow the high target inflation rate to be acheived looks to me like a confusion of ends and means.

    But I suppose your support of 2% inflation to ease the lowering of real wages would work even better with 3% inflation, or 5% inflation, or 1000% inflation.

    As you can imagine, I don’t agree with this approach. I think the problem is confusing relative and nominal prices. And that includes wages. And if the relative wage for some sector drops, then the best signal of this is a surplus of labor and current nominal wages, and a need for lower real wages. If labor supply is highly elastic in a particular sector, then maybe people should shift to jobs in higher wage sectors.

    If all that needs to happen is that the purchasing power of money should change, then any unemployment caused by a surplus of labor at the current trajectory of wages is a mistake.

    If real wages need to change in general, rather than a signaling of changes in the appropropriate composition of employment of the labor force, then I don’t see any reason why having prices adjust at an unchanged growth path of average wages isn’t an appropriate signal. While such changes in productivity will generally be associated with
    changes in relative wages, those can be signaled by changes in nominal wages. (Some rise more, some rise less, or even fall.)

    And so, nominal income targetting at the trend growth rate of output.. a 3% target, looks to me to be the best macroeconomic framework.

    Dealing with sticky wages with planned inflation seems to me to be a mistake.

  7. Gravatar of StatsGuy StatsGuy
    30. June 2009 at 06:21

    Little attention seems to be given to the role of the Yen Carry Trade in Japanese deflation. Much of the Japanese money supply (created by borrowing in Yen) went to buy foreign currencies to pay for higher-yielding investments. I struggle to understand what effect this had (on domestic consumption, expectations of those dollars coming back to yen in the future, trade balance, exchange rate, etc.).

    This seems rather important right now, since we’re starting to observe a dollar carry trade. This trade is financed by very low short term rates (via govt.), but the dollars are being used to buy foreign assets with the expectation of dollar devaluation and hard asset appreciation.

    Viewed in another way, the Fed is subsidizing transactions that are effectively short-selling the US dollar. Have to wonder if it’s time to move from broad to more focused instruments.

  8. Gravatar of ssumner ssumner
    30. June 2009 at 11:27

    Bill, You make a good point. BTW, i simply meant my 5% proposala smore conservative than if I had started from mid-2008. i didn’t mean it was more conservative than yours.

    I suppose one thing holding me back here is that i am dealing with two issues, and tring to avoid confusion. One issue is what should the fed do know unde rtheir current policy regime? And that is the major emphasis of this blog. The other issue is what is optimal. I am certainly sympathetic to the idea that 3% NGDP comboned with NGDP futrures targeting, may be better than 5% under the same regime. Futures targeting takes the lquidity trap off the table, in my view, and onlt leaves downward wage rigidity. Is it important? i really don’t know. On your side lower inflation is better for investment, because we tax nominal returns.

    But in my blog I may still throw out the 5% NGDP number for purposes of influencing current policy.

    Statsguy, Obviously it might have some effect, and to be honest international macro is not my area. But I am still pretty sure that in the long run it is more effect than cause. The bottom line is that a determined central bank can always supply enough money to depreciate its currency. Japan has been in this rut for 15 years, its time they got a bit of inflation and higher nominal rates. As long as deflationary Japanese monetary policies drive nominal rates to zero, borrowers will be tempted to try the carry trade. But Japan can do something about that situation.

  9. Gravatar of happyjuggler0 happyjuggler0
    19. July 2009 at 17:12

    html test. Please ignore.



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