“Hard to imagine,” unless you’ve studied economic history
Between 1929 and 1933, and again between 1937-40, the wholesale price level trended steadily downward. Since 1994 the Japanese economy has experienced a deflation rate of roughly 1% a year in the GDP deflator. What do all three of these famous deflations have in common? During most of the time banks held unusually large quantities of reserves, far above normal levels. High levels of reserves (often excess reserves) is one of the most characteristic stylized facts of prolonged deflation.
Here is Philly Fed Bank President Charles Plosser, quoted in the New York Times:
“I think the fear of deflation in and of itself is probably overblown, from my perspective,” Charles I. Plosser, president of the Philadelphia Fed, said last week in an interview. He said that inflation expectations were “well anchored” and noted that $1 trillion in bank reserves was sitting at the Fed. “It’s hard to imagine with that much money sitting around, you would have a prolonged period of deflation,” he said.
On a more positive note, here’s St. Louis President Bullard moving in our direction:
Fed Member’s Deflation Warning Hints at Policy Shift
By SEWELL CHAN
WASHINGTON “” A subtle but significant shift appears to be occurring within the Federal Reserve over the course of monetary policy amid increasing signs that the economic recovery is weakening.
James Bullard, the president of the Federal Reserve Bank of St. Louis, warned that the American economy was at risk of becoming “enmeshed in a Japanese-style deflationary outcome within the next several years.”
On Thursday, James Bullard, the president of the Federal Reserve Bank of St. Louis, warned that the Fed’s current policies were putting the American economy at risk of becoming “enmeshed in a Japanese-style deflationary outcome within the next several years.”
The warning by Mr. Bullard, who is a voting member of the Fed committee that determines interest rates, comes days after Ben S. Bernanke, the Fed chairman, said the central bank was prepared to do more to stimulate the economy if needed, though it had no immediate plans to do so.
Mr. Bullard had been viewed as a centrist and associated with the camp that sees inflation, the Fed’s traditional enemy, as a greater threat than deflation.
But with inflation now very low, about half of the Fed’s unofficial target of 2 percent, and with the European debt crisis having roiled the markets, even self-described inflation hawks like Mr. Bullard have gotten worried that growth has slowed so much that the economy is at risk of a dangerous cycle of falling prices and wages.
Among those seen as already sympathetic to the view that the damage from long-term unemployment and the threat of deflation are among the greatest challenges facing the economy, are three other Fed bank presidents: Eric S. Rosengren of Boston, Janet L. Yellen of San Francisco and William C. Dudley of New York.
As the Fed’s board of governors shifts, the doves are getting more attention.
President Obama has nominated Ms. Yellen to be vice chairwoman of the Fed. The Senate Banking Committee voted 17 to 6 on Wednesday to confirm her, though the top Republican on the panel, Senator Richard C. Shelby of Alabama, voted no, saying he believed Ms. Yellen had an “inflationary bias.”
Mr. Obama’s two other nominees, Peter A. Diamond and Sarah Bloom Raskin, who like Ms. Yellen are on track to be confirmed by the Senate, have also expressed serious concerns about unemployment.
. . .
“This is very significant,” Laurence H. Meyer, a former Fed governor, said of Mr. Bullard’s new position. “He has been one of the most hawkish members, but he is now calling for the Fed to ease aggressively. There seems to be no question he wants to do it sooner rather than later, and relatively forcefully.”
As you know, I have been emphasizing the very low TIPS spreads on 5 year bonds, currently about 1.4%. Inflation hawks often reply that these spreads are not reliable. But former inflation hawk Bullard seems persuaded:
Mr. Bullard said that inflation expectations had fallen from about 2 percent earlier this year to about 1.4 percent now, as judged by one measure, five-year Treasury inflation-protected securities.
The outcome could be an “unintended steady state” like Japan’s slow-growth economy. “The U.S. is closer to a Japan-style outcome today than at any time in recent history,” he wrote.
Along with changing the “extended period” language and resuming asset purchases, the Fed could lower the interest it pays on excess reserves “” the reserves the banks hold with the Fed in excess of what they are required to “” from its current rate of 0.25 percent.
Lowering interest on reserves? Where’d that crazy idea come from? But I still get frustrated by this sort of reasoning:
Richard W. Fisher, president of the Dallas Fed, said in an interview this week: “Reasonable people can argue that there’s a risk of deflation, but we haven’t seen it in the numbers yet.”
These two regional bank presidents [i.e. including Plosser], along with Thomas M. Hoenig of the Kansas City Fed, are associated with the hawkish camp within the Fed whose focus is continued vigilance on inflation.
If stable prices are the goal, and not 2% inflation, then why did the Fed run 2-3 % inflation for decades, only deciding to go for zero during the worst financial crisis in American history? Oh, I forget, opportunistic disinflation. (aka: “Having cancer is a good opportunity to lose some weight.”)
HT: Marc Stern and David Glasner
Tags:
29. July 2010 at 10:42
Point: if we liquidate 4M foreclosed houses, and refuse to let banks buy them directly, push mark to market on them as well, stop paying them interest on reserves, and run the insolvent banks out of the market.
The 4M winning low ball bids bringing 30-40% cash down payment – will get plenty of bank financing EVEN at higher interest rates.
There will be far less reserves. Far. Less. Reserves. Even at higher interest rates.
There will be less banks, rents will be lower, private capital will BE REJOICING in the streets. And our morals will be intact.
29. July 2010 at 10:59
*FED’S FISHER DOES NOT SEE ‘ANY DEFLATIONARY NET PRESSURE’
*FED’S FISHER SAYS ANY FURTHER EASING `PUSHING ON A STRING’
FYI
29. July 2010 at 11:59
What do all three of these famous deflations have in common? During most of the time banks held unusually large quantities of reserves, far above normal levels. High levels of reserves (often excess reserves) is one of the most characteristic stylized facts of prolonged deflation.
Holding money now is regarded as the thing to do since it is expected to be a good store of value due to low (or even negative) inflation expectations. Isn’t that sort of straightforward, or am I missing something?
29. July 2010 at 13:08
Hey Scott, I was going to ask you why the markets didn’t soar on Bullard’s comments, until I noticed that Plosser probably just canceled him out.
(just pulling your leg)
29. July 2010 at 14:18
“Between 1929 and 1933, and again between 1937-40, the wholesale price level trended steadily downward. Since 1994 the Japanese economy has experienced a deflation rate of roughly 1% a year in the GDP deflator. What do all three of these famous deflations have in common?”
Let’s try this comment here:
Is it possible that one common element of all those is that an economy has gone from supply constrained to demand constrained, contrary to what almost all economists say (aggregate demand is basically unlimited and therefore an economy is basically almost always supply constrained)?
29. July 2010 at 14:20
The real problem is the fed and almost all economists do NOT know the differences between price inflating with currency and price inflating with debt.
29. July 2010 at 14:20
@MW
This was exactly what Marriner Eccles said at a Congressional hearing in early 1935. “there´s no more MP can do. We cannot poush on a string”. Soon after they came up with the increase in reserves because the economy was “booming” and deflation had turned into inflation!
29. July 2010 at 14:41
aggregate demand is basically unlimited and therefore an economy is basically almost always supply constrained)?
Demand has to be able to be expressed, surely?
And, speaking as a “practicing medievalist” I find notions of modern economies being supply constrained a little odd (or, perhaps more precisely, what is taken as ‘supply constraints’). In a globally trading, technologically dynamic economy, supply constraints are transitory. Compared to past economies where harvests could fail (and transport capacities could not deal) or trade could collapse, our notion of supply constraints is almost laughable. Famine free growth is one of the great achievements of human history, and it only starts in C17th Netherlands.
29. July 2010 at 14:58
Morgan, This is the post for you. Found it at Tyler Cowen’s blog;
http://www.liberalorder.com/2009/09/the-oversupply-of-larger-homes.html
MW, Source?
Lorenzo, I also thought it was obvious.
jj, Some people claim that the rise about a week ago was due to rumors of tighter money.
Fed Up, I don’t know what you mean by demand constrained, so I can’t comment. Do you mean a liquidity trap?
Marcus, Good observation.
Lorenzo, I’m not sure if he was talking about a cyclical situation, or a long run constraint.
29. July 2010 at 15:21
Just provoking debate…
http://blogs.wsj.com/economics/2010/07/29/bullard-remarks-dont-signal-wider-fed-shift/?utm_source=feedburner&utm_medium=feed&utm_campaign=Feed%3A+wsj%2Feconomics%2Ffeed+%28WSJ.com%3A+Real+Time+Economics+Blog%29
29. July 2010 at 15:30
scott sumner said: “Fed Up, I don’t know what you mean by demand constrained, so I can’t comment. Do you mean a liquidity trap?”
I mean for the vast majority of goods/services there is more supply than demand or supply and demand are about equal.
For example, there were about 15 to 16 million vehicles sold a year right before the financial crisis. There did not seem to be shortages. However, were vehicles brought forward from the future because of debt? I say that because the term for vehicle loans was up to about 6 years showing strain on the monthly budget.
When the financial crisis hit, it affected the monthly budget (either from less home value extraction and/or lower weekly earnings). Now about 11 million vehicles are sold. Has capacity fallen?
29. July 2010 at 15:38
Lorenzo from Oz said: “aggregate demand is basically unlimited and therefore an economy is basically almost always supply constrained)?
Demand has to be able to be expressed, surely?”
I will try. Let’s say people buy a new car about every 6 years so that about 15 or 16 million are sold a year even though the vehicle will last 10 to 12 years or even more. They would prefer to buy about every 3 years but can’t afford too. The fed makes sure of this thru interest rates because they don’t want people demanding 32 million a year which can’t be supplied right now.
29. July 2010 at 18:32
Ah, RBC-theorist Plosser now posits all is sufficiently well to do nothing. Yet another Bush hack damaging the country. Sumner must be proud.
29. July 2010 at 19:57
Another great post. Maybe we can get Scott Sumner on the Fed board.
29. July 2010 at 22:51
“Between 1929 and 1933, and again between 1937-40, the wholesale price level trended steadily downward.”
Did between 1933 and 1937 happen because the USA went off the gold standard? Did the dollar fall in value? Was the USA attempting to export its way out of bad debt?
30. July 2010 at 02:13
Scott — source was Bloomberg. Quotes were comments from Fisher in the Q&A.
Marcus Nunes — thanks. To be clear, I am not suggesting I agree with Fisher, I simply thought his remarks would be of interest to readers of this blog.
30. July 2010 at 04:33
[…] Philly Fed President Charles Plosser doesn’t know much about the history of monetary policy, which is a problem for someone in charge of monetary […]
30. July 2010 at 06:23
marcus, That’s too bad.
Fed up, But demand depends on monetary policy. Of course demand is currently to low, but monetary policy can raise demand.
ISLM, Actually, I was criticizing Plosser. You seem to be the only one who didn’t figure that out. You must be proud.
Benjamin, I’m more likely to be named the Queen of England.
Fed, Up, Yes, it was because we left gold. No we weren’t trying to export our way out of trouble, we were trying to reflate the price level.
Thanks MW.
30. July 2010 at 22:24
Fed Up: I think you are confusing wants, which are unlimited, from demand, which is not–because people have to have the money (or, if bartering, the goods or services) to express their wants through transactions for it to be demand. Hence, as Scott says, (in a monetasized economy) demand depends on monetary policy .
31. July 2010 at 07:06
Lorenzo, I agree.