Good deflation/bad deflation

Here is Izabella Kaminska of the FT:

Robots, automation and technology may not be responsible for all the deflation experienced in Japan since 2000, but if they play a role “” any role “” is it really fair to call this deflation? Is there perhaps a difference between good deflation and bad deflation that we should now be differentiating?

Yes there is.  Indeed there’s a pretty large literature distinguishing between good and bad deflation (George Selgin, David Beckworth, and many others.)

Now what macroeconomic variable would allow us to distinguish between good and bad deflation?

Just one more reason to stop talking about inflation.  Kaminska continues:

Our crisis was very much Japan’s reflation opportunity. Yes a fair bit of the pick-up in inflation came from energy and food, but one does have to wonder if there is a bit of a whack-a-mole situation going on here. In other words, if Japan truly succeeds at reducing deflation (a.k.a importing inflation from abroad) then to what degree will this just resend deflation back abroad?

The sensible policy would be for all countries (with demand shortfalls) to depreciate their currencies at the same time.  Not against other currencies, but against goods and services.  It’s not a zero sum game.

HT:  Daniel Sherry

PS.  For new readers, the answer is NGDP.


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29 Responses to “Good deflation/bad deflation”

  1. Gravatar of Ashok Rao Ashok Rao
    9. March 2013 at 09:46

    You can excuse pre central bank America for general deflation. You can’t excuse Japan and its tight monetary policies.

    I don’t think tech growth was particularly great in Japan viz. the US. What is clear is that BoJ followed contractionary policies throughout, increasing rates whenever deflation stopped.

  2. Gravatar of Ashok Rao Ashok Rao
    9. March 2013 at 09:47

    You can excuse pre central bank America in the 19th century for general deflation. You can’t excuse Japan and its tight monetary policies.

    I don’t think tech growth was particularly great in Japan viz. the US. What is clear is that BoJ followed contractionary policies throughout, increasing rates whenever deflation stopped.

  3. Gravatar of Suvy Suvy
    9. March 2013 at 10:28

    Good deflation comes from increased production driving down expenses. Bad deflation usually comes from bankruptcy and liquidation.

  4. Gravatar of W. Peden W. Peden
    9. March 2013 at 11:43

    An example of good deflation right now would be Switzerland, where prices are falling at around 0.3% a year, but NGDP is on the trend it’s been from the 1990s onwards (about 2% on the latest figures) and where the trend rate of inflation has very steadily been falling for decades-

    http://research.stlouisfed.org/fred2/graph/?id=CHEGDPNQDSMEI

    http://research.stlouisfed.org/fred2/graph/?id=CHEGDPRQPSMEI

    Is Switzerland the model for how to run a small open economy? Incidentally, the Swiss central bank was also one of the more successful monetarist central banks in the late 1970s, 1980s and much of the 1990s.

  5. Gravatar of Geoff Geoff
    9. March 2013 at 13:17

    https://www.themoneyillusion.com/?p=19669

    “encouraging news of a drop in consumer prices” = certifiably insane.

    There wasn’t a response like “Consumer prices falling CAN be a good thing, provided that the cause(s) is(are)…”.

    Praising falling prices seems to be a universally insane thing to say…sometimes.

  6. Gravatar of W. Peden W. Peden
    9. March 2013 at 16:07

    Geoff,

    If that equals was in the post you linked to and if that post didn’t say what it says (a contextualised point about the economic situation in Britain) that would have been a great “gotcha” moment.

  7. Gravatar of Geoff Geoff
    9. March 2013 at 16:46

    W. Peden:

    I agree, it was a great gotcha.

  8. Gravatar of Liberal Roman Liberal Roman
    9. March 2013 at 18:02

    Jeffrey Sachs (one of world’s renowned economist):

    ‘The US economic emergency in late 2008 and early 2009 WASN’T REALLY AN AGGREGATE DEMAND crisis but a financial crisis’ !!

    http://www.huffingtonpost.com/mobileweb/jeffrey-sachs/professor-krugman-and-cru_b_2845773.html

    I don’t know whether to laugh or cry.

  9. Gravatar of ssumner ssumner
    9. March 2013 at 18:38

    W. Peden, Yes, the Swiss are pretty smart about money. But they also have a more flexible labor market than most countries, AFAIK.

    Geoff, You don’t think it’s insane to call deflation good news, when it occurs because of falling NGDP and soaring unemployment? Hmmm.

    Liberal Roman, Priceless. And when you stab somone who has the flu it’s not really a stab wound crisis, it’s a flu crisis.

  10. Gravatar of Benjamin Cole Benjamin Cole
    9. March 2013 at 19:20

    I am very dubious that “good deflation” can be sustained, on a microeconomic level. And what happens to real estate investment? In any deflation, it becomes sensible to simply stay in cash, and not invest. Thus perpetuating the deflation. I see perennial disintermediation.

    Investors migrate to government bonds, driving yields to zero.

    Japan, here we come.

    Secondly, what about all the screaming about the sin and immorality of inflation–does the immorality of non-price stability not apply to deflation as well?

    I like things that work. We know we had very good economic growth and prosperity from 1982 to 2008 in the USA, over a 26-year period, with varying rates of moderate inflation, through a dot.com crash and two or three wars, multiple administrations of so-so quality, and with all the structural impediments one would want.

    Why there is a fixation on zero inflation, or the putative virtues of deflation is beyond me.

  11. Gravatar of Benjamin Cole Benjamin Cole
    9. March 2013 at 19:22

    I meant to write, “On a macroeconomic level.”

    Oh, P.U.

  12. Gravatar of Mike Sax Mike Sax
    9. March 2013 at 19:24

    Is what distinguishes good and bad deflation whether it’s supply side or demand side driven?

  13. Gravatar of Mike Sax Mike Sax
    9. March 2013 at 19:29

    Jeffrey Sachs AKA “Dr. Shock” He loves austerity and thinks it’s the answer to every problem. In the 80s he went to Bolivia which was a very poor country suffering hyperinflation.

    When he was done it was a very poor country with low inflation-he used this line himself.

    His trouble is he thinks the U.S. today is in the same place Bolivia was back in 1985.

  14. Gravatar of W. Peden W. Peden
    10. March 2013 at 02:42

    Scott Sumner,

    Yes, I think that a flexible labour market becomes more important from about <1% inflation, because the wage rigidities that inhibit downward nominal wage movements seem to be regulatory failures. That explains, for example, why wage rigidity in Britain only became such a problem during the interwar period, after the restructuring of the welfare state and trade union laws.

  15. Gravatar of W. Peden W. Peden
    10. March 2013 at 02:46

    Mike Sax,

    “Is what distinguishes good and bad deflation whether it’s supply side or demand side driven?”

    Yes: deflation from a secular productivity boom is just prices doing their microeconomic function of signalling changes in the supply of goods, whereas deflation from a squeeze to NGDP is bad deflation.

    Re: hyperinflation and Sachs, austerity isn’t always the answer, but has there ever been a country that has successfully stopped hyperinflation without a dramatic disinflationary shock? Once the central bank’s credibility is totally gone, stopping rising inflation rates becomes a very different problem.

  16. Gravatar of W. Peden W. Peden
    10. March 2013 at 02:49

    Put another way: you can’t usefully adopt a gradualist n-1 rule for inflation/NGDP/the money supply when inflation is at >600% a year. People might tolerate a few years of unemployment from disinflatin, but no-one is going to trust a central bank to maintain above-natural-rate unemployment for 575 years.

  17. Gravatar of W. Peden W. Peden
    10. March 2013 at 02:49

    * disinflation

  18. Gravatar of Benjamin Cole Benjamin Cole
    10. March 2013 at 03:36

    Okay, you have general deflation going on, why buy equities or real estate?

    In general, if p/e’s stay the same, your stocks will be worth less in time. Cash is king, all right. Same on real estate, except you are taking risks

    Deflation will kill investment.

  19. Gravatar of Mike Sax Mike Sax
    10. March 2013 at 03:53

    W. Peden I’m not critical of Sachs for Bolivia-though noting while it was a good thing to get rid of hyperinflation the country remained with some deep problems which to this day haven’t been solved.

    My problem with Sachs is he seems to think the U.S. today is Bolivia in 1985

  20. Gravatar of Mike Sax Mike Sax
    10. March 2013 at 03:57

    W. Peden: So based on this distinction one explanation of the paradox of stagflation-where you have both high unemployment and high inflation, whereas the idea of the Phillips Curve at the time was that there was a tradeoff where you could have one of the two but not both-is that the inflation of the 70s was supply side inflation-both periods of the highest inflation in 1974 and 1979 were concurrent with OPEC’s oi shocks.

  21. Gravatar of W. Peden W. Peden
    10. March 2013 at 04:39

    Mike Sax,

    The supply-shocks were part of the story, but insufficient to explain either (a) the extent of the inflation or (b) its persistance over a prolonged period, even when real output growth in the 1970s as a whole was around the US’s long-term trend.

    Stagflation is only a paradox for bad economic theories. The absence of a long-term tradeoff between inflation and unemployment, such that one can have output shocks and high unemployment even with double-digit inflation, is not a paradox for theories that don’t feature an old-style Phillips Curve tradeoff.

    “My problem with Sachs is he seems to think the U.S. today is Bolivia in 1985”

    Yes, that’s certainly incorrect. Indeed, as far as inflation goes, what matters with deficits is not how big they are, but how they are funded.

  22. Gravatar of W. Peden W. Peden
    10. March 2013 at 04:47

    Benjamin Cole,

    Prices fell in the US from 1925 to 1929. I have heard that some purchases of equities took place during this period.

  23. Gravatar of ssumner ssumner
    10. March 2013 at 07:27

    Ben, As long as NGDP growth is on target, I don’t worry about deflation. But as a practical matter, if the US has deflation then NGDP will almost certainly also be inadequate.

  24. Gravatar of Geoff Geoff
    10. March 2013 at 09:17

    “Ben, As long as NGDP growth is on target, I don’t worry about deflation. But as a practical matter, if the US has deflation then NGDP will almost certainly also be inadequate.”

    So target NGDP, and then, if real goods producers outrun the inflation, such that prices fall, then abandon the original target, and inflate more?

    Goody. So committed are NGDP targeting theorists to NGDP targeting. Why not just say you want price inflation?

  25. Gravatar of ssumner ssumner
    11. March 2013 at 06:20

    Geoff, Ever considered a course in reading comprehension?

  26. Gravatar of Floccina Floccina
    13. March 2013 at 07:04

    To me that is the most convincing argument for NGDP targeting. Inflation or deflation could be due to a change is scarcity through technology or through something like peak oil or peak fossil fuel. So if fossil fuels require more expense to find and bring to market and so supply goes down and the price rises do we want deflation in other products to make up for that, I would say no.

  27. Gravatar of Floccina Floccina
    13. March 2013 at 07:13

    Benjamin Cole if deflation kills investment and NGDP is growing you will get inflation because productivity is a function of invetment.

  28. Gravatar of Saturos Saturos
    14. March 2013 at 02:28

    Yeah, just in case any new readers out there are unfamiliar with what this blog is about:

    NGDP NGDP NGDP NGDP NGDP NGDP NGDP NGDP NGDP NGDP NGDP NGDP

  29. Gravatar of Geoff Geoff
    23. March 2013 at 10:05

    Dr. Sumner:

    “Geoff, You don’t think it’s insane to call deflation good news, when it occurs because of falling NGDP and soaring unemployment? Hmmm.”

    NOPE!

    I think it would be insane to call a LACK of falling prices in a context of falling nominal demand a good thing.

    Prices SHOULD be welcomed as falling if there is a fall in nominal demand. That’s how unsold surpluses are prevented!

    Or did you have in your mind that falling NGDP is INHERENTLY a bad thing? Well, even by your own admission, it’s only bad if prices don’t adjust downward enough. So if you set up the scenario of falling nominal demand, and prices fall accordingly, then you have no justification to say that welcoming this is “insane”. It follows from your own convictions!

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