The Economist on good and bad deflation

The Economist magazine has a very good editorial discussing good and bad deflation, and worries that the world is now experiencing (at least in part) the bad type. They conclude by urging central bankers to rely on a less ambiguous indicator:

Change the target

Policymakers should be more worried than they appear to be, and their actions to avert deflation should be bolder. Governments need to boost demand by spending more on infrastructure; central banks should err on the side of looseness. (Next month the ECB will start quantitative easing””and about time too.) Now is also the moment to consider revising the monetary rule book””in particular, to switch the central bankers’ target from the inflation rate that most now favour to a goal for the level of nominal GDP, the total value of spending in an economy before adjusting for inflation. With such a target there is no need to distinguish between good and bad price shocks. And the change in rules would itself send a signal that policymakers are serious about banishing the threat of deflation.

Central bankers change course slowly, and their allegiance to inflation targets runs deep. Conservatism often serves them well. But in this case it could cost the world economy dearly.

Notice that they advocate “level” targeting, which is very important in a world where the zero bound seems to occur with increasing frequency.

HT:  Peter Spence, Frank McCormick

PS. I also recommend Edward Hugh’s post on Spanish deflation.



29 Responses to “The Economist on good and bad deflation”

  1. Gravatar of Brian Donohue Brian Donohue
    19. February 2015 at 12:08

    I imagine you find this sort of stuff gratifying. Keep up the good work.

  2. Gravatar of ant1900 ant1900
    19. February 2015 at 15:22

    OT1: Over the past month, the Hivemind prediction for 2015 NGDP is down from 4.7% to 4%.

    OT2: What ever happened to

  3. Gravatar of benjamin cole benjamin cole
    19. February 2015 at 15:42

    Excellent–and yet, on the ground, where is Market Monetarism?

    Both Plosser and Fisher leave the FOMC this year. The national FRB must approve regional Fed presidents–that is, successors to those two.

    As we know from the White House tapes, Nixon sought expansionists for the Fed.

    Maybe we can Nixonify Obama.

    MM’ers perhaps should find out about the selection process in Philly and Dallas. I will endeavor to do so.

    As they say, a minute of charitable action is worth a year of prayer.

  4. Gravatar of Major.Freedom Major.Freedom
    19. February 2015 at 22:51


    I looked at that Economist article but found it difficult to follow. I couldn’t figure out what free market idea for money they were comparing centralized conterfeiting induced NGDPLT to. “NGDPLT” is not a free market idea.

  5. Gravatar of Kenneth Duda Kenneth Duda
    20. February 2015 at 00:04

    Ben, that’s an excellent point. We should be trying to understand the FOMC selection process and identifying/supporting sensible candidates. Please let us know what you learn.


    Kenneth Duda
    Menlo Park, CA

  6. Gravatar of sdfc sdfc
    20. February 2015 at 01:54

    Couldn’t agree more with raising nominal income.

    However why you favour such an inefficient means of doing so is a mystery.

  7. Gravatar of Luis Pedro Coelho Luis Pedro Coelho
    20. February 2015 at 02:13

    One day, Krugman will write a post on the intellectual superiority of the Left because they support NGDP level targeting unlike the Crog Magnon Rightwingers.

  8. Gravatar of flow5 flow5
    20. February 2015 at 05:10

    As Friedman said: Inflation/deflation is a monetary phenomenon. Inflation occurs when there is a chronic across-the-board increase in prices. or, looking at the other side of the coin, depreciation of money. Inflation is not a temporary increase in the price level, nor a long-term increase in any particular prices.

    From the standpoint of the economy no overall index, or average of all prices, exists. Therefore, no single figure exists which represents the value of money.

    The evidence of inflation cannot be conclusively deduced from the monthly changes in the price indices. They reflect, in only a marginal amount, the inflation that took place in real estate.

    The price indices are passive indicators of the average change of a group of prices. They do not reveal why prices rise or fall. Only price increases generated by DEMAND, irrespective of changes in SUPPLY, provide evidence of inflation. There must be an increase in aggregate demand which can come about only as a consequence of an increase in the volume and/or transactions velocity of money. The volume of domestic money flows must expand sufficiently to push prices up, irrespective of the volume of financial transactions, the exchange value of the U.S. dollar, and the flow of goods and services into the market economy.

  9. Gravatar of flow5 flow5
    20. February 2015 at 05:12

    Any institution whose liabilities can be transferred on demand, without notice, & without income penalty, via negotiable credit instruments (or data pathways), & whose deposits are regarded by the public as money, can create new money, provided that the institution is not encountering a negative cash flow.

    See FRB-STL’s: “FRED” database:

    E.g., “Other Checkable Deposits at Thrift Institutions”

    I.e., the MSBs, S&Ls, and CUs were given the authority to issue NOW and ATS accounts (i.e., to become commercial banks). They eventually became commercial banks (after the S&L crisis).

    Their liabilities are accumulated and reported with the money stock numbers: M1, and M2. But their bank credit is not incorporated with “Bank Credit of All Commercial Banks”, and MSB and S&L figures (savings institutions), were reclassified and bundled in some other category on the Federal Reserve Statistical Z.1 release: “Financial Accounts of the United States”

  10. Gravatar of ssumner ssumner
    20. February 2015 at 05:34

    Thanks Brian.

    Ant1900, I’m not familiar with that site.

    Thanks Ben.

    sdfc, You don’t even know the means I propose. How can you know they are inefficient?

  11. Gravatar of Dan W. Dan W.
    20. February 2015 at 06:57

    Such a shame. The squirrel found the right nut but then opted to set it aside.

    “A third, well-known risk is debt deflation: debts become more onerous because the amount that is owed does not fall, even as earnings do. This is a big worry in the euro zone, where many banks are already stuffed with dud loans.”

    Eliminate bad debt and you will have economic growth. But as long as the bad debt must be maintained economic growth will remain tepid. This is a fundamental concept that has been around for millennia. But now we have the New Economics where there can be no recognition of bad debt. To do so would cause someone to endure financial pain and that just cannot be. Thus we get the gymnastics of bankers calculating how they can inflate away bad debt while never acknowledging it ever existed.

  12. Gravatar of Charlie Jamieson Charlie Jamieson
    20. February 2015 at 07:32

    Dan W, that’s it exactly.
    It’s a natural process that bad debt be liquidated. Lately, however, the forces who hold debt also control the central banks and political offices so that debt holders are protected even from their own foolish actions.
    If you want to boost growth and reduce wealth and income inequality, we’ll need to liquidate debt financial instruments.
    If it’s not allowed to happen in an orderly way, pressure will build up and the debt will be liquidated by war, revolution or depression.

  13. Gravatar of Britonomist Britonomist
    20. February 2015 at 09:01

    I decided to write a small piece on money creation from the perspective of the Bank of England and its implications for economic theory, any thoughts from market monetarists is welcome:

  14. Gravatar of Charlie Jamieson Charlie Jamieson
    20. February 2015 at 09:31

    Good piece, Britonomist.
    The Bank of England paper is starting to change the way people view the monetary system. The word is spreading.
    My takeaways at the time were: banks are not intermediaries, they create money; broad money matters, not base money; there is no multiplier, so take it out of textbooks; if you don’t regulate banks properly they will abuse their powers by creating so much debt/money that they proper flow of money seizes up; financial asset inflation is a major risk of today’s economy.

  15. Gravatar of Doug M Doug M
    20. February 2015 at 10:16

    Dan W.

    Agree with you 100% on bad-debt problems. Delays in recognizing bad debt are delays to recovery.

  16. Gravatar of Britonomist Britonomist
    20. February 2015 at 10:49

    Charlie, thanks.

    However, I disagree with you on a couple of points. First, I disagree that the fact banks create broad money must imply they are not intermediaries, my first few paragraphs in the article explain this. I also disagree that the only thing stopping an explosion of bank credit is regulation – well I may not completely disagree with this – but rather I disagree that you can use the Bank of England paper to argue such, as they explain how credit creation is constrained by their interest rate policy (unless you consider the Bank of England setting interest rates a type of regulation that is).

  17. Gravatar of Doug M Doug M
    20. February 2015 at 11:50

    “the only thing stopping an explosion of bank credit is regulation”
    I completely disagree with this statement.

    From a policy point of view, central banks (and regulators) want credit to expand at a rather consistent pace. And rapid increases in credit followed by contractions in credit exacerbate (are) the business cycle.

    The psychology of regulation, it to increase credit standards and risk controls after banks have lost money. This creates a tightening of broad money at exactly the wrong time. The regulatory framework deepens recessions and delays recoveries.

  18. Gravatar of Britonomist Britonomist
    20. February 2015 at 12:05

    Doug, just to be clear, that was Charlie’s position not mine.

  19. Gravatar of Doug M Doug M
    20. February 2015 at 12:17


  20. Gravatar of Charlie Jamieson Charlie Jamieson
    20. February 2015 at 12:55

    I see ‘money’ (loans) as a public utility of sorts. So in exchange for the ability to create money and earn interest, banks must be regulated.
    Otherwise they will blow themselves up, as we’ve seen in the S&L crisis in the 90s and the leveraged mortgage crisis in the 00s. In each case, other parties suffered as a result of their recklessness.
    Credit expansion of the right kind leads to long-term growth. Foolish credit expansion leads to short-term growth and then recession. And then critics blame the recession on tightening, rather than the too-fast expansion.
    I think interest rates are a minor restraint on lending. There are many, many factors that go into credit expansion — forecasts for growth is important and so, too, is moral hazard. Student loans are expanding, for example, because students don’t truly believe they will have to pay down those debts. They are playing the game the way they’ve seen it played.

  21. Gravatar of Steven Kopits Steven Kopits
    20. February 2015 at 13:22

    Well, now, Wal-Mart has just declared that it’s raising its entry level wages to $9 this year, and to $10 next year.

    It’s not clear what current entry wages are at Wal-Mart, but if they’re around $8 / hour, then we are seeing some mind-blowing wage inflation coming right at us. Wal-Mart’s plans affect 500,000 employees in the US and the chain is influential in setting retail wages in many communities around the country.

  22. Gravatar of assman assman
    20. February 2015 at 20:34

    Deflation is not the problem. Deleveraging is. And large business debts and financial debts are. The typical so-called deflationary cycle consists of businesses have massive debts and banks having a lot of NPLs.

    Businesses react by attempting to raise cash and they do this by firing workers and firesales. THe fired workers respond by spending less. The business respond by fire more. And so on. Banks of course stop handing out loans. And this the money supply contracts quickly.

    Deflation is an effect not a cause of this deleveraging cycle. The Keynesians and the classicals never understood the concept of deleveraging and debt based depressions and so they had to explain what happened during depressions. The answer they gave was that deflation caused people to rationally postpone purchases and thus businesses lower prices and so on. This explanation was always incredibly weak and poor.

    The solution to depressions is simple…ban debt. Easy peasy lemon squeasy.

  23. Gravatar of Scott Sumner Scott Sumner
    21. February 2015 at 09:54

    Dan, Not sure how that relates to this post.

    Britonomist, Here’s a suggestion. If you want to get people to read a very long post then don’t use the phrase “endogenous money” in the opening sentence. For people like me and and Paul Krugman, the term makes our skin crawl. It usually signals someone who doesn’t understand what endogenous means. That may be unfair in your case, just a friendly suggestion. Mountains of drivel have been written on endogenous money. Life is too short.

    For instance, look at the very next comment from Charlie:

    “My takeaways at the time were: banks are not intermediaries, they create money; broad money matters, not base money; there is no multiplier, so take it out of textbooks;”

    The multiplier is M/MB. For there to be “no multiplier” it would have to be true that there is either no base, or no monetary aggregate. Then they respond “but I meant the multiplier is not stable.” Duh, the textbooks say that. There’s no there there.

  24. Gravatar of Benny Lava Benny Lava
    21. February 2015 at 13:11

    Meh. This is the opposite of the problem in 2008, when rising oil prices caused the appearance of inflation but of course what really matters is purchasing power. In 2008 it was going down. Today it is going up.

  25. Gravatar of Britonomist Britonomist
    21. February 2015 at 14:16

    Scott, I use “endogenous money” because that’s what those theoreticians call their theories, even if it’s inaccurate it’s not a big deal, I’m not one to rename other people’s theories if I don’t like what it’s called.

    Regarding the multiplier, perhaps a better term would be ‘textbook multiplier’, because that’s what (some) textbooks present the multiplier as. I still have my textbook from John Sloman that was very popular for UK undergraduate courses. With the money multiplier, it presents a story where any surplus liquidity is immediately lent out again. Admittedly, they do stress that this is a simplification, but even their elaborations leave out crucial details about how credit creation happens in the real world.

  26. Gravatar of ssumner ssumner
    22. February 2015 at 06:08

    Benny, That’s exactly the point.

    Britonomist, All the textbooks I’ve ever used present the multiplier accurately. Leaving out “crucial details” may or may not be a problem, I’d need to know what those details are.

    My point is that lots of endogenous money people say idiotic things like “banks don’t lend out reserves.” As Krugman points out, that’s a meaningless statement because it’s a simultaneous system. As soon as you mention “endogenous money” people are going to worry that you plan to get into theories like MMT.

  27. Gravatar of Britonomist Britonomist
    22. February 2015 at 08:52

    Sumner, true but MMT is a new phenomenon, endogenous money theories/concepts have existed in the literature (mainstream and ‘heterodox’) long before MMT existed.

    I also agree that “banks don’t lend reserves” is a meaningless statement, it’s just semantics.

    I think what’s most pertinent is that the Bank of England is telling us in this paper that it provides reserves on demand to the banking system; under a system like that, a sudden exogenous increase in bank reserves would have very different implications compared to a regime where the Bank of England didn’t do this.

  28. Gravatar of W. Peden W. Peden
    22. February 2015 at 09:57

    “I think what’s most pertinent is that the Bank of England is telling us in this paper that it provides reserves on demand to the banking system”

    In the only sense in which this is true, it’s just the trivial fact that the base is endogenous under inflation targeting.

  29. Gravatar of Britonomist Britonomist
    22. February 2015 at 10:03

    It’s pertinent for instance because, assuming this also applies to the Fed (which I have been assured multiple times it does), it makes articles like this seriously flawed:


    “as banks transform their idle excess reserves into new loans and deposits””a process that is well under way””inflation undoubtedly will rise.”

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