In an article discussing the drop in the year over year inflation rate in the euro zone to 0.4 percent, the New York Times told readers that the inflation rate could fall further, turning into deflation, which it told readers:

"causes consumers to delay purchases and undercuts corporate profits and jobs."

That is true of deflation, but it is also true of very low inflation. The reported inflation rate is an average of the inflation rate seen in millions of different goods and services being sold at millions of different outlets. At any point in time roughly half of these inflation rates are more rapid than the average inflation rate and half are less. This means that the prices of a large number of goods and services are already falling. Insofar as this is a factor causing a delay in the purchase of goods, we would already be seeing it. A further drop in the overall rate of inflation to make it negative would change the picture little.

In terms of the impact on corporate profits and jobs, the issue here is the real interest rate, which is the nominal interest rate minus the inflation rate. Any drop in the inflation rate means a higher real interest rate and therefore provides a disincentive for investment. Whether the inflation rate crosses zero and turns negative really has no consequence in this story.

The point here is important. The euro zone is already suffering from an inflation rate that is way too low, causing real interest rates to be far higher than would be desired given the weakness of its economy. The problems of deflation are not something that it may have to worry about in the future. Those problems are here now. The situation worsens anytime the inflation rate falls further, but crossing zero and turning negative has no particular economic significance.

I should probably also mention that there is huge error in measurement. The Boskin Commission, to the widespread applause of most elite economists, said that our consumer price index overstated the annual inflation rate by 1.1 percentage point. After some changes in the index were made, they said it still overstated inflation by 0.8 percentage points. There is no reason to think the euro zone measure is more accurate than the U.S. measure, which means if people follow our elite economists then they should believe that the euro zone already is facing deflation.

I should probably also mention that the Boskin Commission's estimates were pushed as part of an effort at the time to cut the annual cost of living adjustment to Social Security benefits. For some reason no one seems to mention their work anymore, even though the Bureau of Labor Statistics has not addressed most the sources of bias they identified.

 

Note: Typo corrected, "inflation" changed to "deflation." Thanks kea.

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