CEPR - Center for Economic and Policy Research

Multimedia

En Español

Em Português

Other Languages

Home Publications Blogs Beat the Press Deflating the Post's Deflation Fears

Deflating the Post's Deflation Fears

Print
Friday, 01 July 2011 05:39

It's always fun to read the Post's editorials on economic issues, since you never know what you might find. For example, it recently told readers that reducing the annual cost of living adjustment for Social Security beneficiaries by 0.3 percentage points annually (i.e. 3 percent after 10 years, 6 percent after 20 years, and 9 percent after 30 years) "won't hurt."

Today we get the Post's assessment of the Fed's QE2 policy. It praises the policy for preventing deflation, which it says was a risk at the time the Fed started the program. Actually, it is hard to see how deflation was a serious risk in the fall of 2010 or much impact of QE2. The core inflation rate has been pretty constant over this period, running in the range of 1.0 to 1.5 percent, with nominal wage growth running close to 1.6 percent.

The Post also makes a common mistake in viewing deflation as some sort of grave economic threat. There are good reasons for wanting a higher inflation rate (e.g. 3-4 percent) as economists across the political spectrum have argued. Most importantly it would reduce the real interest rate at a point where the nominal interest is already stuck at its zero lower bound.

In this context, a lower inflation rate is worse than a higher one, but crossing zero holds no special magic. In other words, it is bad news if the rate of inflation falls from 0.5 percent to -0.5 percent, but there is no reason to believe that this decline in the inflation rate is any worse than the drop from 1.5 percent to 0.5 percent.

The Post may be thinking about the sort of rapid deflation that was seen at the start of the Great Depression, when prices were dropping at near double-digit rates. That kind of deflation makes any sort of economic planning almost impossible, but there was little risk that economy would see rates of deflation go that high.

The other oddity in the Post's piece is that it blames QE2 for the run-up in commodity prices:

"But the negative consequences of QE2 — all of them also foreseeable — have canceled out some of the positives. Perhaps the most important of these was a commodity price boom, caused by the fact that many investors used the Fed’s freshly printed money to speculate on grain or oil. The winnings accrued to a wealthy few, while the U.S. middle class coped with higher prices for groceries and gasoline."

There are two big problems with this story. First, much of the recent run-up in commodity prices is likely to be enduring, driven by rapid growth in China and elsewhere in the developing world. I don't know anyone betting on a return to $40 a barrel of oil.

However the other part is even more bizarre. Speculators did not need QE2 to speculate. The Post's editorial writers are probably too young to remember, but back in 2008, before the collapse of Lehman, most commodity prices were even higher than their recent peaks. The Fed was in a tightening phase at that point. Given that we saw a much larger speculative bubble just three years ago, when the Fed still had relatively tight monetary policy, why would anyone think that the current bubble was primarily due to the Fed's actions?

Oh well, that's why it is always fun to read the Post's editorials on economic issues. 

Comments (6)Add Comment
...
written by Moopheus, July 01, 2011 7:22
"Speculators did not need QE2 to speculate."

No, but it did help. Fed officials themselves have said that part of the point of buying bonds was to drive investor money out of the bond markets and into risker asset classes; i.e., to inflate those markets, including stocks and commodities. So it is not really unreasonable to feel there is a connection between QE2 and increased speculation.
...
written by izzatzo, July 01, 2011 7:47
In other words, it is bad news if the rate of inflation falls from 0.5 percent to -0.5 percent, but there is no reason to believe that this decline in the inflation rate is any worse than the drop from 1.5 percent to 0.5 percent.


Exactly. For example if the last engine still running on an airplane fails compared to only one engine failing among several engines still running it makes no difference since at the margin the failure rate is the same.
Wait, what?
written by Paul, July 01, 2011 9:15
The WaPo says QE2 was a good thing because it prevented deflation, but it was a bad thing because it caused some inflation? Who writes these things?

P.S. Dean, Great job on Fox News Wednesday night altho I was waiting for you to point out that T-Bond rates are lower now than when the budget was in surplus during the Clinton Admin.
Inflation Expectations Matter
written by Mark A. Sadowski, July 01, 2011 12:13
"Actually, it is hard to see how deflation was a serious risk in the fall of 2010 or much impact of QE2. The core inflation rate has been pretty constant over this period, running in the range of 1.0 to 1.5 percent, with nominal wage growth running close to 1.6 percent."

You're not looking in the right place. Inflation expectations fell off a cliff in the summer of 2010. For example the 2 year zero coupon inflation swap fell from 1.5% to 0.9% between early May and the end of August. After Bernanke's speech at Jackson Hole it rose straight through early May of this year to 2.7%. Since then, when the FOMC said there would be no QE3, it has been falling and is around 1.9% currently.
...
written by ted bundy, July 01, 2011 2:38
Mark A. Sadowski, commenter above, makes an excellent counterpoint.

However, 'Beat the Press' readers must keep in mind that Dean Baker does not believe in using movements in the financial markets to make assessments on the economy. His head is firmly in sand when the financial market moves don't bode with his prognostications.
...
written by RW, July 03, 2011 12:07
No they didn't need QE2 to speculate. But so many investors became convinced that QE and QE2 were inflationary that they piled into commodities to hedge against inflation.

Write comment

(Only one link allowed per comment)

This content has been locked. You can no longer post any comments.

busy
 

CEPR.net
Support this blog, donate
Combined Federal Campaign #79613

About Beat the Press

Dean Baker is co-director of the Center for Economic and Policy Research in Washington, D.C. He is the author of several books, his latest being The End of Loser Liberalism: Making Markets Progressive. Read more about Dean.

Archives