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Home Publications Blogs Beat the Press Is Our Economists Learning? The Case of Deflation

Is Our Economists Learning? The Case of Deflation

Thursday, 05 June 2014 07:57

It was gratifying to see the following in the Washington Post:

"It's called 'lowflation,' and it's crippling Europe. It's, simply enough, inflation that's well below target. Now, there's a common misconception that low, positive inflation is alright, but low, negative inflation is the end of the world. As the IMF points out, though, these are continuum of the same problem. See, it doesn't really matter whether prices aren't rising enough or are actually falling. In either case, it's harder to pay back debts, harder for real wages to adjust, and harder for countries to regain competitiveness. Of course, deflation is worse than lowflation, but not so much that we should fear the former and not the latter. We should fear them both."

For those of us who have been making this simple point as loudly as possible for many years (here, for example) it is good news to finally see its truth finally recognized by the honchos in the profession and the reporters who defer to them. It just proves that if you say something that is true long enough, the right people will eventually repeat it.

Comments (7)Add Comment
written by Ryan, June 05, 2014 9:30
All I can say is wow. If it were the Times, I'd wonder of O'Dowd brought back extra to share with the newsroom. The WaPo? Wow!
written by Peter K., June 05, 2014 10:11
O'Brien is a young gun who I've been following since 2008 or so. He used to be at the Atlantic:


The IMF seems to be getting mildly better. As has Krugman who has repeated this point at his blog more often after focusing on Japan's disastrous deflation. O'Brien pretty much agrees with Krugman on things as many of us do.

He's one bright spot for the Washington Post. Last night Colbert hammered Amazon and Bezos, comparing him to Voldemort. The Amazon bit is at bout the 4:10 mark:

gotta get those real wages down, man....
written by pete, June 05, 2014 10:45
At least these bloggers, and Krugman, are quite honest about the mechanism by which unexpected inflation increases corporate profits, allowing firms to hire more workers at lower real wages. Most folks try and obscure this fundamental Keynesian point. E.g., AFLCIO was very (rationally) suspicious of this kind of trikery.
unexpected inflation is not the problem...
written by Peter K., June 05, 2014 3:11
Unexpected inflation is more of a problem for the 1 percent and savers, not wage earners. That's why we've had lowflation for too long. Last time we had unexpected inflation was the 1970s, 40 years ago, and Volcker crushed it.


"Wednesday, 04 December 2013 05:36

Binyamin Appelbaum had an interesting post about how many economists would like to see a higher rate of inflation to help recover from the downturn. The piece emphasizes the role of inflation in lowering real wages, with the argument that lower real wages are necessary to increase employment.

While there may be some truth to this point, it is worth fleshing out the argument more fully. At any point in time, there are sectors in which demand is increasing and we would expect to see rising real wages and also sectors where demand is falling and we would expect to see real wages do the same (e.g. Wall Street traders -- okay, that was a dream).

Anyhow, when inflation is very low, the only way to bring about declines in real wages in these sectors is by having lower nominal wages. Since workers resist nominal pay cuts, we end up not having this adjustment and therefore we end up with fewer jobs than would otherwise be the case. However it is an important qualification in this story that it is not about reducing real wages for all workers, only for some subset.

The other important point is that higher inflation promotes growth in other ways. First and foremost it makes investment more profitable by reducing real interest rates. Firms are considering spending money today to sell more output (e.g. software, computers, Twitter derivatives etc.) in the future. If they expect to sell this output for higher prices because of inflation, then they will find it more profitable to invest today. If we can keep interest rates more or less constant and raise the expected rate of inflation, then firms will have much more incentive to invest. This process seems to be working successfully in Japan at the moment.

Finally, inflation reduces debt burdens. Everyone who has debt in nominal dollars, such as homeowners, students, state and local governments, and the national government, will see the real value of its debt fall in response to inflation. This reduces their debt burden and makes it easier to spend. This would likely also be an important source of demand growth from higher inflation.

While many economists do emphasize the wage story, to my mind the other parts are likely more important. And, if higher inflation leads to more employment, this will increase workers' bargaining power and allow them to achieve wage gains that are likely to quickly offset any losses due to inflation -- although the Wall Street traders may not make up the lost ground.


Let me make a quick comment to clear up unnecessary confusion (can't do much about the deliberate confusion). The notion of inflation being a way to lower wages in the U.S. refers to the wages of some workers, not all workers. There are always industries seeing increased demand and some seeing reduced demand. The response to the latter would be lower wages. That is difficult to bring about in a situation of near zero inflation and nominal wage rigidity. By having higher inflation so that real wages can fall in these industries, we can increase employment, output, and real wages more generally. That is the argument. Folks can say why that may not work, but it's really not worth anyone's time to deliberately misrepresent it so you can say it's stupid."
IMHO it is total spending that matters
written by Floccina, June 05, 2014 3:56
IMHO it is total spending that matters. Why would we worry about deflation if spending and income are growing at a good clip. One could also see a situation were some major spending category, for example fossil fuels, got much more scarce and some prices rose but more people got into producing more fossil fuels and employment grew at a healthy clip.
I forgot to say spending is grow much too slow in EU
written by Floccina, June 05, 2014 4:01
I forgot to say spending is grow much too slow in EU.
It's an O'Brien thing
written by Larry Signor, June 06, 2014 7:17
He is a young man to watch. His analysis has been more interesting and insightful than most folks.

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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.