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Home Publications Blogs Beat the Press Moderate Deflation Is Just an Inflation Rate That Is Too Low

Moderate Deflation Is Just an Inflation Rate That Is Too Low

Monday, 11 March 2013 04:46

Zero holds a bizarre place in policy debates. In the United States we have many policy types who seem to worship a balanced budget. At the start of the last decade there was a modest clamoring on the right for a monetary policy targeting zero inflation. In the same vein we continue to see assertions that deflation would pose some inordinate problem, as though something awful happens when the change in the aggregate price level turns negative.

The culprit today is the NYT, which has an article on the European Central Bank's decision to leave its short-term interest rate unchanged. At one point it told readers that deflation is:

"a broad decline in prices that, by discouraging consumer spending and business investment, can be more economically destructive than runaway inflation."

Actually, a moderate rate of deflation (e.g. less in absolute value than -1.0 percent) would have only a very modest impact in depressing demand. The inflation rate is an aggregate of hundreds of thousands of price changes. When the rate is near zero, many of these price changes are in fact negative. (Some are negative because of imputations of quality improvements by government statistical agencies, as has often occurred with new cars and computers. Actual prices in the market may be increasing.)

The shift from a low positive inflation rate to a low rate of deflation simply means that the price change is negative for a larger share of these items. It is not remotely plausible that this shift can have disastrous economic consequences.

There is a story where falling prices lead to more rapidly falling prices, which would have a devastating impact on the economy, but this acceleration downward is no more likely (and probably less likely) than a sudden acceleration upward. As a practical matter, the economy would benefit from a higher rate of inflation, since that would reduce real interest rates and thereby spur growth. In this sense, a 0.5 percent rate of deflation is worse than a 0.5 percent rate of inflation in the same way that a 0.5 percent rate of inflation is worse than a 1.5 percent rate of inflation. There is no magic to crossing the zero line.

Comments (5)Add Comment
written by Theo Clifford, March 11, 2013 7:19
Zero is important.

Prices and in particular wages exhibit strong downward nominal wage rigidity - they get a lot stickier as inflation approaches zero.

This implies that a fall in inflation from 0.5% to -0.5% would result in a larger short-run rise in unemployment than a fall in inflation from 1.5% to 0.5%.
written by Merijn Knibbe, March 11, 2013 7:41
Indeed. But:

A. Inflation in Japan was during the last quarter of 2012 4%, after decades of moderate inflation. Hmmm.
B. And wages are a price to. When wages decline we go right into debt deflation at the present levels of debt. Surely when real wages decrease. The rate of wage increase in the USA, 2012, was 1,4%, the lowest since ... 1948 (and 2009). Despite job growth. Despite modest economic growth.

We do have to prevent such occurances from happening.
written by skeptonomist, March 11, 2013 8:50
A sudden major acceleration of inflation is highly probably, possibly inevitable, in case of several types of events that raise oil or food prices (specifically grains). There is nothing that could cause a corresponding acceleration of deflation, at least nothing of this sort has happened since the Great Depression.
written by Jim A., March 11, 2013 1:03
And deflation hasn't been terrible for the telecommunications or computer industries. Although it didn't do the airlines any favors.
written by Rademaker, March 11, 2013 2:25
All of this in addition of course to the fact that measuring a change in a broad range of prices is not an exact science. What is 0% on one inflation metric is something different on another. There is no absolute significance to the 0% mark on any individual metric.

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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.