WHAT is a central banker’s main job? Ask the man on the street and the chances are he will say something like “keeping a lid on inflation”. In popular perception, and in their own minds, central bankers are the technicians who squeezed high inflation out of the rich world’s economies in the 1980s; whose credibility is based on keeping it down; and who must therefore always be on guard lest prices start to soar. Yet this view is dangerously outdated. The biggest problem facing the rich world’s central banks today is that inflation is too low...More at the link, and in this companion article.
The most obvious danger of too-low inflation is the risk of slipping into outright deflation, when prices persistently fall. As Japan’s experience shows, deflation is both deeply damaging and hard to escape in weak economies with high debts. Since loans are fixed in nominal terms, falling wages and prices increase the burden of paying them. And once people expect prices to keep falling, they put off buying things, weakening the economy further. There is a real danger that this may happen in southern Europe...
What’s more, too little inflation will undermine central bankers’ ability to combat another recession. Normally, during a period of growth bankers would raise rates. But policy rates are close to zero, and central bankers are reliant on “unconventional” measures to loosen monetary conditions, particularly “quantitative easing” (printing money to buy bonds) and “forward guidance” (promising to keep rates low for longer in a bid to prop up people’s expectations of future inflation). Should the economy slip back into recession, the central bankers will find themselves unusually impotent...
11 November 2013
The risks of disinflation and deflation
From an article in The Economist:
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With an economy based on "hot-air" currency that isn't tied to physical resources,or economic productive capacity the rise and fall of inflation should leave us all a little twitchy. In the end we all have to worry if making more or less nothing out of nothing is worth tying something (our economies) to.ReplyDelete
It is quite humorous that virtually all of the comments for that article stand in stark disagreement. Deflation has been maligned, but it should be embraced. While it is true that extreme and rapid deflation is exceedingly damaging to the economy, all deflation is not evil. For some reason, certain Krugman Keynesian type economists equate all deflation with the extreme examples. Doing so is as silly as equating all inflation with Zimbabwean hyperinflation.ReplyDelete
Gradual deflation does not keep people from buying goods. Take plasma and LCD televisions. They become cheaper every year (in some cases, dramatically so) , and yet consumers still purchase them.
Inflation tends to benefit three groups: the government, the wealthy, and those with extreme debts. It tends to punish the working poor, as their income rarely rises as fast as the rate of inflation, and those who have saved, especially people who are at the age of retirement.
In general I would agree with you, but I would suggest that it is worthwhile to make a distinction between disinflation (a slowing or lower rate of inflation) and true deflation (an actual lowering of prices). The last significant deflation in the U.S. was during the Great Depression of the 1930s. I don't think you should predict with any certainty that prices of consumer electronic goods would be resilient during a true deflation (and the examples you cite of LCD and plasma TVs would be items purchased mostly by the wealthy and thus perhaps less susceptible to loss of discretionary spending by the general public)Delete
This article came out during our last period of (mild) deflation in 2009:Delete
It is a good starting point for looking at the other side of the argument. Yes, the 1920's was a long period of deflation (with 1921 in particular being extreme), followed by deflation due to the depression in the 30's. However, if you look at the big picture of the impact of gradual deflation on countries in the last 100 years (or further, as is the case for the UK), it is tough to link deflation to depression.
As far as LCD/plasma TV's, it seems like virtually everyone owns them these days. Even my family, though we very seldom watch television. It seems that unless a person is homeless, or odd (like my family), they own a newer style of television, and falling future prices didn't prevent that purchase.
Surely we must not conflate the falling in price of a single item, like LCD televisions, or even items in a single industry, like consumer electronics, with systemic deflation.Delete
When true systemic deflation sets in nearly everything drops in nominal dollar value. When you try to sell your house you cannot recoup what you paid for it. When you get laid off you cannot find another job without taking a (dollar valued) pay cut because the value of your labor is lower. Sure your living expenses are "lower" to compensate for that loss of income, but so is the value of all non-cash assets you have.
I would say a small amount of inflation or deflation isn't a big deal. +/- 2% per annum either way shouldn't hurt much.
However, I would favor the inflation side of the equation. Since inflation tends to hurt lenders (they lend "good" money and get slightly less good money in return) and help borrowers while deflation does the opposite.
Roy is correct that inflation helps the US government exactly because it is a MAJOR borrower. Other governments that regularly run a surplus (creditor nations) certainly don't think that inflation helps them.