GETTING THE DEFLATION VAPORS:

Deflation Nation: Could falling prices send the U.S. into a Japanese-style recession? (Robert Shapiro, September 10, 2002, Slate)

[D]eflation also can be malignant, as Japan demonstrates. There, a collapse in stock and real-estate prices triggered falling demand and rising unemployment. Consumers cut back, and so did firms; and as the economy slipped into recession, normal inflation receded. The downward spiral continued as banks called in loans collateralized by the stocks and real estate now worth a fraction of their former value. Bankruptcies spread, demand and employment fell further, and prices and wages began to actually fall. And the Japanese government found itself virtually powerless. Even as the Bank of Japan cut interest rates to stimulate the economy, the deflation was increasing the real cost of borrowing and investing. (A 1 percent nominal interest rate is a 3 percent real interest rate if prices are falling 2 percent.) When nominal interest rates hit nearly zero, the economy found itself in a classic "liquidity trap," in which high real rates and stagnant growth continue to discourage investment and spending, and the central bank can't reduce nominal rates further to do anything about it. That left Japan in a spiral of rising debt and stagnation. [...]

We could elude deflation entirely with a resumption of strong growth, but that's hard to imagine in the near future. Consumers have taken a multi-trillion-dollar hit in the stock market, and their household debt as a share of GDP is the highest on record. Nor are we likely to get help from foreign demand: In Europe, Japan, and Latin America, growth is slowing--and in many of these places, prices are falling, too. Business investment, the engine of the '90s boom, is also unlikely to revive strongly.

Still, there's no reason to expect the United States to endure anything like the spiral of deflation, debt, and bankruptcy that has gripped Japan. U.S. stocks did experience a bubble, but there's little evidence of another one in real estate that could burst. Moreover, U.S. bank capital standards are quite strict, leaving no prospect here of a Japanese-style banking crisis. Deflation won't make us stronger, as price cutting did for Dell; nor will it drive us to a Kmart-type bankruptcy, as it nearly has in Japan. Rather, the mild deflation that seems most likely here will probably dampen growth in the short term, but maybe with some long-term benefits.

As is typical of most pieces where mainstream journals suddenly discover things like the threat of deflation and the demise of Japan, this one has some basic facts right but fails to comprehend most of the big issues and implications. Most importantly, Mr. Shapiro ignores or didn't notice a vitally important series of differences between Japan and America.
Posted by Orrin Judd at September 15, 2002 9:57 AM