March 29, 2015


Deflation: the modern policy bogeyman (Gillian Tett, 3/29/15, Financial Times)

In 2009, the Bank of Japan conducted a public survey on deflation. The results were not what the esteemed central bank wanted or expected - at least not after a "lost decade" of falling prices. Instead of expressing horror at the idea of deflation, 44 per cent of those surveyed deemed it "favourable"; 35 per cent felt neutral about the phenomenon; and just 20.7 per cent described it as "unfavourable". Although a subsequent survey painted a slightly more negative picture, the pattern was clear. As Kathy Matsui, vice-chair of Goldman Sachs Japan, says: "More Japanese actually feel that deflation is a positive than a negative." [...]

[A]n institution called the Bank for International Settlements has just published a striking study of the history of deflation. The BIS, as it is known, operates as something of a central bankers' bank-cum-think-tank. Given its position, you might expect it to echo the orthodox view that deflation is a disaster. But in recent years the BIS has started to pump out some rather subversive research. Its deflation study - like that BoJ survey - goes against the usual grain: it argues that price falls are not always such a disaster, or a reason to panic. Sometimes they can be almost positive.

This argument will horrify most policy makers, not to mention mainstream economists. The BIS paper begins by pointing out that price falls are not so unusual. On the contrary, it states that "deflations were very common before the second world war". And even in the postwar period, there have been 100 or so transitory deflations in the 38 economies that the BIS studies and four persistent ones (in China, Hong Kong and - twice - in Japan).

The crucial point is that you cannot assume that falls in the price of goods (such as food or travel) and assets (shares, houses and so on) are the same. Economists typically assume these price falls go hand in hand, and use the "d" word to describe both. But their impact can differ.

When asset prices crash, this undermines growth because it shatters confidence and increases the size of debt relative to assets. But if the price of goods and services declines, the result is more mixed.

If wages stay high as prices fall, that can hurt productivity and undermine growth. Falling income can also sometimes make it harder to repay debt. But lower prices can boost consumer and corporate spending power, and thus confidence. And in practical terms, the BIS research shows that there have been numerous periods since 1870 when deflation occurred amid growth. "The evidence from our long historical data set sheds new light on the costs of deflations," the report states. "It raises questions about the prevailing view that goods and services price deflations, even if persistent, are always pernicious."

The simple reality is that we create more wealth more cheaply.  Pretending that's a crisis is silly on its face.

Posted by at March 29, 2015 7:45 AM

blog comments powered by Disqus