February 27, 2016

IT'S A DEFLATIONARY EPOCH:

Stuff Keeps Getting Cheaper (Justin Fox, 2/26/16, Bloomberg View)

The great durable-goods deflation is what I'll focus on today. It does not appear to be driven by central banks and their ability to create and destroy money. "Inflation is always and everywhere a monetary phenomenon," Milton Friedman wrote, and that presumably means that deflation is always and everywhere a monetary phenomenon, too. But monetary forces sweeping across the whole economy don't explain why durable-goods prices would follow such a different trajectory than other prices. So what does explain it?

One explanation is that goods (both durable and nondurable) are tradeable while services generally are not. That is, unlike most services, goods are bought and sold across national borders. So the rise of China as a giant new low-cost producer of manufactured goods in the 1990s and 2000s put lots of downward pressure on durable-goods prices, but not so much on nondurable goods (the three main categories of nondurables are food, energy and clothing, and China is a big exporter of only the third) and none at all on services.

The other explanation is that manufacturers of durable goods keep getting better at making them. The economics term for this is multifactor productivity growth, and it's been much higher for the past few decades in durable-goods manufacturing than in nondurable-goods manufacturing. Productivity growth in services is harder to measure, but seems to have been lower than in manufacturing (although there's some argument about that).

It's not just that durable-goods manufacturers have gotten more efficient in making things. It's also that they churn out products that are often vastly superior to those of the past, most notably computers and other electronic devices. Government inflation measures in the U.S. incorporate "hedonic quality adjustments" to try to reflect such improvements. These adjustments are often criticized by skeptics as a manipulation of the inflation rate, but they can't really be avoided. Yes, an iPhone costs a lot more than a Princess telephone did 25 years ago, but it is capable of exponentially more. And a low-end Android phone that does almost as much as an iPhone costs less than a Princess does now!

Technological progress (the driving force behind multifactor productivity growth, and also of the huge gains in living standards over the past two centuries) is a wonderful reason for persistent durable-goods deflation. Global competition isn't bad either. Brian Barnier, the consultant and economic-data maven who gave me the initial idea for this column, sees goods deflation as a cause for economic optimism.

Posted by at February 27, 2016 10:12 AM

  

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