Is deflation bad?
Here’s David Andolfatto:
Everyone knows that deflation is bad. Bad, bad, bad. Why is it bad? Well, we learned it in school. We learned it from the pundits on the news. The Great Depression. Japan. What, are you crazy? It’s bad. Here, let Ed Castranova explain it to you (Wildcat Currency, pp.160-61):
Deflation means that all prices are falling and the currency is gaining in value. Why is this a disaster? … If you hold paper money and see that it is actually gaining in value, it may occur to you that you can increase your purchasing power–make a profit–by not spending it…But if many people hold on to their money, this can dramatically reduce real economic activity and growth…
In this post, I want to report some data that may lead people to question this common narrative. Note, I am not saying that there is no element of truth in the interpretation (maybe there is, maybe there isn’t). And I do not want to question the likely bad effects that come about owing to a large unexpected deflation (or inflation). What I want to question is whether a period of prolonged moderate (and presumably expected) deflation is necessarily associated with periods of depressed economic activity. Most people certainly seem to think so. But why?
So far, so good. There are lots of reasons to be skeptical of the notion that expected deflation is bad:
1. Wages and prices should adjust to expected changes in the price level.
2. Changes in the price level are not important; it’s changes in NGDP that impact the business cycle.
What puzzles me is the evidence Andolfatto uses to evaluate this claim:
Let’s take a look at some more recent data from the United States, the United Kingdom, and Japan. The sample period begins in 2009 (the trough of the Great Recession) and ends in late 2013. Here is what the price level dynamic looks like since 2009:
[Graph showing Japanese deflation]
Over this five year period, the price level is up about 7% in the United States and about 11% in the United Kingdom. As for Japan, well, we all know about the Japanese deflation problem. Over the same period of time, the price level in Japan fell by almost 7%.
Andolfatto then claims that Japanese real GDP per capita is up about 15% since the first quarter of 2009. I think the actual figure is about 10%, but even that is higher than the real GDP per capita growth rates for the US and Britain. Unfortunately this data doesn’t tell us anything, as the claim (by people like Paul Krugman) is not that expected deflation leads to lower growth, it’s that expected deflation leads to lower levels of output (due to downward nominal wage inflexibility.) It is unexpected deflation that leads to lower growth.
Then Andolfatto discusses the rise in Bitcoin prices, which means deflation of goods prices measured in Bitcoin:
One might think that given the prospect of continued long run deflation (price appreciation), that people would generally be induced to hoard and not spend their bitcoins. And yet, available data seems to suggest that this is not the case:
At this point data is presented that Bitcoins are used in about 65,000 transactions each day. I’m not quite sure what to make of that data—how many transactions would occur each day if Bitcoins were being hoarded? I also wonder about the claim that Bitcoin holders faced the “prospect of continued long run deflation.” How do we know this?
In my view deflation is neither good nor bad, just irrelevant. On the other hand falling NGDP matters a great deal, and should be avoided.
HT: Michael Byrnes