Deflation
I’ve gone a few rounds with some readers over this, but the reason I don’t want policymakers to be worrying about inflation is that we’re very close to a period of deflation. The recently released March CPI numbers, for example, saw the cost of living falling. That was nice for me, personally, since I have a job and I don’t think I’m at great risk of being laid-off in the short term. But it’s very troubling for the economy as a whole. The party line was that we shouldn’t panic about deflation because the “core” CPI—excluding volatile food and energy prices—was slightly positive.
But via Ryan Avent at his new Portfolio.com digs, I see that “more than 60 percent of the gain in so- called core prices came from an 11 percent jump in tobacco products,” a jump that was tied to a one-off tax increase to pay for children’s health care expansion.
The economy, in other words, is still under huge deflationary pressure. And that’s very bad. Businesses that are able to expand will tend to choose not to expand if they anticipate that prices will drop. And consumers will tend to delay discretionary purchases if they anticipate that prices will drop. And these deflationary expectations can form positive feedback and get us into a cycle out of which it’s very hard to break.
38 Responses to “Deflation”
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April 16th, 2009 at 10:21 am
The economy, in other words, is still under huge deflationary pressure.
No. The economy IS in deflation, and the models are not properly reflecting what is going on. Massive unemployment, rapidly falling price and drastic reductions (20%) in production, rail, port and intermodal traffic mean the real economy is deflating. If the reported numbers don’t match the underlying reports about the physical world of stuff, then the reported inflation numbers are off/wrong/cooked. Full stop.
max
['Who do you believe, them or your lying eyes?']
April 16th, 2009 at 10:32 am
The economy, in other words, is still under huge deflationary pressure.
No. There is no deflationary pressure at all.
The core CPI increased 2.2% over the last 3 months. The core CPI increased 1.8% over the last 12 months. Both figures are almost exactly at the 2% target we are shoting for.
The headline 0.4% decrease in inflation over the last 12 months is ENTIRELY due to gigantic decreases in energy and transportation. Every other sector has increased over that period.
It seems clear to me that, not only is there no deflation, but the focus on deflation by the likes of people like Matthew is simply a political ploy to try to spend more tax money.
April 16th, 2009 at 10:36 am
Mark Halperin’s response to this deflation was, I swear to god, “Better performance than the 0.1% rise economists had expected.”
For a leading political commentator to reflexively cheerlead for deflation? That is a dangerous signal that our media landscape is not at all reality-based. And, frankly, that they still are trapped in a philosophical mindset that boils down to: “what’s good for rich people is good for America.”
April 16th, 2009 at 10:44 am
The headline 0.4% decrease in inflation over the last 12 months is ENTIRELY due to gigantic decreases in energy and transportation. Every other sector has increased over that period.
Yeah, just look at real estate. That’s been booming, baby!
No problems here. Things are secretly AWESOME and getting better! Yep, we don’t need no stinking regulations. Or stimulus. Or, you know, healthcare or energy reform or anything. Because the market is TOTALLY fixing itself, and once it does, all those other problems will magically fix themselves, too.
April 16th, 2009 at 10:48 am
I’ll just note again that excluding energy if you are concerned about deflation is an extremely bad idea.
April 16th, 2009 at 10:56 am
The water rushes out before the tsunami. A period of deflation is a current possibility, and something we need to watch. But it will without doubt precede a period of seriously damaging inflation. Expect a U.S. inflation rate of 9% in 18 months. It won’t be the worst in the developed countries, and it may not be the lowest inflation rate in the upcoming cycle.
April 16th, 2009 at 11:01 am
That was nice for me, personally, since I have a job and I don’t think I’m at great risk of being laid-off in the short term.
No Matt, you mean it is fine for you because you are not over-indebted. Deflation is also good for unemployed people without debt. Foods and necessaries (as the Political Economists of yore used to say) are cheaper for unemployed people too. In other words, I agree with you, but come on. Let’s get basic stuff right.
April 16th, 2009 at 11:04 am
What the hell is tobacco doing in the “core” cost-of-living index? Lots of people live just fine without it. Tobacco is a luxury.
April 16th, 2009 at 11:07 am
One month does not a trend make. Call me again when you have a series of data points.
April 16th, 2009 at 11:12 am
Deflation is also good for unemployed people without debt.
To clarify, it is good insofar as lower living costs are good. But you are right to point out that it could make investment less likely and thus make job creation harder, which would suck for the unemployed.
April 16th, 2009 at 11:17 am
Tom Fuller Says:
“The water rushes out before the tsunami.”
There’s analogy to *illustrate* an argument, and then there’s argument by analogy.
“A period of deflation is a current possibility, and something we need to watch. But it will without doubt precede a period of seriously damaging inflation. Expect a U.S. inflation rate of 9% in 18 months. It won’t be the worst in the developed countries, and it may not be the lowest inflation rate in the upcoming cycle.”
You realize that this would require a massive economic resurgance, don’t you?
April 16th, 2009 at 11:22 am
Barry,
Yes, I do. I expect administration efforts to be rewarded starting Q4 this year with a period of above trend growth. Sadly, I think that inflation will mask this and erode many of its benefits.
April 16th, 2009 at 11:26 am
a jump that was tied to a one-off tax increase to pay for children’s health care expansion.
The tax increase did not go into effect until April 1. Were tobacco prices raised in anticipation of the tax increase? It wouldn’t surprise me, but it was not something that got much press before hand.
The bloomberg article did say without tobacco, core inflation would be the 0.1 percent everyone predicted. Imo, we’re past the period of deflation. (though there may be still one or two months of negative core cpi over the next year)
April 16th, 2009 at 11:27 am
I’ll just note again that excluding energy if you are concerned about deflation is an extremely bad idea.
Why? During the past 12 months, oil (the most important driver of energy prices) dropped by about $100/barrel. It is impossible for it to drop that much in the future. In fact, it is impossible for it to drop by half that much in the future.
There should be very little concern that future decreases in energy prices will contribute substantially to overall deflation.
April 16th, 2009 at 11:29 am
Yeah, just look at real estate. That’s been booming, baby!
Prices in the housing sector have increased by 1.4% over the past 12 months.
April 16th, 2009 at 11:33 am
Yes, I do. I expect administration efforts to be rewarded starting Q4 this year with a period of above trend growth. Sadly, I think that inflation will mask this and erode many of its benefits.
Why do you think this? What are the mechanics? Are you one of those gold bug nutsbags?
Best case scenerio, because unlike during the Great Depression all the major government are spending and lower rates and behaving rationally from experience,
Bernanke’s predictions are right and everything turns around except employment which turns around later. Obama enacts effective financial regulations so that our house is built on rock and not sand.
Worst case scenerio, banks in worse shape than people think, psychology remains bad, stimulus efforts aren’t enough and credit still doesn’t flow. We get stuck in a decades-long liquidity trap. Things have the potential to get really ugly.
“The water rushes out before the tsunami.”
Inflation happened in the 1970s because of relatively strong unions (and I’m pro-union). Unions are weak now. For someone to worry about inflation now is insane to me.
April 16th, 2009 at 11:37 am
Why?
Because energy prices are a leading indicator of general inflation/deflation.
Please note that doesn’t mean energy price deflation is guaranteed to be followed by general deflation. Rather, it means energy price deflation is an indicator of a risk of general deflation in the future.
But we went through this before. At this point, either you get the idea of a leading indicator or you don’t, and apparently you don’t.
April 16th, 2009 at 11:41 am
So, would raising consumption taxes be an effective means of fighting deflation?
April 16th, 2009 at 11:45 am
Inflation distorts economic behavior too and has the additional feature of being an effective additional confiscation of wealth. Deflation is one way to cure excesses of the economic cycle, and as far as these things go historically, the more “natural” way. When demand dries up, why shouldn’t prices drop? Why is it so obviously superior to stimulate more demand by pushing cheaper money into the system?
I agree it is the policy we have chosen, but only for the past 75 years or so. The policy has its limitations on effectiveness, however. Namely there is prevalent view that undoing inflation will be rather routine. Historically, it is not. The worst recession before this one was caused by the Fed cutting off lending essentially for an extended period until the people had confidence in the future stability of prices. Usually, inflation is ended by a total collapse of the inflated currency and a fresh start with a new foundation.
April 16th, 2009 at 11:48 am
Prices in the housing sector have increased by 1.4% over the past 12 months.
But this is worrisome, because places like Calculated Risk have been documenting other indications of declining residential rents. And yet the latest CPI numbers seem to be missing that decline, in which case the CPI may be overstating inflation. See here:
http://www.calculatedriskblog.com/2009/04/consumer-prices-decline-slightly-in.html
April 16th, 2009 at 11:51 am
I agree it is the policy we have chosen, but only for the past 75 years or so.
Right, and before that we went through a series of increasingly disasterous depressions, culminating in the Great Depression. Which is why we decided to try something different, and as a result got many decades of significantly moderated recessions instead of depressions.
April 16th, 2009 at 11:53 am
Inflation happened in the 1970s because of relatively strong unions (and I’m pro-union).
Other contributing causes to the 1970s inflation included the collapse of Bretton Woods, oil shocks, Nixon’s failed price controls, and a Fed policy that kept unemployment at an inflationary rate. None of those factors exist today.
April 16th, 2009 at 12:11 pm
But this is worrisome, because places like Calculated Risk have been documenting other indications of declining residential rents. And yet the latest CPI numbers seem to be missing that decline
Or, alternatively, the data is the data and the Calculated Risk folks don’t know what they are talking about. I know lots of people like to take a few anecdotes here and there and extrapolate. But I believe the data, not the anecdotes.
April 16th, 2009 at 12:23 pm
Bretton woods still collapsed, but likely to collapse further as dollar’s status as preeminent reserve currency declines. Price controls still failed. Fiscal stimulus directed towards reducing unemployment. Monetary policy directed at promoting borrowing and spending capacity of consumer even without real wage increases. Slightly different factors, not different enough.
The other great factor in our recent (past 10-20 years)success is the degree to which foreign central banks and investors have soaked up our excess dollars. When that slows down or reverses, we will have a brand new factor for too many dollars chasing assets in this country.
April 16th, 2009 at 12:32 pm
Or, alternatively, the data is the data . . .
The BLS’s data is not perfect and comes with a margin of error. Basically, for rents they conduct a survey of what they hope is a representative sample of landlords and tenants. Already, that introduces the possibility of modeling and sampling error. Moreover, on the theory that rents are not as volatile as other consumer prices, they don’t do the whole survey at once: instead, they divide it up into six panels, doing each panel twice a year. That further increases the possible monthy error, particularly if rents enter a period of higher-than-expected volatility.
I know lots of people like to take a few anecdotes here and there and extrapolate.
The sources for Calculated Risk have included an analysis by the firm Reis Inc. for 79 U.S. metropolitan areas, data from the National Multi Housing Council’s Quarterly Survey of Apartment Market Conditions, and so on. The BLS isn’t the only entity in the world capable of collecting data.
April 16th, 2009 at 12:40 pm
Slightly different factors, not different enough.
Nonsense. To take just one example, unemployment in 1969 was 3.5%. Today it is 8.5%. To call that “slightly different” is just being silly.
The other great factor in our recent (past 10-20 years)success is the degree to which foreign central banks and investors have soaked up our excess dollars. When that slows down or reverses, we will have a brand new factor for too many dollars chasing assets in this country.
There is no sign of this happening, and indeed the dollar has become even more attractive thanks to the rest of the world being in worst economic shape than we are. Which is why it makes no sense to imagine a foreign sell-off of the dollar happening during the U.S. recovery, since the world economic recovery is quite likely to lag the U.S. recovery.
April 16th, 2009 at 1:08 pm
I really find it amazing that any consumer would cheer for higher prices. It’s like having a prisoner ask for his sentence to be extended and not shortened.
Now you might be of the mind that deflation is bad for jobs or business, but you’d be mistaken. Businesses only lay people off when they’re not needed, not because they read about deflation in the paper. The fact is that many businesses hire during deflations, because they have a demand for their product that flies in the face of common perception of what deflation is supposed to mean. Now these may not be car, boat or tank manufacturing jobs, but expecting consumers to buy the same thing year after year is ridiculous. If this type of attitude had been held throughout history, then we’d style have buggy whips and typewriters being sold in the marketplace, since these were once the jobs that everyone felt they had to have.
Give it up, deflation is good for consumers and there is nothing to fear about paying less for the things you buy. You’re still going to buy things and that is what will keep people employed. Trying to to keep people in jobs making things that people don’t want to buy is the problem we’re really facing.
April 16th, 2009 at 1:22 pm
Deflation? Live with it. Stagnant prices? Live with it.
We need this window to print money. That’s the bottom line.
We will have inflation again, soon enough. The trick is to get through this crisis without producing Weimar levels of hyper-inflation.
April 16th, 2009 at 1:28 pm
I said this over at Kevin Drum’s place at MoJo (hate to be a bore). First, that deflation as a trend is bad because the incentive for employers is to minimize their expenses which is in part your wages. They trim hours, lay off folks and cut wages & benefits. The incentive for lenders is to raise interest rates and collect every penny possible on loans which you will be paying with dollars that are worth more than the ones you borrowed.
And second, that the energy/transportation sector of the world economy is–obviously–in a huge deflation. That’s not such bad news in the US because we are an importer of energy. But it cannot be good news that a large, important sector of the world economy is in deflation–even if it is a part that is associated with swarthy muslims and former KGB creeps.
April 16th, 2009 at 1:39 pm
Now you might be of the mind that deflation is bad for jobs or business, but you’d be mistaken. Businesses only lay people off when they’re not needed, not because they read about deflation in the paper.
Your business used to be able to sell its widgets for $100. Now it can only sell widgets for $90. But at $90, your business can’t afford to make widgets unless it cuts costs. And so someone gets fired.
A consumer is thinking about buying a car. But they don’t necessarily need one right now, and next month the same car will likely cost less. So they wait. And inventory piles up. And someone at a car factory gets fired.
You’re still going to buy things and that is what will keep people employed.
You get fired from your job at the car factory, so you cut back on spending, including eliminating your daily Starbucks run. Come to think of it, you are desperate for employment, and maybe Starbucks is hiring. Sorry, no, they were hiring a while ago, but business is down–apparently some people are cutting out their daily Starbucks runs.
Oh, and by the way, your neighbor was trying to get a loan to open a new Starbucks. That just fell through–apparently Starbucks isn’t expanding like it used to.
And so on.
All this isn’t just theory: they are observed, empirical facts about how economies respond to deflation. In short, they go into negative spirals which don’t just cause a restructuring, but rather cause a permanent loss of economic value.
April 16th, 2009 at 3:11 pm
Mark Thoma isn’t too worried.
April 16th, 2009 at 3:40 pm
China’s foreign reserves grew in the first quarter of this year at the slowest pace in nearly eight years, edging up $7.7 billion, compared with a record increase of $153.9 billion in the same quarter last year.
Unemployment was about 8.5% in 1975.
April 16th, 2009 at 3:53 pm
Inflation in the 1970s was due to the Unions? Sure let them take the blame.
How about the huge 1960s Vietnam/Great Society debts that Nixon decided to pay back by printing lots of dollars? Nah, monetary and gov’t fiscal policies have nothing to do with inflation.
There will be inflation due to the current desperate monetary and fiscal policies. Maybe that’s the best way to pay for the Bush debts, i don’t know. But deflation is the last thing anyone should be worried about.
April 16th, 2009 at 5:33 pm
Inflation in the 1970s was due to the Unions? Sure let them take the blame.
It was due to them having power, which they no longer have. It wasn’t “their fault” per se.
Here’s an example of the way things used to be: In May 1981, the United Mine Workers signed a contract with coal mine operators locking in wage increases averaging 11 percent a year over the next three years. The union demanded such a large pay hike because it expected the double-digit inflation of the late 1970s to continue; the mine owners thought they could afford to meet the union’s demands because they expected big future increases in coal prices, which had risen 40 percent over the previous three years.
At the time, the mine workers’ settlement wasn’t at all unusual: many workers were getting comparable contracts. Workers and employers were, in effect, engaged in a game of leapfrog: workers would demand big wage increases to keep up with inflation, corporations would pass these higher wages on in prices, rising prices would lead to another round of wage demands, and so on.
Once that sort of self-sustaining inflationary process gets under way, it’s very hard to stop. In fact, it took a very severe recession, the worst slump since the 1930s, to get rid of the inflationary legacy of the 1970s.
But as I said, this time around there’s no wage-price spiral in sight.
http://www.nytimes.com/2008/06/02/opinion/02krugman.html?_r=1&hp
The weakness of the union movement is a reason people shouldn’t be afraid of inflation. But for some reason people like to obsess about it, especially people of the conservative persuation who insist on blaming everything on power-hungry government officials.
In this crisis, in this debacle, the government is trying to fix the mess the private markets unleashed in their greed and fear and stupidity.
April 16th, 2009 at 6:00 pm
Peter, are you saying inflation does not occur in places without strong unions?
The recession in the 1970s did not halt inflation (see stagflation). What got rid of the “1970s slump” was direct intervention by the Fed to control the money supply (see Paul Volcker), which lead to the early 1980s recession, it was not due to weaker unions.
Look, monetary policy, which is to say printing dollars to pay off gov’t debts can (actually i should use the term “will” here) cause inflation.
That is undeniable. Whether Bernanke will know when to put on the brakes (and have the political will to do it) when his current policies start causing inflation, is the question. I say no to both.
April 16th, 2009 at 7:23 pm
Re: But it will without doubt precede a period of seriously damaging inflation.
Well, I have doubts about that. Sure, we may eventually (maybe middle of next decade) see inflation up in the 5% range again– though not for several years. But in order for a real inflationary spiral to get going wages have to be able to increase as well as prices. Otherwise, if sellers raise prices people can’t/won’t pay them, and inflation is halted dead in its tracks (supply and demand– some Econ 101 stuff really is true). Does anyone here foresee a time on the horizon when workers will be able to go into their bosses’ offices, demand a significant raise, and walk out with it? I sure the hell do not, and if you do I suspect you are smoking something.
April 16th, 2009 at 10:53 pm
Not that I am a big fan of unions, but I would not blame them for hte stagflation of the 1970s. The collapse of Breton Woods and the abandonment of the international gold standard are what caused the 1970s.
To clarify, it is good insofar as lower living costs are good. But you are right to point out that it could make investment less likely and thus make job creation harder, which would suck for the unemployed.
Actually, as people with savings see the purchasing power of their money grow, they will begin to spend and to invest (because they can get more stuff at lower cost), effectively ending the deflation, or bringing it to more reasonable levels.
You realize that [inflation] would require a massive economic resurgance, don’t you?
The government recently doubled the monetary base. You think that that won’t start raising prices really soon? If the government starts spending on all of the new programs that are in the stimulus package and the budget, you don’t think that that will raise prices really soon? As production levels start to drop, you don’t think that that will raise prices really soon?
Right, and before that we went through a series of increasingly disasterous depressions, culminating in the Great Depression. Which is why we decided to try something different, and as a result got many decades of significantly moderated recessions instead of depressions.
Most of the Depressions of the 1800s were not as long or severe as they are made out to be. The “Long Depression of 1873,” for example, occurred during a decade when the average annual real GNP growth was 6.8% (4.5% per person) and farm and manufacturing employment both increased by about a third. The severity of the Depression was exaggerrated because of the falling consumer prices, which modern economists have a phobia of.
Moreover, the Great Depression was the result of the inflation of the 1920s, and it was exacerbated by the Federal Reserve’s attempt to reinflate the economy from Q4 1929 to Q3 1931.
The real solution to the economic displacement of deflation is for wages to decline enough relative to the deflation to keep the businesses profitable. If businesses that sell a widget for $100 and make a profit of $5 a widget now can only sell them for $90 a widget can reduce labor costs by more than $5 a widget, they can remain profitable (as their suppliers also can reducel labor costs, and as material costs in general wil be falling, they probably will not need to reduce their own labor costs by that much, or anywhere near it).
Hoover pushed mightily on business not ot let this happen in the early years of the Depression (on the theory that high wages allowed people to buy more stuff), and this helped to contribute to the high unemployment rate. The fact that high wage rates do not help people who cannot find jobs did not occur to him.
If wages ultimately decline proportionally to the deflation, then the only big negative effect of deflation will be to increase the real debt of those who are in debt. If this becomes a huge problem, the obvious solution is to try to find some way to arbitrate between the most impossibly indebted people and their creditors – not to try to wipe away all debts by inflating them away.
April 16th, 2009 at 11:08 pm
From the Retired-Person-on-Fixed-Income Corner. I’m a lot more worried about inflation than deflation. Right now, for example, gas is just above two bucks a gallon and I can afford to visit my grandchildren. At five bucks…. I gotta give up something else to make that trip.