It’s fascinating to see how glibly and assuredly financial commentators and their guests have been talking about both inflation/deflation since the onset of the Great Recession. What I keep thinking when I hear them is that to have practical experience of either phenomenon someone must either have lived in Japan or an emerging economy, or been an adult during the 1970s. So most of these “experts” are just rehashing what they learned in a textbook.
What I think is important to consider about either inflation or deflation:
–what makes either dangerous is not simply that occasional spells of price rise/fall can happen. It’s the possibility that people will begin to believe that inflation/deflation has become a permanent fact of life and alter their economic behavior to take this into account. A mindset change, in other words. Once that happens–and inflation/deflation is entrenched–it becomes extremely difficult to eradicate. (In the inflation case, companies/consumers tend to favor hard assets over bonds or bank accounts, to consumer heavily and to avoid saving. In deflation, they tend to hoard, underconsume and–again–favor hard assets like gold.)
–inflation and deflation are not mirror images of one another. Historically, inflation has tended to spiral upward at ever-increasing velocity but can be cured by the monetary authority in a country boosting interest rates high into positive real territory. Deflation, on the other hand, has tended to be a continuous downward grind. Positive interest rates make borrowing a crushing burden. The cure requires slower-to-act, less-likely-to-be-done fiscal stimulation or structural economic reform.
–in advanced economies, inflation and deflation are all about changes in wages.
–Japan is the current deflation poster child. Its economic experience over the past quarter-century is the main reason, I think, that the word “deflation” strikes so much fear into global investors’ hearts. Japan has recently devalued its currency by almost half in a so far vain attempt to get wages to rise. In fact, real incomes for ordinary citizens have declined, because the local currency price of imported commodities like food and fuel has risen while wages have been relatively flat.
Japan is unusual in two ways, however:
—-the population is significantly older than in the EU or the US. The local workforce has been declining for many years because of retirements; the country is strongly opposed to immigration.
—-resistance to structural change of any sort, and particularly change led by foreigners, is extremely strong. As far as I can see, Japanese industrial technology is stuck back in the 1980s, maybe for this cultural reason.
It’s possible, therefore, that Japan’s current woes are more a function of an aging, hidebound population than anything else. If so, then generic treatment of deflation–monetary and fiscal expansion–isn’t going to have much of an effect. Unfortunately for the EU, “aging, hidebound” also sounds an awful lot like Europe. So the EU may be next in line for the lost-decade syndrome.
Two other caveats:
–historical instances of inflation and deflation in the US have come during times when fixed-interest-rate bank lending was the norm for raising debt finance. A changing price level could alter the real cost of that debt significantly. This is no longer the case.
–indexing of wages and prices was common in the US during the 1970s and could easily have acted as a transmission mechanism for inflation. Again, this is no longer the case.
my bottom line
I think the current economic situation is a lot more complex than pundits are making it out to be. I also think they’re making a fundamental mistake by failing to distinguish between transitory inflationary/deflationary influences, like commodity price changes, and more fundamental, mindset-changing ones. My guess is that this is because they’ve only read about the phenomena in books.