Dear Monetary Policy Observer,
A common argument we hear from the Federal Reserve is that the economy needs inflation to avoid financial crises like the Great Depression. APIA’s Economics director Rich Danker makes a case for deflation in a recent article for the Wall Street Journal’s Market Watch, citing history and a study for the Minneapolis Reserve Bank as evidence that maybe falling prices aren’t so bad for the economy after all.
We hope you find this material of interest.
American Principles In Action
What’s so bad about falling prices? Nothing
Opinion: Fed is mistaken to think that deflation is a bad thing
As Ben Bernanke hands over the Federal Reserve chairmanship to Janet Yellen at the end of January, leadership of the central bank will be passed from one strident deflation foe to another.
All the way back in 2002, Bernanke in his speech “Deflation: Making Sure ‘It’ Doesn’t Happen Here,” proposed what would become his program to fight deflation in response to the 2008 financial crisis: a zero fed funds rate and large-scale Treasury debt purchases aimed at bringing down interest rates to encourage economic activity. We came to know it as quantitative easing.
Yet five years in, those policies are still entrenched (despite last month’s “taper”) with Yellen set on maintaining them.
What’s happened in the American economy since then? Not deflation, defined as a decrease in the broad price level. You can conclude that Bernanke’s experiment worked in achieving its purpose of making sure “it” didn’t happen here, but you can also conclude from the data that his purpose was misguided from the start and it backfired.
Bernanke’s seminal academic experience is the Great Depression, an era he interprets (influenced by Milton Friedman) as caused by deflation from the Fed.
But does deflation cause depression? That’s a question two economists, Andrew Atkeson and Patrick Kehoe, examined in a 2004 paper for the Federal Reserve Bank of Minneapolis. No, they say. Their data set of 17 countries across 100 years found that nearly 90% of periods of deflation did not have depression. They acknowledge an exception in the surprise deflation of the Great Depression, but say that it is “not an overwhelmingly tight link.”
But their point is not to try and refight the cause of the Great Depression, as Bernanke is wont to do, but defend the concept of deflation from the catastrophe ascribed to it. After all, what is so bad about falling prices? As the publisher and financial historian James Grant likes to point out, this is exactly what draws carloads of people to Walmart every weekend.
The Walmart era of American economic history isn’t actually the contemporary one, but the 1879-1914 period when a surge in innovation and output made commodities cheaper and even food prices stable.
This was natural “good” deflation driven by the increase in the supply of goods — as opposed to a Fed-driven decrease in the money supply that Bernanke and Friedman blame for the Great Depression. People got the dual benefit of a robust economy and flat-to-falling prices.
Read the Fulll Article Here: http://www.marketwatch.com/story/whats-so-bad-about-falling-prices-nothing-2014-01-24