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Would you delay buying a $30 shirt for months to save 8 cents? Me neither Would you delay buying a $30 shirt for months to save 8 cents? Me neither
(6 months later)
The point here is incredibly simple – apparently too simple for the ECB to understand. The inflation rate The point here is incredibly simple – apparently too simple for the ECB to understand. The inflation rate in the eurozone is too low right now. If it falls below zero and turns negative, this problem becomes more serious, but there is no qualitative difference between a drop from 1.5% inflation to 0.5% inflation and the drop from a 0.5% inflation rate to a -0.5% inflation rate.
in the eurozone is too low right now. If it falls below zero and To understand this dilemma, you just have to understand what the inflation rate is. It’s an aggregate of millions of different price changes. When the rate of inflation is near zero, there will be tens of thousands of prices that are falling. But these will be outweighed by the prices that are increasing, thereby making the aggregate inflation rate positive. What possible difference can it make to the economy if the mix of falling prices and rising prices goes from 45% falling and 55% rising to the opposite?
turns negative, this problem becomes more serious, but there is no Another factor that shows the absurdity of deflationary fears is another pretty simple one: prices in our indices are quality adjusted prices. The price that people pay for a car or a computer may rise year-to-year, while the inflation index shows a decline for these items.
qualitative difference between a drop from 1.5% inflation to 0.5% This would happen if the statistical agency calculated that the quality improvements were larger than the price increases, leading to a fall in the quality adjusted price. So we are supposed to believe that the economy is in trouble if the quality of computers and cars starts to increase more rapidly?
inflation and the drop from a 0.5% inflation rate to a -0.5% One of the oft-repeated deflation horror stories only needs a moment’s thought to realize its absurdity. Supposedly, if prices start to fall, then consumers will put off purchases. Really? If the price of a $30 shirt is falling at an annual rate of 0.5%, will many people delay buying a new shirt for six months to save 8 cents? Even in the case of a $20,000 car, delaying the purchase for a year only saves a consumer $100.
inflation rate. Of course, the quality adjusted price of computers has been falling for decades. This sector has not exactly been struggling.
To understand this dilemma, you just have to Sometimes we hear a story of a deflationary spiral, wherein deflation reduces demand, leading to more deflation and a still further drop in demand. It’s a great story, but no one has seen anything like this since the start of the Great Depression. Even in the Japanese deflation horror story, the rate of annual deflation never exceeded -1.0%.
understand what the inflation rate is. It’s an Incidents of runaway deflation, like hyperinflation, are extremely rare and would occur under extremely unusual circumstances. Both may make for good fairy tales for the kids, but they are not the sort of thing with which serious people need concern themselves.
aggregate of millions of different price changes. When the rate of While the concerns about deflation can be dismissed as silly children’s tales, there are two reasons that we should be troubled by their appearance in policy discussions. The first directly relates to current policy.
inflation is near zero, there will be tens of thousands of prices The eurozone is suffering from a lower than desired inflation rate now. With the overnight interest rate near the zero bound, the real interest rate cannot fall further unless the inflation rate rises. Since a lower real interest rate would help move the economy to full employment, the ECB should be trying to raise the inflation rate, not saving its ammunition against the risk that the inflation rate would turn negative. The menace of deflation provides an absurd excuse for inaction.
that are falling. But these will be outweighed by the prices that The other reason that we should be troubled by deflation talk is that it seems our top policymakers still don’t have the most basic understanding of the economy. The failure to see the bubbles was not a one-time lapse in judgment, it stemmed from seriously confused thinking about the economy. There really was no excuse for an informed economist not to recognize these bubbles and the threats they posed. It doesn’t appear that much has been learned in the last six years. The basic problem is that the economy is far too simple for economists to understand.
are increasing, thereby making the aggregate inflation rate positive.
What possible difference can it make to the economy if the mix of
falling prices and rising prices goes from 45% falling and 55% rising
to the opposite?
Another factor that shows the absurdity
of deflationary fears is another pretty simple one: prices in our indices are quality
adjusted prices. The price that people pay for a car or a computer
may rise year-to-year, while the inflation index shows a decline for
these items.
This would happen if the statistical
agency calculated that the quality improvements were larger than the
price increases, leading to a fall in the quality adjusted price. So
we are supposed to believe that the economy is in trouble if the
quality of computers and cars starts to increase more rapidly?
One of the oft-repeated deflation
horror stories only needs a moment’s thought to realize its
absurdity. Supposedly, if prices start to fall, then consumers will
put off purchases. Really? If the price of a $30 shirt is falling at
an annual rate of 0.5%, will many people delay buying a new shirt for
six months to save 8 cents? Even in the case of a $20,000 car,
delaying the purchase for a year only saves a consumer $100.
Of course, the quality adjusted price
of computers has been falling for decades. This sector has not
exactly been struggling.
Sometimes we hear a story of a
deflationary spiral, wherein deflation reduces demand, leading to more
deflation and a still further drop in demand. It’s a great story,
but no one has seen anything like this since the start of the Great
Depression. Even in the Japanese deflation horror story, the rate of
annual deflation never exceeded -1.0%.
Incidents of runaway deflation, like
hyperinflation, are extremely rare and would occur under extremely
unusual circumstances. Both may make for good fairy tales for the
kids, but they are not the sort of thing with which serious people need
concern themselves.
While the concerns about deflation can
be dismissed as silly children’s tales, there are two reasons
that we should be troubled by their appearance in policy discussions.
The first directly relates to current policy.
The eurozone is
suffering from a lower than desired inflation rate now. With the
overnight interest rate near the zero bound, the real interest rate
cannot fall further unless the inflation rate rises. Since a lower
real interest rate would help move the economy to full employment,
the ECB should be trying to raise the inflation rate, not saving its
ammunition against the risk that the inflation rate would turn
negative. The menace of deflation provides an absurd excuse for
inaction.
The other reason that we should be
troubled by deflation talk is that it seems our top policymakers
still don’t have the most basic understanding of the economy. The
failure to see the bubbles was not a one-time lapse in judgment, it
stemmed from seriously confused thinking about the economy. There
really was no excuse for an informed economist not to recognize these
bubbles and the threats they posed. It doesn’t appear that much has
been learned in the last six years. The basic problem is that the
economy is far too simple for economists to understand.