Who’s afraid of deflation?

August 24, 2009

christopher_swann1.jpgFor most policymakers, deflation is the stuff of nightmares — scarier even than bank failures and stock market collapses. As the economy stumbled, deflation became Lords Voldemort and Sauron rolled into one.

In recent months, however, this economic supervillain seems to have lost its power to intimidate.

With growth reviving, many economists now believe that deflation is highly unlikely to materialize.

Another group suggests that deflation is not nearly as nefarious as often portrayed. Since falling prices are not generally associated with depression, we were wrong to be frightened in the first place.

Sadly, both of these reassuring premises are wrong. We should still be afraid of deflation.

First, the notion that deflation is a misunderstood and potentially benevolent economic force is only partially true. Supporters of this theory often cite research from the Federal Reserve Bank of Minneapolis, which showed that falling prices seldom coincide with depression.

Looking at data for 17 countries over more than a century, the Minneapolis Fed concluded that “nearly 90 percent of the episodes with deflation did not have depression.”

A swelling dollar can clearly be good news for shoppers as well as for those who are sitting on cash. Deflation is often a result of economic progress — productivity improvements that increase spending power. This was the friendly species of deflation caused by surging Chinese output from the 1990s onwards.

The current variety of deflationary pressure is far less benign. It stems not from efficiency savings but rather from weak demand. Worse still, it is accompanied by record levels of debt.

Despite frantic efforts to pay off loans, household debt is still around 130 percent of disposable income. This was precisely the combination that Irving Fisher warned about in his celebrated 1933 article on debt deflation.

Under these conditions, the rising real value of debts encourages households and businesses to sell their assets to pay down loans. As fire sales reduce asset prices — stocks and property — real net worth declines further. Output and employment decline, accelerating the slide in prices.

To add to the pain, real interest rates increase whether central bankers like it or not, discouraging borrowing and promoting even more savings.

“The more debtors pay, the more they owe,” Fisher wrote, since “the liquidation of debts cannot keep up with the fall of prices which it causes.”

But with the U.S. economy clawing its way out of recession, surely the danger has passed? Not quite. Prices are the ultimate economic straggler.

In Japan, for example, the country only started to experience falling prices roughly three years after the start of the recession in 1991. Wages didn’t start to fall until 1997. The United States could still follow Japan’s lead.

Downward pressures on prices in the United States continue to intensify, according to the latest research by Capital Economics. Core inflation may have held at a respectable 1.5 percent, but this is deceptive. U.S. goods inflation has defied gravity in part because of hefty increases in tobacco taxes over the past six months. A 28 percent increase in tobacco prices from a year ago is adding one percent to core goods inflation, according to Paul Ashworth of Capital Economics.

“Without this, core inflation would already be matching the lows reached at the end of 2003,” he says. The tobacco effect will soon fade.

Services inflation, meanwhile, has been very weak. Here the key factor has been weak rental prices, which account for about 40 percent of the total core index. Unemployment and foreclosure will continue to put relentless downward pressure on rents. Already the rental vacancy rate is at a record 10.6 percent.

So we are right to be afraid of deflation — very afraid. It still has the potential to sap energy from the American economy for years to come.

The Federal Reserve is preparing to lay down its unorthodox monetary policy instruments. But it may have to dig deep into its tool box before too long if deflation takes hold.


We welcome comments that advance the story through relevant opinion, anecdotes, links and data. If you see a comment that you believe is irrelevant or inappropriate, you can flag it to our editors by using the report abuse links. Views expressed in the comments do not represent those of Reuters. For more information on our comment policy, see http://blogs.reuters.com/fulldisclosure/2010/09/27/toward-a-more-thoughtful-conversation-on-stories/

I suggest everyone read the speech given by Ben Bernanke in November 2002. This was before he became Fed Chair.

http://www.federalreserve.gov/boarddocs/ speeches/2002/20021121/default.htm

Posted by George | Report as abusive

Deflation is just not seen in the fall of the price for an item or items. It can be also seen in the decrease in the quality/durability of consumer goods. If consumer goods we buy are less durable then we have a hidden deflation that is costing us over our life time. There are many examples, but take the example of furniture quality. Furniture use to last a life time because workmanship was high and most furniture was made with solid wood construction. Now I have many of my fiends replacing furniture because the vernier on the furniture they buy is getting thinner and thinner. So when it is damaged they replace it. Many items now are made not to be repaired but to be disposable. So even thought the price for those items has not increased we are having to buy consumer goods more often over our lifetime. This is as I stated a more subtle form of deflation.

Posted by Eric Martin | Report as abusive

The last author of a commentary said nothing new about the value of the dollar, and this one talked in extremely vague terms.

This author looks hardly old enough to shave yet- can he be so knowledgable about historic trends?

Which Freshman class is Reuters getting its columnists from?

Posted by Bob | Report as abusive

If a true deflation takes place, cant the government raise taxes on most of the essential commodities to keep deflation in check. This will also help keep deflation in check and may be even bridge the fiscal deficit, so long we don’t overkill the demand.

Posted by manu | Report as abusive

Can someone explain to the economic layperson how is it that unemployment and foreclosure are forcing rental prices down and vacancies up?

Seems like that’s backwards…

Posted by Benny J | Report as abusive

Yes, deflation can happen and was a reality in the depression of the 1930s. My grandfather summed it up by saying you bought overalls for $1.80 a pair, put them on the shelf and next week someone offered you the same thing for $1.70 a pair. The store owner made less profit, the seller got less for the product and it backed up through the system. In 1936 my grandfather bought a new Pontiac for $550 but the list price was $600. My folks bought a repo house for $2500 which cost more than $3000 for the former owner to build. Deflation can happen on a national and international scale, and bankers and stockbrokers can again be selling apples on the street corners. What we are seeing right now in the stock and commodities market is just a smoke screen. It is not good out there.

Posted by f belz | Report as abusive

Here’s a very speculative answer to the previous gent’s question. Perhaps people are moving in with relatives or friends rather than pay full rent on an apartment. I have heard anecdotally that many new college grads are being forced back home from whence they left four short years ago. Without a job who can even afford to rent? This is an imperfect answer, but worth considering.

Posted by Bob Foster | Report as abusive

Can someone explain to the economic layperson how is it that unemployment and foreclosure are forcing rental prices down and vacancies up?

Seems like that’s backwards…

To answer your question: primary demand factor is employment growth. if unemployment is rising, then demand is falling. Also, rise in foreclosures increases supply (additional rental units on the market). With vacancies rising due to these factors, landlords drop rents to increase velocity of leasing. Final note: Most markets in the US have too much supply of new apartments. This imbalance of supply and demand caused by a speculative bubble is also a huge issue contributing to high vacancy rates in markets.

Posted by Darrell | Report as abusive

Benny J.: Rent is down despite the rising foreclosures because when the going gets tough, the tough get bunched together (roommating) or else go back to under their moms’ roofs.

Posted by jenny | Report as abusive

Thanks to the Reserve Board reference link posted by the first commentor. So far everything that Bernanke said we don’t need to worry about has come true – we do indeed seem to be on track to repeat Japan’s deflationary period. It’s interesting to note that deflation need only be feared if one is in significant long-term debt. If one lives within ones’ means and only takes on a small amount of short-term debt, then deflation can actually be a beneficial reset to an economy. The US has really gotten itself into a pickle economically, primarily due to greed.

Posted by Steve | Report as abusive

It sounds like debt, not deflation, is the big scare in this article. If you assume debt is good, then yeah, I suppose you need to be against deflation and turn to inflation as your champion. This is why statists argue for it, since the state is so deep in debt.

The deflation we’re experiencing (or fighting) is merely the healing process after unsustainable inflation. The healing process is painful, but it will put us on a sustainable path. Just like a drug addict trying to clean up his life will go through withdrawal. It will be painful, but it’s the healing process. To continue the abuse just to avoid the pain of withdrawal is not a solution, and it’s increasing the problem. Inflation is the real problem and what we should avoid. It provides a temporary stimulant and makes the economy feel good, but disastrous consequences await.

Posted by Josh | Report as abusive

From Subsidy Road to Market Street: Repeat, No Inflation………….

Antonio Ivan Easterling
31 years of Continued Military Service for the United States of America and Global NATO Forces
Southern Illinois University Alumni
President, Founder and Owner (PFO)
The Proletarian Review News Groups
Apogee Incorporated Enterprises (AIE): Global Risk Management Firm
EZ Mobile Taxation Services (EZMTS): International Taxation Services
6904 East 46th Street, Suite 1
Indianapolis, Indiana 46226
Tel: (317)562-9084-home office
(317)946-4198-cell 24 hours of service

The Proletarian Review
To: Mass Media Groups

Topic: The American Economy: A State of Remission {Market Correction Theorems (MCT)}


1. The America marketplace is making adjustments from a subsidized war-base economy of imaginary numbers to those of the jungled free enterprised marketplace (un-subsidized markets). The adjustment is causing higher than normal market prices. When the financial markets lose both public and private investment capital in any given marketplace, the market reactance is to raise prices to regain lost capital. As a result, there are imaginary forces causing un-do stress fears on our business markets, thus, projecting fear to the consumer and merchant. Because the corporate governance cannot raise enough tax revenue to fully fund these subsidized markets, i.e. 1.1 billion dollar tax cuts and massive unemployment rate at 80 percent of the working populous, therefore, these subsidized marketplaces are not being fully funded. Moreover, the cause and effect, now, translates to higher prices for fuel, food-stocks, goods and services.

2. The American marketplaces has been depleted of tax investment capital by approximately 80 percent during Bush Presidential Administration; thus, the normal taxation process of feeding money to various subsidized markets has been disturbed by under taxation and massive unemployment (The Great Depression). Simply put, the American economy is in the flux of change. The change is going from a subsidized economic market to free enterprise markets. Where the laws of supply and demand are the order of the day. The genesis of free enterprise and free markets are being established to replace war-base markets of subsidized corporate welfare. Corporate welfare or Ponzi schemes are draining the Central Bank {Federal Reserve} of much-needed cash reserve for the stimulation of job creationism. High unemployment is the cancer rooted in our economy. Conversely, high employment is the causal effect of high prices. Therefore, a throttled economic recovery of long term targeted investment is the true answer to the hypothesis of inflation.
3. However, as these markets grow, there is a sense of un-do fear that our corporate governance has no regulatory affect on the markets. But, in the real world of global economics, and my humbled opinion, we do not want corporate governance intervention to bring discourse to our growing markets.

4. In closing, based on the dynamics of the marketplace, inflation does not exist or never have existed in the marketplace. Inflation is an imaginary condition of the business marketplace. Employment prospective and employment appraisals are the true dynamics of any financial market.
The problem at-hand is that the corporate governance is not generating enough taxation to feed markets that are depending on subsidies. These markets are said to be in a state of retardation. Thus, our own economy recovery is a state of retardation. The state of retardation is curbed by injecting budgetary constraints, long term targeted investment practices and the utilization of technology. The 3 themes in the marketplace will cure the disease of market retardation which is a cancer to market formation. Again, the United States’ economic recovery is in a condition of remission {corrections and development}. There is no recovery.

Therefore, artificial pricing and market retardation have been disturbing to the genesis of market formation. Fiscal conservative practices are only edicts which to save the global and national economic recovery from the implosion of imaginary numbers of lost tax revenue. Increasing tax revenue vectors without a high tax increase are the real change required to spur the development of New Generation Global Economy {NGGE}. It’s the economy, stupid, the economy is base on the generation of tax revenue. Chief Executives stop cutting off your hands. Word………

P.S.: The corporate governance must develop job generation programs, and cut governmental infrastructure to reduce its cost of operation. Lastly, liquidate any governmental aspect of public domain property assets. At this fragile moment, it’s imperative that our corporate governance entities do not raise taxes to subsidized retarded business activity that does not meet the standards of the market, but, must port money to markets that are having business success. Then, educate the labor market about those financial gains, i.e. labor union and associations.

Antonio Ivan Easterling
Chaplain; Chief Editor
The Proletarian Review

Posted by Antonio Ivan Easterling | Report as abusive

Benny J
Im guessing that he is speaking of the fact that ppl have less dipsosable income so they arnt traveling much. Many parts of the country (las Vegas south NJ are dependant on travelers.
Stupid Americans using there money to pay down there debts instead of borrowing to vaction, wtf is the world coming to…..

Posted by Eron | Report as abusive

There is no long term risk of deflation. Price declines we have seen have been like a reset down to more reasonable levels. With the actions taken by Congress and the Fed on fiscal and monetary policy recently there will be inflation. Hopefully the fed is able to control it as it claims.

Posted by Dustin Siemers | Report as abusive

Well Christopher,

All I can say is if your analysis is true, why?
Why would policy makers fear a strengthening U.S. Dollar? For in this global economy, If we’re talking about an increase in the purchasing power of the USD, that’s what we are truly talking about. The USD has fluctuated in value ever since we abolished the gold standard and replaced it with fiat currency. Whatever you may be lad, a historian, you’re not! How ayone could think deflation is remotely possible is baffling to me. Lets go back to the basics here. Supply and Demand. Let’s say there are oh, 800 million USD floating around and then the Federal Reserve Prints up another couple trillion dollars. Hmm. So you think tripling the money supply will actually increase the value of the dollar? All it will do is increase the price of USD priced commodities such as oil and gold. I suggest you save yourself a copy of this comment so that you can refer back to it in 10 or 20 years. You might learn something. Here’s something you can do today. Look at a long term chart of the USD and cross reference it with a gold chart. I think you’ll find in gold terms everything is relatively stable. It’s the USD that’s actually in over supply. This results in what is commmonly called inflation. Not deflation. Any signs of deflation that we currently see are simply driven by fear. Blowing inventories out the door because we’re afraid we won’t meet fixed costs otherwise, resulting in reduced profit margins, and all the negatives that result from that. The bold will snap up the undervalued and will be the next bunch of USD billionaires. Personally, I see nothing but opportunity in the wreckage.

Posted by George Christensen | Report as abusive

Ben Bernanke and his buddies don’t understand or don’t care to understand and admit that monetary manipulations will not bring back demand. We are now experiencing a DEMAND DEFLATION in everything. The sub-prime real estate buyers are not coming back to market, and the credit worthy borrowers are not going to get into debt any time soon to support the speculative bubble blowing any longer. We don’t need to “unfreeze lending” if nobody wants to borrow (while assets are depreciating). Mr. Bernanke somehow believes that he can magically circumvent creating economic product, which is always based on labor and goods it produces, by just hitting a button on his computer to add a few zeros to FED’s account in a coup of counterfeiting. This illegal act does not provide employment to anyone except Mr. Bernanke and does not result in any economic product on the other end of this labor intensive operation. His academic theories, being tested on live human beings, will be proven wrong and disastrous soon enough. The prices will go where they naturally want to go. All FED can do is slow the process of decline, not arrest it – and that will only prolong this recession that has all the underpinnings of becoming another Great Depression.

[...] Who’s afraid of deflation? [...]

Deflation hurts Tax Revenue, little else. For such a long time, we have been warped into believing that the D word is catastrophic, only because without Artificial Inflation, designed to increase the rolls of the IRS and to Inflate our way out of debt, we have thwarted Market Activity that always does one of or a few in combination: Better, Cheaper, Faster.

No business ever enters a market or even exists by not doing one of those three to capture market share and sales.

Consider the philosophy that we (citizens) are little more than the gasoline in the engine of the Government (and or Powers that Be). Once we are burnt, we are exhausted in the wind while they go on to their next filling station.

Deflation will only take us back down to a level of our Needs. The sooner we exit the Fiat Currency, so we have a Baseline for measuring Units of Labor to Produce Goods and services, we will continue to be held hostage to the White Collar Slavery imposed upon us for nearly a century.

Inflation is a Thief, Deflation is the Tough Love for acting imprudently for too long.

Posted by Das Ram | Report as abusive



Posted by wones | Report as abusive

I do not generally bother with idiot’s posts but Antonio Ivan Easterling got my goat, 31 years Military Service my a$$, No self respecting Vetran would ever refer to themselves as a member of “Global NATO Forces” yes we are part of NATO but no member of the military would refer to themselves as such. The completely nonsensical post that followed his grandiose list of titles was the clincher, no one with that disorganized and delusional a thought process could have ever survive 31 years in the military.

Posted by Garrett Knoche | Report as abusive

One of the best articles in a LONG time, Real interest rates being Nominal rates less (inflation). Thank you for smoking ! Well done !

Posted by Hour glass | Report as abusive

Debt, unemployment and an oversupply of housing have devastated consumer demand. At the same time, quantitative easing, the budget deficit and a continued decline in international confidence in the dollar are creating inflationary pressures. Which will win out? I don’t know. Either way, the U.S. stands to lose.

Many Americans might welcome deflation. I too look forward to housing prices that are more in line with reality. The people in charge of our economy should have allowed the overheated economy to rectify itself on its own by allowing housing and stock prices to decline. Instead they attempted to reinflate the bubble and now a collapse in prices could lead to complete devastation for the American economy.

Either way, I think we can all agree that the U.S. is pretty far from entering any kind of recovery. I’m also pretty angry about Obama renominating Bernanke.

What do you think? Whats coming: inflation or deflation? http://cbfe-econ.blogspot.com/2009/08/de flation-danger.html

…if it is both or neither, maybe stagflation ?

Posted by Hour glass | Report as abusive

Let’s call this song exactly what it is:

a bizarre war economy with upwardly-mobile consumer prices while titanic public subsidy stimulates boardroom looting of zombie corporations amidst plummeting wage levels and mass unemployment at ground level, equals…


Posted by The Bell | Report as abusive

[...] Christopher Swann says yes. He explains the nature of the current deflationary pressures and argues it still poses a threat: [...]

You say deflation – but have you paid your real estate taxes lately, or may be you happen to pay admission to mary-go-round in a local park?

In my experience, everything that is not goods – taxes, admissions, surcharges, co-payments go up.

Here, in tri-state, rents are not falling either.

How does this not constitute inflation – if about 80% of my expenses are not goods, I can not understand.
May be Mr Swann will explain?

Posted by ForeverSPb | Report as abusive