Inflation vs. Deflation

June 18, 2009

The always great Ed Yardeni has a smart take on the inflation-deflation debate, comparing US quantitative easing efforts to those of Japan in the 1990s:

During that time, the Bank of Japan (BoJ) adopted Quantitative Easing (QE) in a desperate effort to stop deflation and revive bank lending. Nevertheless, bank loans plunged during this entire period, and have been rising anemically since 2005. Japan’s CPI inflation rate, ex food and energy, on a y/y basis has been below zero this decade, with a brief peek just above zero late last year.

Japan was in a liquidity trap. All the reserves pumped into the commercial banking system by the BoJ had absolutely no stimulative impact on bank lending and the economy, and no inflationary consequences. The BoJ abandoned QE in early 2006. Reserve balances plunged 76.2% from January 2005 to November 2006. In other words, the BoJ executed its exit strategy from QE and once again there was no obvious impact on the economy or inflation. …

In any event, Japan’s experience confirms that inflation isn’t always and everywhere a monetary phenomenon. It is more complicated than that. Market structure plays an important role. Competitive markets tend to be less prone to inflation than highly regulated and monopolized ones. Labor costs are the key drivers of inflation. Unions don’t have the power they once had, and productivity has been growing even during this recession. By definition, stimulative monetary policy isn’t inflationary in a liquidity trap, when the banks aren’t lending and the borrowers aren’t borrowing.

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