Institute of Economic Studies Charles University Prague PCPE, April 18, 2015
Motivation: Deflation has a bad reputation Bernanke (2002): Sustained deflation can be highly destructive to a modern economy and should be strongly resisted. Probable reason Knowledge about deflation is mostly limited to 2 episodes: (1) : e.g. Bernanke (1995), Romer (1992) (2) Japan from 1990 onward: e.g. Krugman (1998) Natural question arises: are these episodes representative of all experience with deflation that we have?
Figure: US real GDP and Consumer Price Index 1804-2011 (log of index where 1804 = 100) By brief inspection, real GDP and prices do not have a clear-cut relationship.
- Two approaches. Deflation as a symptom: 1. Of economic growth: in M v = P Y, with M and v constant, rising Y implies falling P 2. Of recessionary distressed selling and higher money demand Deflation can accompany both growth and recession, but is not their cause. No need to counteract it using monetary policy.
- Two approaches. Deflation as a cause of recession: 1. Delay of spending contraction of aggregate demand 2. Fisher s debt-deflation: real value of debt bankruptcies and distressed sales further deflation, etc. both aggregate demand and supply contract 3. Mundell-Tobin effect: in i = r + π, inflation affects r, not only i Extreme case: liquidity trap, where inflation gets fully reflected in r r aggregate demand Scope for monetary policy.
Data Output and prices for 19 countries, time span c. 1840-2011. Overall 2789 observations. Control variables mostly unavailable, only limited investment series. Attention restricted to inflation rates -20 % to 20 %. Model: Unobserved effects Y it = β 0 + β 1 Y it 1 + β 2 P it + β 3 P it 1 + a i + u it a i represents a time-constant unobserved effect for country i. So-called fixed-effect estimation allows any correlation between a i and regressors.
with and without control variable (investment). Unconditional Conditional on I Coefficient p-value Coefficient p-value Y t 1 0.116** 0.020-0.158*** <0.001 P t -0.043 0.212 0.011 0.706 P t 1 0.064** 0.046 0.010 0.650 I t - - 0.156*** <0.001 I t 1 - - 0.051*** <0.001 Observations 2769 1346 Adj.R 2 0.022 0.322 Table: Regression of output growth on inflation: All data Inflation is both statistically and economically insignificant for GDP growth. There is practically no relationship between price movements and GDP growth.
The is unlike any other episode in the sample. Figure: Regression for (a) and (b) all data except
Relatively few annual data to draw conclusions. However, GDP and inflation charts do not show a deflation problem. Figure: Contemporary Japan (1991 = 100): (a) Output and prices, (b) Unemployment and prices
In a large dataset, there is no evidence of deflation-recession relationship. Deflation is perfectly compatible with high rates of economic growth. is rather an exception than a rule, and can hardly be used as a standard for judging deflation. There were many special factors in the that we cannot empirically control for.
Cited literature Bernanke, B. (1995): The Macroeconomics of the Great Depression: A Comparative Approach. Journal of Money, Credit and Banking, Vol. 27, No. 1. Bernanke, B. (2002): Deflation Making sure it doesnt happen here. Speech before the National Economists Club, Washington. Krugman, P. (1998): Its Baaack: Japans Slump and the Return of the Liquidity Trap. Brookings Papers on Economic Activity, No. 2. Romer, C. (1992): What Ended the? Journal of Economic History, No. 4.