July 16, 2013
Bruce Bartlett has a good piece on fears of inflation from the Great Depression. It’s worth reading if for no other reason to show that otherwise intelligent people are able to believe completely absurd propositions about the economy and the world. (Sorry, worrying about inflation in the 1930s was loony.)
Anyhow, the piece is useful for another reason; Bartlett has a chart showing the rate of deflation at the start of the depression. Prices fell by 2.3 percent in 1930, 9.0 percent in 1931, 9.9 percent in 1932, and 5.1 percent in 1933. These rates of a price decline are a serious problem. They hugely increase the real value of debt held by individuals and businesses.
They also create an environment in which investment is virtually pointless. Why would anyone borrow to expand a business when they will end up repaying the debt in money that is worth 25 percent more? It would make more sense to park the money under a mattress.
While this may be pretty obvious, it is worth contrasting the rates of deflation at the start of the Great Depression with the rates that we may have plausibly seen in the United States in 2009-2010, if things had gone more poorly. In a worst case scenario, we might have seen Japanese style deflation, which has been less in absolute value than -1.0 percent in all but one year. (In 2009 it was -1.3 percent).
This would have been unfortunate, since it would have implied higher real interest rates and some increase in the real burden of debts held by students and homeowners. However, this sort of deflation is bad in the same way that 0.5 percent inflation is worse than 1.5 percent inflation. In a time when the economy is operating well below full employment, higher inflation will encourage more spending than lower inflation, and lower inflation will encourage more spending than low rates of deflation.
However the deflation that we saw at the start of the Great Depression was a qualitatively different beast than the deflation that we might have plausibly seen at the start of the Great Recession. There was really no basis for fearing the sort of destructive inflation the economy saw at the start of the Great Depression. Wages and prices are too sticky today.
This point is important for both conceptual and political reasons. At the conceptual level, we should realize that there is no magic about the inflation rate turning negative. It is just an inflation rate that is too low. Politically, since moderate deflation is not a depression causing disaster (nor was it likely in the cards in any case), we probably should not be giving too much credit to the Bernanke-Geithner crew for heading it off. The fact that inflation stayed positive through the crisis was good news, but it really was not that big a deal. Bernanke will have to do something else to get the Nobel Prize in economics.
Note: The year 1930 was written “2030” in the original post. Thanks Tracer.
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