September 05, 2014
A useful NYT article on the latest moves by the European Central Bank’s to try to prop up the euro zone economy included a comment near the end:
“Thursday’s moves signaled that at least one European institution is doing all it can to avert the threat of deflation — the pernicious downward spiral of prices that often leads to high unemployment.”
Actually there is no basis for the fears of this sort of downward spiral. As the piece correctly points out, the euro zone economy is already suffering from very low inflation. With many long-term loans contracted with the expectation of much higher rates of inflation, the current near zero rate of inflation is imposing serious burdens on debtors. The low rate of inflation also means a higher real interest rate for firms considering investments for the future.
Crossing zero from low rates of inflation to low rates of deflation doesn’t change this story. Having a lower rate of inflation makes matters worse, but there is no particular importance to crossing zero. (At low rates of inflation, the prices of many goods and services are already falling.)
There could be a problem if there was a downward spiral with deflation leading to more unemployment, leading to more deflation, but we have not seen anything like this in a wealthy country since the Great Depression. Even Japan never really saw anything along these lines. It’s inflation rate fell to -1.0 percent in 1999, was -0.7 percent in 2000, and peaked at -1.5 percent in 2001. It became positive again in 2004 and remained positive, with the exception of 2005 until the economic crisis in 2009.
There was no tendency for the rate of deflation to continue to get more rapid during this period. In other words, there is zero reason to think that anything qualitatively different happens to an economy if the inflation rate turns negative, except that in a weak economy a lower inflation rate is worse than a higher one.
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