After the decline of the core CPI of -0.1% for October 2008 (reported last month), I have been telling students and associates to watch out if we had another decline in the core CPI in November. Two consecutive declines in this more stable measure of consumer prices (it excludes the volatile food and energy components) would signal an increased likelihood that a destructive deflationary spell is upon us. The Bureau of Labor Statistics reported today that core inflation
actually increased by 0.02%. This is a very small number that is practically zero. But at least it is positive. In keeping with the analogy of my last post, we have dodged the deflation bullet for the month of December (November CPI).
Deflation is bad because deep recessions and depressions are associated
with falling prices. Households and firms put off consumption and
investment decisions in the face of deflation in order to buy later at
the lower prices. This incentive exacerbates the recessionary forces
that caused the fall in demand that resulted in the fall in prices in the
first place. This is a feedback effect or feedback loop.
We should now be hoping that December's core CPI is positive as well (to be reported on January 16, 2009). The scary thing about the January release is that the Fed can't lower the fed funds rate anymore to try and stimulate the economy (see last post). Cross your fingers for positive numbers in January.
We should now be hoping that December's core CPI is positive as well (to be reported on January 16, 2009). The scary thing about the January release is that the Fed can't lower the fed funds rate anymore to try and stimulate the economy (see last post). Cross your fingers for positive numbers in January.
While deflationary periods in the US have coincided with deep recessions, what is the direction of causation? Did the slow economy cause deflation or did deflation cause a slow economy?
With a fixed stock of money, we should see deflation as the economy becomes more productive. Nothing seems wrong with deflation in this case.
I'm not sure I'm on board with the classic story of why deflation is bad- that people hold off their decisions to buy things. While this may be true with hyper-deflations, it doesn't seem to be a problem with moderate deflation.
Think about how much cheaper you can get a computer of equivalent quality today than 10 years ago? Did you wait? Surely computers have fallen in price much faster than other products (I've seen the statistic that the fall in prices for computers has been in the area of 30% per year), yet this is one of the fastest growing sectors in our economy.
I do see deflation being a problem in our present circumstance- but because it makes the real interest rate higher, not because it makes consumers delay purchases. And the last thing we need now is for it to be more difficult to pay back outstanding loans.
I just am not sold by the type of argument as in this 1933 piece of propaganda (which sounds eerily similar to today's undergrad macro texts):
http://nl.youtube.com/watch?v=99Dzdc1H0wM&eurl=http://itulip.com/