Tag Archives: Deflation

Secular Deflation Fears Are a Thing of the Past

Between November 8 and 9, medium and long-term US Treasury Yield Curve rates increased substantially:

Date	1 Mo	3 Mo	6 Mo	1 Yr	2 Yr	3 Yr	5 Yr	7 Yr	10 Yr	20 Yr	30 Yr
11/01/16	0.24	0.35	0.50	0.65	0.83	0.99	1.30	1.61	1.83	2.24	2.58
11/02/16	0.24	0.37	0.51	0.64	0.81	0.98	1.26	1.57	1.81	2.22	2.56
11/03/16	0.24	0.38	0.52	0.64	0.81	0.98	1.26	1.58	1.82	2.25	2.60
11/04/16	0.25	0.38	0.52	0.62	0.80	0.95	1.24	1.55	1.79	2.22	2.56
11/07/16	0.28	0.41	0.54	0.63	0.82	0.99	1.29	1.60	1.83	2.26	2.60
11/08/16	0.28	0.43	0.56	0.71	0.87	1.04	1.34	1.65	1.88	2.29	2.63
11/09/16	0.30	0.45	0.56	0.72	0.90	1.12	1.49	1.84	2.07	2.52	2.88

Source: US Treasury.

Redistribution From Unexpected Deflation in the Euro Area

In the JEEA 14(4) (August 2016) Klaus Adam and Junyi Zhu argue that

unexpected price-level movements generate sizable wealth redistribution in the Euro Area (EA) … The EA as a whole is a net loser of unexpected price-level decreases, with Italy, Greece, Portugal, and Spain losing most in per capita terms, and Belgium and Malta being net winners. Governments are net losers of deflation, while the household (HH) sector is a net winner … HHs in Belgium, Ireland, Malta, and Germany experience the biggest per capita gains, while HHs in Finland and Spain turn out to be net losers. … relatively young middle class HHs are net losers of deflation, while older and richer HHs are winners. … wealth inequality in the EA increases with unexpected deflation, although in some countries (Austria, Germany, and Malta) inequality decreases due to the presence of relatively few young borrowing HHs. … HHs in high-inflation EA countries hold… systematically lower nominal exposures.

The table reports the estimated effects of a one-time unexpected change in the general price level by 10% (expressed either in thousand EUR per capita, or as a share of GDP); a positive sign indicates a gain from deflation.

	Government (1000 EUR p.c.)	Households (1000 EUR p.c.)	ROW (1000 EUR p.c.)	Government (share of GDP)	Households (share of GDP)	ROW (share of GDP)
Euro Area	−18.6	7.8	10.8	−0.73	0.30	0.42
Austria	−21.7	11.6	10.1	−0.70	0.37	0.32
Belgium	−27.6	40.8	−13.2	−0.93	1.37	−0.44
Cyprus	−9.9	−7.2	17.0	−0.52	−0.38	0.89
Finland	−3.0	−8.4	11.3	−0.10	−0.27	0.37
France	−22.3	10.6	11.7	−0.81	0.39	0.43
Germany	−17.4	15.3	2.2	−0.60	0.53	0.08
Greece	−22.9	−1.2	24.1	−1.34	−0.07	1.41
Ireland	−19.2	21.8	−2.6	−0.54	0.61	−0.07
Italy	−23.2	8.1	15.1	−0.99	0.35	0.64
Luxembourg	22.7	12.0	−34.7	0.35	0.18	−0.53
Malta	−8.3	20.1	−11.8	−0.63	1.52	−0.89
Netherlands	−16.5	−9.5	25.9	−0.50	−0.29	0.78
Portugal	−13.1	−0.2	13.3	−0.88	−0.01	0.89
Slovakia	−4.8	2.2	2.6	−0.54	0.24	0.29
Slovenia	−8.6	2.9	5.7	−0.56	0.19	0.37
Spain	−12.4	−6.7	19.1	−0.60	−0.32	0.93

Costs of Negative Interest Rates

James McAndrews of the Federal Reserve Bank of New York doubts the merits of negative interest rates. He lists the following types of complications:

Avoidance

Legal and operational frictions

Economic frictions

Pass-through to market rates, and retail v. wholesale

Effects of negative rates on the health of financial intermediaries

Signal of deflation

Public acceptance

Deflation and Growth

In a BIS working paper (abstract page) Claudio Borio, Magdalena Erdem, Andrew Filardo and Boris Hofmann analyze the link between growth and deflation from a historical perspective. They conclude:

First, before accounting for the behaviour of asset prices, we find only a weak association between goods and services price deflations and growth; the Great Depression is the main exception. In some respects, this confirms previous work. Second, the link with asset price deflations is stronger and, once these are taken into account, it further weakens the association between goods and services price deflations and growth. Finally, we find some evidence that high private debt levels have amplified the impact of property price deflations but we detect no similar link with goods and services price deflations.

Non-Neutral Helicopter Drops

In an August 2014 Economics article, Willem Buiter discussed the conditions for a Friedman-type helicopter drop of money to be effective.

First, there must be benefits from holding fiat base money other than its pecuniary rate of return. Only then will base money be willingly held despite being dominated as a store of value … Second, fiat base money is irredeemable: it is view[ed] as an asset by the holder but not as a liability by the issuer. … Third, the price of money is positive.

Deflation … are therefore unnecessary. They are policy choices. This effectiveness result holds when the economy is away from the zero lower bound (ZLB), at the ZLB for a limited time period or at the ZLB forever.

The feature of irredeemable base money that is key … is that the acceptance of payment in base money by the government to a private agent constitutes a final settlement … It leaves the private agent without any further claim on the government, now or in the future. The helicopter money drop effectiveness issue is closely related to the question as to whether State-issued fiat money is net wealth for the private sector, despite being technically an ‘inside asset’ …

… because of its irredeemability, state-issued fiat money is indeed net wealth to the private sector … even after the intertemporal budget constraint of the State (which includes the Central Bank) has been consolidated with that of the household sector.

Harmless Deflation

John Cochrane argues in the Wall Street Journal that deflation fears are overblown. His main points are:

According to the Friedman rule, low deflation is beneficial.
Sticky wages only cause problems if the deflation rate exceeds the rate of productivity growth. This is not in the cards.
Similarly, the debt burden does not rise dramatically when prices fall by only two percent per annum say.
Low deflation limits the flexibility of monetary policy but that’s ok.
Implosive deflation spirals of the type feared by commentators have never been observed. They cannot happen because investors who hold government bonds would sell the securities (fearing default) and try to buy goods instead.

Dangers of Deflation

The Economist worries about deflation, specifically in the Euro area. The central passages are:

Central bankers can no longer set real (that is, inflation-adjusted) interest rates low enough to restore demand. Wages, incomes and tax revenue all stall, undermining the ability of households, businesses and governments to pay their debts—debts which, in real terms, will grow more burdensome under deflation.

… bad deflation results when demand runs chronically below the economy’s capacity to supply goods and services, leaving an output gap. That prompts firms to cut prices and wages; that weakens demand further. Debt aggravates the cycle: as prices and incomes fall, the real value of debts rise, forcing borrowers to cut spending to pay down their debts, which ends up making matters worse.

Dirk Niepelt

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