July 06, 2003

Take a razor to the deflation debate
(via Institutional Economics)

Samuel Brittan isn't convinced by all the deflation concerns:

It is as well to know just what we are talking about. Just as inflation is a general rise in the price levels, so deflation is a general fall. Apart from Japan, the industrial world has not seen deflation for 70 years. Once there is a single currency and a single monetary authority, inflation and deflation refer to movements of the price level of the whole area. To raise the alarm about possible German deflation, because the rate of inflation in that country has fallen to 0.6 per cent - against a euro area rate of 1.9 per cent - is simply to ignore the advent of the new currency. To talk about German deflation makes as much sense as to talk about deflation in Texas or Cornwall, unless you believe monetary union is premature or still immature.

In any case it seems inherently absurd to believe that a ¼ per cent annual increase in prices is satisfactory, while a ¼ per cent decrease spells catastrophe. Very often the difference between these low rates of inflation and deflation will depend mainly on the price index used. A ½ per cent rate of deflation based on the European Union's Harmonised Consumer Price Index usually translates into a ¼ per cent rate of inflation on the British Retail Prices Index.

(...)

Let us suppose that nominal demand - or the national income in nominal terms - is rising by 3 per cent. Would you rather have a 4 per cent increase in output offset by a 1 per cent fall in prices? Or no increase in output but a 3 per cent rise in prices? The deflation-mongers implicitly assume the latter outcome would be better because there is a positive rate of inflation. This is no way to conduct a sensible debate.