Suppose monetary policy never changed for 99 years. Suppose nothing ever changed for 99 years. Would it be possible for there to be a deficient Aggregate Demand recession for 99 years? Why wouldn't prices adjust? Wouldn't 99 years be long enough for prices to adjust?
Suppose that monetary policy never changed for 99 years, but every year people knew that there was a 1% chance that it would change that year. And that if it did change there would be a very big loosening of monetary policy. A 100% loosening -- requiring a hypothetical flexible price equilibrium price level 100% higher than the current hypothetical flexible price equilibrium price level.
So every year for 99 years, when firms set prices at the beginning of the year, they are 99% confident that monetary policy will continue unchanged, in which case they would do better by cutting their prices 1%. But there is a 1% chance that monetary policy will change, in which case they would do better by raising their prices 99%. So they leave their prices unchanged, because the expected benefits of cutting their prices by 1% are exactly balanced by the expected benefits of raising their prices by 99%.
For 99 years out of 100, firms regret they did not cut their prices 1% at the beginning of the year. For 1 year out of 100, firms regret they did not raise their prices 99% at the beginning of the year.
So, on average, a recession lasts for 99 years, during which firms' prices are 1% too high, given the monetary policy in effect during those 99 years. And, on average, there is a boom every 100 years that lasts for one year, during which firms' prices are 99% too low, given the monetary policy in effect during that one year.
(This does not necessarily mean that booms are 99 times bigger than recessions, even though they are 99 times more rare. Not everything is linear. There are supply constraints, as well as demand constraints.)
1. Do we ever observe Peso Problem recessions?
2. What would be the empirical signature of a Peso Problem recession?
3. Is it conceivable that some countries right now are in a Peso Problem recession? Is the average firm 100% confident that those who fear imminent hyperinflation are wrong? Or only 99% confident?
(This post is a restatement of a comment I made on Frances' Smaug post. Here is a good discussion of the Peso Problem, which is normally applied to exchange rates and financial markets. A Peso Problem is an extreme case of a probability distribution that is highly skewed with a fat tail on one side. A sample size large enough to reflect the whole probability distribution would be a very large sample.)
If you had told me in 2008 that the recession in some countries would last as long as it has, I would have predicted inflation in those countries would have been lower than it has in fact been. I would have been wrong.