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Yes, it's clear that there's an insurance aspect to inflation spreads and that this was an important factor at the end of 2008 (as was liquidity). Bob Barro made this point at the time IIRC, cited on Greg Mankiw's blog. (I don't have the reference, but one should be able to find it on Greg's blog, and I don't recall if it was just a point Bob Barro made casually to Greg in an email or something like that or if he said publicly.)

But, dude, you have a heck of a lot of confidence on the BoC after witnessing the experiences of the BoJ and ECB (and even the Fed, which has struggled to keep the inflation rate up, though right now it appears it will succeed). Zero probability mass below 1%? Don't you think just possibly that the BoC got lucky post-2008 (e.g. by avoiding the severe housing crash that affected the US) and might not necessarily have so much success if another severe shock hits?

What I said on December 5, 2008.


Andy: Hmm. OK, I shouldn't have zero mass below 1%, even today. But it would be very small, for a 5 year average. (I actually wanted to draw the tails out a little, but I can only manage a one-way curve with Paint.)

But I do have a lot more confidence in the BoC than in the BoJ, ECB, or the Fed. Yes. The people who run the BoC are better macroeconomists, they speak with one voice, and they have the support of the government in doing what they are doing. You do not hear them say totally stupid things, like you do with people making decisions at other central banks.

Looking at TIPS is complicated by the fact that TIPS at or near par contain an important deflation protection option, in that principal repayment at maturity can never be below par. This is particularly applicable to small fear of a big deflation: TIPS can actually protect you from that so looking at yield spreads is going to be misleading. Initially, this seems to support the flight to liquidity argument. However, there is literature comparing 2008 newly issued and seasoned (out of the money) TIPS maturing in 2013 to isolate this deflation protection option value as a way to think more creatively about how deflation risk was being priced. Here is one example that supports the idea that there was more going on to TIPS spreads than just a flight to liquidity, and that deflation insurance mattered quite a bit:


"The results show that the deflation fear was severe at the peak of the crisis as the priced probability of a 10 percent decline in the general price level over the following five years was about one in three"

Bruce: thanks for that link. Though you didn't put a number on it, it is quite clear from what you wrote then that the risk of a big deflation, and how to avoid it, was at the front of your mind.

dlr: excellent comment.


When you say you were afraid of "deflation," what exactly were you afraid of?

1. Stuff getting cheaper. (Which presumably requires some nontrivial argument to present as a bad thing, e.g. the money illusion making wages downward-rigid and leading to unemployment.)

2. The pyramid of money multiplier based on maturity mismatched accounting collapsing. (With fractional-reserve banking as the most well-known but by no means the only case -- or even the most important one in the era of government deposit insurance.)

3. Something else?

Whatever it is, do you really think "deflation" (which in most people's mind will register as simply the opposite of their everyday experience of mild to moderate inflation) is the right word that should be the central focus of public discourse?

Vladimr, "...Stuff getting cheaper" ... you mean like hours of my time... while my nominal debts don't get any cheaper?


1. Deflation would be a symptom of falling demand, falling volumes of trade, falling output and falling employment. Like the 1930's.

2. Plus the arbitrary redistributions of wealth, and the defaults, from non-indexed nominal debts.

Nick asks, "How scared of deflation were you, in 2008?" My answer: "not at all".

Amongst other reasons that was because in the 1800s there was on average NO INFLATION in the UK: at least the price of bread in 1900 was the same as it had been in 1800. To be more accurate, there were periods of rising prices and periods during which prices FELL. The latter did not cause the sky to fall in.

Ralph: what about the 1920's? A quick Google tells me that the wholesale price index fell from 300 in 1920 to 100 in 1932. And the 1920's were not good times in the UK.


I think, though, that there's a difference between deflation brought about by technological change resulting in increased productivity (i.e., lower costs) and deflation brought about by decreased demand.

The 19th century saw widespread deflation as transportation costs plummeted and output increased. For the same reason, no one is too fussed by the rampant deflation in the tech sector today (in 1980, a computer with the capabilities of my $500 desktop, if it even existed, would have cost tens of thousands, if not millions, of dollars.)

On the other hand, if prices are falling not because goods are getting cheaper to produce, but because no one is buying them, that's a problem,

Nick and Bob,

Good points. My attempt at a summary herewith.

Re the 1920s, the central problem was inadequate demand (which lead to falling prices). So the central problem was inadequate demand, not falling prices as such (unless you think there’s a lot of hysteresis in falling prices, i.e. people hoard money so they can buy stuff cheaper in a year’s time).

Re the 1800s, much the same applies. I.e. in that falling prices were due to improved technology, that’s no problem (unless you think . . . same hysteresis point etc).

Conclusion: since I don’t think the hysteresis is a powerful effect (and I’ve no evidence to back that), I’m not scared of deflation in the “falling prices” sense of the word. At least prices falling at 2 or 3% a year wouldn’t be a problem. 10 or 20% could be different.

Bob and Ralph: some economists make the distinction between "good deflation" (1800's) and "bad deflation" (1920's for the UK, 1930's elsewhere, because of gold standard timing). But like Bob, I think it's better to see deflation as a symptom, that can come from increasing supply (good) or from insufficient demand (bad).

Let's say you are a farmer back in the 1920's and produced as much as you could. Technological progress allow you to use mechanized equipment to plant and harvest crops more quickly than you could by hand. What happens under each situation:

Situation #1: You have no debt. Prices fall because you (and other farmers) are producing more crops than what are demanded. You end up burning crops / letting them rot on the vine. Lesson learned, next year you don't plant as many crops. You still own the farmland.

Situation #2: You borrow money against your farmland to buy the mechanized equipment to increase your production. Your nominal cost of debt remains fixed while your real cost may rise. The bank seizes your farmland after you are unable to make the payments on the debt. Now the bank has farmland that could be used to plant crops, but instead lies fallow.

When deciding whether deflation is good / bad, I think it is helpful to look at both cause (technological progress / inadequate demand) and well as outcome.

Can you please give your perspective on the debate between Beckworth and Krugman here?


Paul Krugman and Josh Barro are going after conservatives for their "new love affair with Canada". They claim conservatives are incorrect to view Canada's successful fiscal consolidation in the 1990s as evidence of "expansionary austerity." Here is Krugman:

Canadian austerity in the 1990s was offset by a huge positive movement in the trade balance, due to a falling Canadian dollar and raw material exports...Since we can’t all devalue and move into trade surplus, this meant that the Canadian story in the 1990s had no relevance at all to the austerity debate of 2010.

Actually, the Canadian story is very relevant to the austerity debate of 2010, but not in the way portrayed by most conservatives. For the Canadian story is largely about expansionary monetary policy offsetting contractionary fiscal policy. The Canadian dollar's fall was not some random event, but the result of concerted efforts by the Bank of Canada to counter the drag of fiscal austerity. This is an important story and it is not the first time it has transpired. About fifteen years earlier the Bank of England also used monetary policy to offset fiscal policy. Ramesh Ponnuru and I wrote about it these experiences back in 2012 in The Atlantic:..."

Peter: [I found your comment in the spam filter.]

I basically agree with David. Monetary policy *can* offset fiscal policy, and US conservatives need to get that, and support a better monetary policy.

But given Paul's perspective, that the ZLB is a constraint on monetary policy, you can see why he would argue that Canada 1995, where the Bank of Canada had lots of room to cut nominal interest rates, and did, is not the same as the US recently.

What is so ironic in all this is that it was a Liberal Canadian government that cut spending in the 1990's. And the current Conservative Canadian government, which many lefties accuse of being extremely right wing, that did a textbook New Keynesian fiscal policy in the recent recession. They increased government spending, especially on "infrastructure investment". They deliberately ran a deficit, even though there had developed a strong popular consensus, since the 1990's, that deficits are bad things and we mustn't throw away all our hard-earned fiscal rectitude. And then when the Bank of Canada lifted off the ZLB, they started tightening again. Straight from the NK playbook! (Though also, straight from the orthodox micro textbook too, because it makes sense to borrow and invest more when you face very low (or negative) real interest rates.)

Thanks for your response!

How scared? Almost none. Because (1) I had little understanding of monetary matters back then and (2) I live in Australia. I assumed the exchange rate would take the shock, as it did in 1997 with the Asian Crisis, when most of our major Asian trading partners all had problems all at once. And we hadn't had a recession in 17 years, and you get out of the habit of being fearful.

Of course, in some countries the central bank is explicit about their deflation worries.

For example, the Bank of England has long published their subjective probability distributions for inflation (and GDP growth). Quarterly. For example, you can find the November 2008 distributions at


As you can see, they thought the risks of deflation were small (I'm eyeballing it at around 15-20% two years out.)

Then again, a number of economists have crunched the numbers on their probability forecasts and found that they don't do very well.....

I basically agree with David. Monetary policy *can* offset fiscal policy, and US conservatives need to get that, and support a better monetary policy.

It's a tough road to hoe, let me tell you. They all view this in terms of governments monetizing their ever-increasing debt. Sigh.

Nick Rowe: "I'm trying to remember that lovely quote from Keynes."

"In the long run we are all deflated"?


Being in the US, in '08 after the bank bailout passed in Congress, I was not really worried about deflation. A Republican administration, of all things, was pumping money into the economy. I would have preferred a Main Street bailout, but you take what you can get. It was in '09 that I began to worry, maybe not about deflation, but about low inflation and long term stagnation, because a Democratic administration, of all things, was not committed to economic recovery.

Min: no, it was about fears, and nightmares. Damn, my memory has gone.

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