Deflation: Is It Coming? Is It Here? Has It Come and Gone?

John Makin recently warned that the US economy faced a risk of deflation.  Paul Krugman suggested that it might already be here.  I believe that outright deflation may have actually come and gone.  Nonetheless, I agree that sub-normal inflation will continue to delay the recovery, and support their calls for easier money.

A year ago I did a post discussing flaws in the way the US government computes price indices.  Official government statistics showed that housing prices were rising, even relative to other goods, between mid-2008 and mid-2009.   I hope I don’t need to explain how crazy that is—we were in the midst of the greatest housing price crash in American history (at least since record-keeping began.)   Because housing makes up 39% of the core inflation rate, it is quite possible that we actually experienced deflation in late 2008 and early 2009, even in the core rate.

The basic problem is that housing ”prices” are based on imputed rents from out-of-date rental contracts signed while prices were still much higher, and which also ignore the frequent offers of one or two months rent-free on new contracts signed during the recession.  This is only slightly better than estimating housing costs on the basis of current monthly payments on 30 year mortgages taken out in 1981.

On implication of the flawed data is that the overall inflation rate was probably much lower than the official data showed during 2008-09.  Another implication is that at a later date these same sources will probably understate the actual rate of inflation.  I believe that has already begun to occur, and may explain part of the discrepancy between the two graphs in Krugman’s post.  As a result I think the second graph is more accurate—we now have low but slightly positive inflation.  Still, as Krugman argued in today’s column, we need much higher inflation if we are to have a robust recovery.

PS.  I was asked if I had ghostwritten Krugman’s most recent column.  All I am able to tell you is that thus far Paul Krugman has not authorized me to confirm or deny ghostwriting any of his columns.   Should I receive such authorization, I will let you know.

Seriously, he has made these points on some other occasions.  But I think he is certainly becoming more forceful on the subject of monetary policy, and other bloggers apparently share that perception.  In late 2008 I began this crusade amidst a widespread perception that the Fed had run out of ammunition.  I argued that it was fiscal policy that was out of bullets, that the $780 billion stimulus was probably all we would get.  I argued that monetary policy was our only hope.  I think it is fair to say that these views are now considerably more widespread than in late 2008 and early 2009.  I can’t say whether this blog has played any role in changing the intellectual climate on these issues, but at least I feel like I haven’t been wasting my time.  As I said in a recent post, “truth” is the view that gets accepted by my peers in the long run.  So my ideas are “truer” than 20 months ago.

PPS:  Makin and Krugman’s warning can also be interpreted as referring to the risk of deflationary expectations setting in.  That would be different from the transitory deflation of 2008-09.

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About Scott Sumner 492 Articles

Affiliation: Bentley University

Scott Sumner has taught economics at Bentley University for the past 27 years.

He earned a BA in economics at Wisconsin and a PhD at University of Chicago.

Professor Sumner's current research topics include monetary policy targets and the Great Depression. His areas of interest are macroeconomics, monetary theory and policy, and history of economic thought.

Professor Sumner has published articles in the Journal of Political Economy, the Journal of Money, Credit and Banking, and the Bulletin of Economic Research.

Visit: TheMoneyIllusion

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