Inflation or Deflation?

Inflation and deflation of debts produce very different outcomes.

A shift from deflation to low inflation would accelerate this process.

America fears deflation Europe driven by its largest economy, Germany fears national debt and inflation.

Historically, failure to protect against inflation or deflation has helped spur calamitous outcomes.

Whereas China is threatened by inflation, the US faces the risk of deflation.

Deflation increases the real (inflation adjusted) debt burden, as well as the real interest rate.

Indeed, except for deflation ridden Japan, central bankers could meet just about anywhere and see high and rising inflation.

The risks associated with inflation are probably less dangerous than those generated by collapsing output and the threat of deflation.

With a global recession a near certainty, deflation rather than inflation will become the main concern for policymakers.

The Swiss central bank recently adopted this position, and the ECB is worrying about higher inflation, not deflation, in the eurozone.

As a result, it recognizes only inflation as a threat to stability, and ignores deflation, which is the real threat today.

In contrast to the Great Depression, collapsing national output was in recent decades accompanied by accelerating inflation, not deflation.

One reason for a rise in the interest rate would be a shift from low deflation to low inflation.

But that is a phantom risk, because it is the risk of deflation, not inflation, that haunts the PIIGS.

As concerns about deflation replaced fear of inflation, gold prices started to fall with the correction in commodity prices.

We live in an age of simultaneous fear of inflation and deflation of unprecedented prosperity amid growing inequality and of technological advancement and resource depletion.

Low inflation is already a serious obstacle to economic recovery and rebalancing within the eurozone. Outright deflation would be an even more dangerous threat.

First, while we are still in a world of global deflation, large, monetized fiscal deficits are fueling concerns over medium term inflation.

This is a real beginning, and we should encourage such contracts to grow in order to help billions of people hedge their inflation and deflation risks.

Inflation and deflation of debts produce very different outcomes. Inflation reduces the value of debt, which for many people and companies feels like slowly sipping champagne, producing a nice buzz of light headed excitement as they are unburdened.

Not wedded to central bankers obsolete doctrines, he has made a commitment to reverse Japan s chronic deflation, setting an inflation target of 2 .

The ECB should not try to balance inflation in the south and east with deflation in the north in order to hit artificial continent wide targets.

And the burden is unequal, because there is much more pressure on deficit countries to adjust via deflation than on creditor countries to allow higher inflation.

The inability of unconventional monetary policies to prevent outright deflation partly reflects the fact that such policies seek to weaken the currency, thereby improving net exports and increasing inflation. This, however, is a zero sum game that merely exports deflation and recession to other economies.

The second adverse effect of deflation is to raise the real interest rate, that is, the difference between the nominal interest rate and the rate of inflation.

Just as inflation helps debtors by eroding the real value of their debts, deflation hurts them by increasing the real value of what they owe.

Throughout the world, people suffer from a serious perception error that has inhibited them from taking concrete steps to protect themselves from inflation or deflation.

Such an approach would reduce the risk of debt deflation, while capping inflation expectations to prevent a damaging surge in prices as recovery takes hold.

Deflation and Democracy

But it would not require falling wages or significant price deflation annual wage growth of 1.7 and productivity growth of 2 would be compatible with inflation close to zero.

Deflation increases the real (inflation adjusted) debt burden, as well as the real interest rate. Though there is little evidence of the importance of small changes in real interest rates, the effect of even mild deflation on real debt, year after year, can be significant.

CAMBRIDGE The investors that I talk to these days are not sure whether to worry more about future inflation in the United States or about future deflation.

Deflation Doldrums?

For both sides, it is more desirable to let the adjustment take place through changes in nominal exchange rates, which would help contain deflation in the north and inflation in the south.

Historically, failure to protect against inflation or deflation has helped spur calamitous outcomes. When spectacular inflation hit Germany in 1923, it wiped out the real value of the (unhedged and unindexed) life savings and social security benefits of millions of people, whose anger contributed to the rise of Nazism.

Putting Deflation First

The Deflation Bogeyman

Excluding Japan, which remains mired in seemingly chronic deflation, Asian inflation rose to 5.3 in the 12 months ending in November 2010, up markedly from the 3.5 rate a year earlier.

The years since then have seen the fastest global average income growth rate of any generation, as well as remarkably few outbreaks of mass unemployment causing deflation or wealth destroying inflation.

Can China Beat Deflation?

Can China Avoid Deflation?

So the good news is that the possibility of significant inflation or deflation during the next few years is low on the list of economic risks faced by the US economy and by financial investors.

Yet, in the face of overwhelming evidence of the importance of inflation or deflation risk, most people even in countries that have been warned generally still have not taken steps to protect themselves.

If normal times call for a conservative central banker who helps to anchor inflation expectations, now is the rare time when we need a more unorthodox central banker who will fight deflation expectations.