Why is deflation continuing in Europe and Japan?

by on January 22, 2015 at 8:19 am in Economics | Permalink

Here is an update from Japan:

Four years after the Bank of Japan set a 2 percent inflation target, price gains may still be coming up short, according to a survey of economists by Bloomberg News.

Consumer prices will rise an average 1.4 percent the fiscal year through March 2017, after failing to reach 2 percent — stripped of fresh food and a sales-tax boost — in any of the years since the goal was set, the median of 16 estimates shows. Governor Haruhiko Kuroda wanted to get there in about two years when he unleashed his record stimulus plan in April 2013.

Here are further data points from Krugman about other locales.

I am not seeking (today) to argue about liquidity traps, credibility, and the like.  Clearly the Japanese central bank can influence inflation at least somewhat, and recall the BOE helped bring inflation in at over five percent but a few years ago.  The ECB really could do much more.  But my view is this:

1. Most countries have labor market incumbents with sweet real wage deals, deals which could not be renegotiated anew today because the world has seen a repricing of labor downwards for the wealthy countries.

2. Higher rates of price inflation would cut into those deals and thus high rates of price inflation are unpopular.  Voters don’t quite understand the monetary economics here, but they have a vague sense that “inflation screws them.”

3. We are no longer at the point where two percent inflation is easy to achieve in Europe or Japan.  Central banks are doubted.  To achieve two, they would have to shoot for four, and thus announce a target of four.  Few voters wish to hear this, and furthermore a credible stab at four percent inflation might in fact bring three percent inflation or maybe more.  A non-credible central bank can indeed still debase its currency, yet the achievable targets are given by lumpy notches, not a smooth sliding scale.  In the case of the eurozone, too high an inflation target is probably illegal as well, given the sole mandate of price stability.

4. We thus end up stuck having central banks which announce a target of two percent but undershoot it.

As for Japan, here is a clue from the same article:

While Kuroda’s campaign — which has seen the BOJ’s balance sheet dwarf that of counterparts relative to the size of the economy — has spurred bank lending to the biggest jump in two decades and seen the end of outright deflation, it has yet to spark pay rises big enough to secure the 2 percent CPI target.

“It’s necessary to create an environment where wages rise sustainably,” said Kinoshita…

This also helps explain why European QE would need to be shock and awe, why it won’t be, and why it won’t help that much after all, even though it is better than doing nothing.  Few governments wish to boast they are lowering the real wages of their employed middle class citizens more rapidly than would otherwise be the case.  Reaping some extra votes from the marginally unemployed is not going to swing the electoral calculus on that one.

Let’s not blame the policymaker or the journalist.  I blame the economists who promote the notion that higher rates of inflation will boost rather than erode real wages.  That’s going to leave policymakers — and voters — waiting for a long, long time.

1 ummm January 22, 2015 at 8:42 am

Economic and demographic factors are blame for the chronic sluggishness of those countries. America has the huge baby boomer and millennial population whereas Japan has shrinking population and poor demographics. Americans consume more. American monetary policy more proactive and aggressive. America has much less regulation regarding how business can fire employees, resulting in a more dynamic business environment. It’s cheaper and easier to start a business in America. America has lower income taxes.

2 carlolspln January 22, 2015 at 5:12 pm
3 Daniel January 22, 2015 at 8:43 am

This is just retarded.

Back in the 70s economists were saying that central banks were powerless in the face of inflation.
Now we have economists saying that central banks are powerless in the face of deflation.

This is just bullsh*t. Economists are simply stupid. And that obviously includes mr Cowen, who is living proof you don’t have to be particularly smart to be a professor.

4 dan1111 January 22, 2015 at 10:03 am

As for your second paragraph, do you think those two positions are contradictory? If so, why?

More proof needed that everyone except you is stupid.

5 Daniel January 22, 2015 at 10:11 am

More proof needed that everyone except you is stupid.

Your answer is additional proof of that.

6 dan1111 January 22, 2015 at 10:34 am

That was a pretty good comeback.

But seriously, why can’t central banks be powerless to control both deflation and inflation?

I am powerless to control both deflation and inflation. Am I a paradox?

7 Daniel January 22, 2015 at 4:10 pm

You don’t own the printing presses, moron.

8 dan1111 January 22, 2015 at 4:55 pm

Central banks can’t just do whatever they want.

9 Daniel January 22, 2015 at 5:37 pm

The point is that the constraints on the central banks are political (ze Germans, for example), not technical.

10 Mark Cancellieri January 22, 2015 at 8:47 am

My question is this: Are there any examples where ZIRP actually worked and countries escaped the need for ZIRP?

Japan has been trying it since the mid-1990s. The US and Europe have been trying it since late 2008 or early 2009. Supposedly the US will start raising rates this year. We will see.

Perhaps ZIRP is the problem and not the solution. Maybe ZIRP creates a situation where the markets become dysfunctional. I think that there is a good chance that ZIRP shifts investment away from entrepreneurial activity and towards speculation, investment in government securities, inflation hedges, etc.

It seems like economies do better when the currency is strong, which makes it strange that pretty much every country is trying to make their currency weaker. Of course the arrow of causation could be that currencies become strong when the economy does better. I’m just skeptical about the proposition that countries can devalue their way back to prosperity.

11 ummm January 22, 2015 at 10:03 am

America was pretty close to zipr in 2004

12 Daniel January 22, 2015 at 10:14 am

You have the causality backwards. Low interes rates are a SYMPTOM of tight money.

Also, you’re a moron who’s completely ignorant of macroeconomics.

13 The Anti-Gnostic January 22, 2015 at 11:31 am

You know what’s moronic? “Macroeconomics.” Moronic and manic: Add money and stir. Add money and stir. Add money and stir.

Buggy-whip factories idle? Add money and stir. People saving for a rainy day? Add money and stir. Houses too cheap? Add money and stir.

It’s complete and utter bullshit. It’s contrived, ungrounded, non-falsifiable hypotheses. It’s sophistry to persuade that governments can do what households and businesses cannot. It’s a fraud to justify continuous, upstream transfer of wealth.

14 MoneyReflux January 22, 2015 at 9:10 pm

Did a macroeconomist fuck your wife or something? Get a grip

15 Ricardo January 22, 2015 at 1:26 pm

The point about low interest rates being a symptom of tight money is a classic monetarist view.

People who hold monetarist views are monetarists.

Monetarists are a subset of economists.

Per your earlier statement, “economists are simply stupid.”

Therefore you are stupid.

However, you are quite possibly also correct (e.g., Scott Sumner would agree with you).

16 Ricardo January 22, 2015 at 1:27 pm

(I should have said *previously* tight money, by the way.)

17 Mark Cancellieri January 22, 2015 at 1:59 pm

You have serious issues.

18 Daniel January 22, 2015 at 4:14 pm

You’re an idiot.

19 Bill January 22, 2015 at 8:54 am

Re: I am not prepared to argue about liquidity traps

I am not prepared to argue about liquidity traps,


I am prepared to

Talk about your wages.

20 Bill January 22, 2015 at 9:22 am

I used to read books by economists who argued, when Japan was in its heyday, that the strong implicit growth of the Japanese manufacturing system was due to the strong employment contract. Loyalty it engendered cause companies to increase human capital investment in employees; workers identified problems and solved them on the floor with authority to shut down the line; there was employment security which improved productivity.

Maybe instead of arguing about wages, maybe one should look at an employment workforce that is aging and a society that does not admit immigrants.

21 MOFO. January 22, 2015 at 8:58 am

So, im confused as to why creating inflation is seeming so hard. Cant the government just print money and spend it until they get inflation? How could that not lead to inflation?

22 dan1111 January 22, 2015 at 10:06 am

I, too don’t understand this and would like to hear an explanation.

23 pbc January 22, 2015 at 10:10 am

“creating inflation” is not hard at all … once you create a central bank for your national economy.
In fact, the primary purpose of central banks is “easy money” (low interest rates) by means of artificial credit-expansion & monetary inflation. Printing lots of extra paper money works great for inflation, but modern banking & computer systems permit so much easier inflation methods with a few mere keystrokes. Any inflation is ALWAYS bad for a national economy, but some economic sectors benefit greatly from it, at the expense of the majority — government, big banks, and politically well connected businesses benefit. The con-game always painfully collapses eventually.

Mainstream economists are now confused too. Japan and U.S. QE had exactly the opposite of intended effects, but the ECB is proudly making the same blunder; none of these brilliant PhD economists predicted the major collapse of oil prices or the Swiss NB currency move. Lots more ‘unforeseen’ economic shocks coming. One might kinda begin questioning economists’ credibility?

24 Daniel January 22, 2015 at 10:15 am

low interest rates != “easy money”

Go away, moron.

25 Miguel Madeira January 22, 2015 at 10:37 am

The definition of “easy money” is “low real interest rates”

26 Daniel January 22, 2015 at 4:12 pm

No it isn’t, moron.

27 Miguel Madeira January 22, 2015 at 10:40 am

The dificulty is creating inflation using only monetary policy, without the government spending more.

28 dan1111 January 22, 2015 at 10:48 am

Ok, but if you want inflation, then why is it bad to do it through spending rather than monetary policy? Then, in addition to causing the inflation you want, you get the “stuff” you bought, as well. Or why not print money to pay off the national debt, freeing you from future interest obligations?

I know that there may be some policy/legal barriers to doing this in practice, but given politicians’ interest in having money to spend, one would have think that would be very little obstacle.

Not an economist here, sorry if these are stupid questions.

Also, I’m not advocating the policy–I’m just asking, why doesn’t it happen, given the premise of wanting more inflation?

29 Ray Lopez January 22, 2015 at 11:03 am

@dan1111- MM is saying that printing money alone is not enough; the government has to spend it as well. This is also BTW Krugman’s thesis.

30 dan1111 January 22, 2015 at 4:47 pm

But my whole question is: why not spend it? (Given the premise that we want inflation). Spending it is really easy to do.

No one seems to have given an answer to that.

31 Jordan B January 22, 2015 at 11:03 am

Expansionary fiscal policy creates debt, and we already have high levels of that. At a certain point, the negatives outweigh the positives. Also, politics.

32 MOFO. January 22, 2015 at 11:23 am

Why would printing money lead to more debt?

33 MOFO. January 22, 2015 at 11:18 am

Yes, this question is exactly what i was wondering, except more clearly stated.

34 Ray Lopez January 22, 2015 at 11:02 am

@MM – but consider this scenario: fiscal and monetary expansion fail to yield any growth–then what? The FDR NRA did not stop the Great Depression, only arguably WWII did. What will the government spend money on today? Building roads is capital, not labor, intensive. Helicopter drop will not stimulate spending if we have a thrift paradox where people save money in anticipation of higher taxes later, as they do in Japan. The TARP and other plans did not do much, including Cash for Clunkers. As Rogoff et al say, financial crisis take about 20 years on average to turn around, so 2008+ 20 = 2028. If Koo is right about a balance sheet recession, ditto until companies cover their debts. Creating hyperinflation might work to shorten the turnaround, but the cure may be worse than the disease? Let’s face it: due to bad choices in the last 25 to 45 years, an aging population, and other such structural reasons including a Great Stagnation in technology (due to a non-optimal patent system IMO), America is in decline, it’s as simple as that. Neither printing money nor building bridges to nowhere will cure that.

35 MOFO. January 22, 2015 at 11:22 am

Well, im not arguing that printing money will cure what ails us, i agree with you on that front. What i want to know is why everyone is acting like creating inflation is so hard? If we cant think of anything to spend it on, how about not collecting taxes one year? Or some ‘national greatness’ vanity project? Figuring out ways to spend other peoples money doesnt seem to be a problem that politicians have.

36 TallDave January 22, 2015 at 11:42 am

Living standards fell sharply during WW II, even in the U.S. The US is not in economic decline, real living standards are still getting better for most people.

Ideal monetary policy doesn’t create growth, it merely optimizes the possibilities for growth.

The Fed can always hit an inflation target, they can buy every asset in existence as long as they find willing sellers. They could start by retiring the national debt — if we can (we probably can’t) why wouldn’t we? — and then start buying index funds. But long before that, people will notice the Fed is actually serious about hitting its target now. And if excess inflation arises, those assets can be sold.

37 carlolspln January 22, 2015 at 5:40 pm


Don’t believe what you read, especially here. There is no ‘Great Stagnation’


38 Daniel January 22, 2015 at 4:13 pm

The dificulty is creating inflation using only monetary policy

You don’t have the slightest clue of what you’re talking about.

39 TallDave January 22, 2015 at 11:32 am

That’s what Zimbabwe did, and they got lots of inflation. But most people do not want one million percent inflation.

40 MOFO. January 22, 2015 at 11:42 am

Nor do i, but couldnt you just not print so much? And in any event it sounds like the problem your describing isnt “we cant create inflation” the problem is “we cant safely create inflation without it getting out of control”

41 TallDave January 22, 2015 at 11:45 am

The issue isn’t so much how you print, it’s how much markets expect you to print in the future. When governments start financing their spending by printing money instead of borrowing through the markets, it tends to create panic because no one trusts the politicians.

But the Fed doesn’t need to finance fiscal spending to increase money supply, they could just buy Treasuries instead.

42 MOFO. January 22, 2015 at 11:56 am

Isnt that what QE is?

43 TallDave January 23, 2015 at 12:19 am

Pretty much. The problem is the Fed keeps assuring everyone they will unwind QE, which is a form of deflationary forward guidance. They should stop being coy and just announce they don’t care how large the balance sheet is, they will hit their targets. And their target should be the NGDP trend, not inflation.

44 Brian Donohue January 23, 2015 at 2:48 pm

@TallDave, Good comment. See the graph at the attached link, which shows the huge drop in the ECB balance sheet over the past couple years:


45 Boonton January 22, 2015 at 1:29 pm

Let me address MOFO’s question.

Modern economies do not simply allow their government to print money. The Central Bank doesn’t just print money and toss it in the air. The Central Bank prints money to buy things, so it has a balance sheet. A common thing for a Central Bank to buy is short term gov’t debt thereby setting the 3 month interest rate (but not other interest rates). But a Central Bank can buy other things, like foreign currency, bonds, stocks, even old comic books if it really wanted too.

This creates a check on gov’t spending. Even if the Bank is printing, the gov’t doesn’t get the money. It must either tax people or borrow from the market to get cash to pay for its spending. Taxing people creates angry voters. Borrowing from the market raises interest rates if the market thinks the gov’t is out of control in its spending and borrowing.

The more money a central bank prints, the bigger its balance sheet gets because the more it buys. For example, the Swiss Bank had until just now pledged that it would not let its currency rise against the Euro. So it printed lots of Francs and brought Euros. The bank’s balance sheet swelled with lots of Euros.

This is a good thing. If the Central Bank ever finds that there’s too much money, it has an easy way to get it back. Just sell some of the stuff it brought. A big balance sheet can be a problem, though. Some stuff may not sell at the price you paid for it. The Swiss Central Bank may find that the market doesn’t want to buy Euros for the same amount of Francs. A Central Bank that brought old comic books may find the collectible market has changed. Say the Central Bank printed 100 Francs and brought 100 Euros. Now that inflation seems too high, the bank decides it should pull 100 Francs out of the economy. It puts its 100 Euro note up for sale. But the market only is willing to offer 60 Francs! The Central bank has no way to pull out those remaining 40 Francs easily. Maybe it can charge more interest to banks that want to borrow from it. Maybe it can tell banks they must keep more reserves at their accounts with the Central Bank. It’s possibly workable but it would have been easier to have just sold those Euros for the same price.

Three month bonds have an edge since the Central Bank is more or less guranteed to get the cash back if they decide to sell. Three months isn’t very long so unless you have very bad inflation interest rates are not likely to matter much if you sell early. Otherwise just wait a few months and the gov’t will collect cash out of the economy and use it to pay off the bond.

The EU has to figure out what to buy if they are to ‘print money’. There is no central EU gov’t that issues bonds so instead the EU can only buy the Euro bonds of its member countries. Which countries should it buy from? Greece, Spain, Italy? Germany worries that if the Bank buys those bonds those countries could turn around and default, which means the money has been sent out into the economy but the bank will never be able to get it back unless German taxpayers step in to make good on those bonds. What about buying German bonds? Maybe but the German gov’t has been inclined to avoid running deficits. What about private bonds backed by things like mortgages, loans etc.? OK diversification would mean you could keep the risk of default low but you still might run into trouble getting the cash out of the economy quickly if you need too, plus its a huge political question of who is lucky to get all this printed money? Remember how much political heat TARP generated in the US?

The solution? IMO the EU should issue 500 Euros each quarter to every European citizen. If inflation picks up to 1%, drop that to 250 Euro. If it picks up to 2% discontinue the program. Yes the Bank has no way to get that cash back, that’s a positive in this case since part of the problem is the market doesn’t believe the Bank has the guts to stand by stimulus. Yes it also raises a question of whether that is really monetary policy. That looks a lot like a central gov’t giving everyone a 500 Euro tax cut or subsidy. But it would address Germany’s concern about giving money to irresponsible governments like Greece. Individuals would be free to choose what to do with their 500 Euros. If they decide to buy government bonds, they would have an incentive to favor more responsible gov’ts over less responsible ones. If they spend the money most of the money goes to the private sector with gov’t only collecting after the fact (higher taxes if employment and earnings go up).

So can I have my Nobel now please?

46 MOFO. January 22, 2015 at 3:12 pm

So the shorter answer is that central banks cant print money and spend it due to political concerns and restrictions on how they can operate?

47 Boonton January 22, 2015 at 3:27 pm

Yes. And while I think more money def. needs to be printed, those political concerns are valid. If a Central Bank just prints money it can basically become an alternative government…passing out entitlements, loans, gifts and so on. That’s a bit problematic since the Central government isn’t elected and the actual elected gov’t isn’t going to want to give away its powers.

Which I think is a part of Germany’s concerns here. Suppose Greece starts issuing 50B of bonds every quarter and the ECB buys them. Then after two years or so Greece declares it will default on its bonds. What has essentially happened is the central bank printed 200B and gave it to the Greek gov’t to spend. Why should they spend 200B? Why not have Germany built a pan-European autobahn? Why not have the ESA mount a manned Mars mission?

When the Central Bank is buying and selling only a portion of a gov’ts debt load, any default impacts the entire market. If just the Central Bank debt can be defaulted on, then there’s a credibility problem.

48 ladderff January 22, 2015 at 5:19 pm

Dumbest thing I didn’t didn’t read today.

49 dan1111 January 23, 2015 at 6:52 am

Thanks Boonton, you answered it for me. Although I think your “solution” is just as dubious as the government printing money to fund itself.

50 Boonton January 23, 2015 at 9:34 am

Perhaps what the EU needs then is a real central gov’t. Give it the power to tax and spend and borrow and the ECB can buy only its bonds. If Greece or Spain or Italy appear like they are going bankrupt, the central gov’t can decide whether or not they want to help them just like the US Federal gov’t may or may not help a city or state that is going insolvent.

If Germany thinks the gov’ts of Greece and Spain are too soft, then it can take over (via their dominence in a centralized gov’t) their welfare systems as well as its tax collection and demonstrate how they can do a better job.

51 andy January 22, 2015 at 8:59 am

Prices of oil/energy is falling. This is one of the things causing deflation as energy is usually in the base inflation index. Why is it a problem?

52 The Anti-Gnostic January 22, 2015 at 11:36 am

Because in the bizarrely inverted worldview of academic economists, all prices should inexorably rise, except the price for labor.

This is another area where economists’ wives are smarter than their husbands.

53 Michael Cain January 22, 2015 at 12:06 pm

I have a friend who facilitates deals between land owners and small drillers. By his insider estimate, the banks/hedge funds/etc have loaned a few hundreds of billions of dollars to drillers at terms that require wellhead oil prices around $75 for there to be any hope of repaying the loans. Plus a couple trillion in derivatives based on those loans, with no idea if one of the big players in finance has done an AIG and made all their derivative bets in one direction. He expects the small-driller bankruptcy wave to start around mid-2015, and trigger another financial crisis.

54 Alan January 22, 2015 at 12:42 pm

Too optimistic. It has started but you cannot see it yet. Leases that require drilling in a time frame are expiring unused already.

55 The Anti-Gnostic January 22, 2015 at 12:58 pm

I’ll ask this again: why aren’t we seeing broker-dealers jumping out of windows? Was everybody really hedged against a 50% price drop two years ago?

56 Sam Haysom January 22, 2015 at 1:15 pm

From what I can tell a lot of people think that Obama is letting the Saudis stick it to the frackers for now, but will eventually tell them to call it off possibly in exchange for a hardline stance agianst Iran’s nuke program (yes not only Netanyahu cares about it ). In the Houston Chronicle Tuesday they were already predicting and oil spike by March so either they know something or else they are delusional.

57 Boonton January 22, 2015 at 1:52 pm

Yes Saudi oil barrons really enjoy making Fox News Watching Americans angry by flooding the country with cheap gasoline. They love it so much that they are willing to give up their own income by keeping prices ‘too low’ for that pleasure.

58 Sam Haysom January 22, 2015 at 2:18 pm

You are comically ignorant, if I were Obama on the today show I might even call you retarded, the Saudis are absolutely artificially keeping the price low to drive frackers out of business. I’m genuinely amused by your low status and ever recurring need to run down Fox News watchers in order to feel better about your pathetic life. There’s something delightful in knowing how much you must hate yourself.

59 Boonton January 22, 2015 at 3:20 pm

Let’s think about this for a moment. The frackers go back in business the moment oil prices go back up so the only way the Saudi’s can keep the frackers out of business forever is if they keep prices low forever. If they keep prices low forever, they lower their income forever and someday they will pump the last of their oil, at which point the frackers come back into the market.

Saudi Arabia does, however, have other fish to worry about. You have Russia’s Putin that until recently was getting very loud and very arrogant. Cheap oil probably serves as a bit of tonic on that hothead. You have Iran, which is the Saudi’s ideological enemy in the region. Cheap oil really hurts them because the rest of their economy is under harsh sanctions (and there is no ‘rest of the Saudi economy’, Saudi Arabia produces nothing of interest besides oil while Iran at least has the infrastructure to produce other types of goods). Then you have ISIS vs. Iraq. The Saudi’s see Iraq as a puppet state of the Shia Iran so cheap oil keeps them down. ISIS is ideologically aligned with the Saudi’s but they view it as a threat since Sunni Jihadist groups have in the past targetted the Saudi regime.

So cheap oil at the moment is serving a lot of interests for the Saudi’s that have nothing to do with presumably punishing Red State frackers for not being Obama supporters. Your analysis basically assumes the entire world is nothing but a stage for whatever the American Newsatainment industry happens to be obsessed with at the moment.

60 Al January 22, 2015 at 3:23 pm

On the general topic of ‘sticking it to the frackers’ — is this something that will need to be done over and over again?

I mean, the frackers lose this round, but, if oil creeps back up to $80, won’t a new round of fracking projects spring up, and not just in the US, but in other countries too?

Will the Saudis have to play “whack-a-fracker” for a long time to come?

61 Boonton January 22, 2015 at 4:11 pm

Fracking has been a positive success story for the US. It has provided something like 100K jobs to the economy and Republicans love a narrative where the economy is saved by oil and gas extraction…but…. we are talking 100K jobs out of 3+ million created. The US is a net importer of energy so lower oil prices are a net boost to the US economy even if it is a negative to Texas.

62 John January 22, 2015 at 6:39 pm

Are any of them personally liable for the losses? If’ you’re looking for comparing behavior between the 1929 crash and the 2009 one look into the degree of personal liability some of these people might have faces that none would face today. I think there will be some major differences.

63 Eric January 22, 2015 at 9:03 am

Just thankful this wasn’t about the Patriots. On a more serious note. . .great blog.

64 Ricardo January 22, 2015 at 1:29 pm


65 Matthew January 22, 2015 at 9:15 am

I think there are a few points to consider about the effectiveness of monetary policy in combating deflation and wage stagnation. From the US’s perspective at least, QEs do this: they allow governments to issue excess entitlements. Those entitlements get spent on high-margin goods, shared with employees. Repeat 1/(1-r) times with r maybe around 0.3. And finally, this money ends up in the hands of the the wealthiest 0.01%. What choice does that person make? What does he consider?

(1) What is the marginal profitability of US labor? It it even positive?

(2) Which types of labor have positive MPL? Is it commodity labor? Is it specialized labor (graduate degree level)? Is it HIGHLY specialized labor (Nobel prize level)?

(3) What is the value of using cheap leverage to speculate in the stock market/derivatives? What is the perceived value of doing so? How much of the US labor market is actually just temporary infrastructure building to facilitate the investment in more assets (e.g. construction on spec buildings and oil fields that aren’t profitable unless crude is over $80), rather than labor-supporting businesses.

(4) How does a globalized economy with several currency pegs affect QE programs? If other countries maintains a peg to the dollar, and their MPL is significantly higher than the US, why shouldn’t investment in labor go overseas instead when it occurs at all?

I personally think that the times in which we calibrated Taylor rule and other economic models (the modern economics times, since 1930), have had very different answers to all of thee questions. And the fact that Krugman thinks that today’s economy is the same as ones past, and it will respond in the same way those economies would have to similar stimulus is foolish.

My answers to many of the questions above would lead to my belief that we wouldn’t see and domestic wage increases, and thus little domestic inflation. We would ultimately see asset price inflation, especially in highly-uncertain assets like Venture investments, and large increases in developing economy GDPs.

66 Nigel January 22, 2015 at 9:30 am

This does not augur particularly well for the outcome of the experiment:

Draghi says 80pc of the debt will be carried out at the risk of national central banks..

67 Boonton January 22, 2015 at 1:54 pm

Why exactly is that a risk? If a country defaults the central bank is hurt, but it isn’t even really hurt since it is essentially little more than a gov’t institution that can print its own money.

68 dearieme January 22, 2015 at 9:39 am

“Most countries have labor market incumbents with sweet real wage deals”: this is a reference to tenured academics, I assume?

69 Luis Pedro Coelho January 22, 2015 at 9:41 am

#1 is huge in the European PIGS, especially in public sector workers and pensioners (in Portugal, the Supreme Court has declared that nominal cuts in pensions are unconstitutional, but freezing pensions is OK—talk about nominal rigidities).

70 tedm January 22, 2015 at 9:45 am

(5) How about shadow banking? Maybe central banks can cause inflation with some of their tools, but the tools they have chosen are not the ones that could cause inflation under current circumstances because they have not adequately accounted for the components of the actual money supply. Central banks have swapped a government bond (or similar relatively safe) asset for a deposit. In the presence of shadow banking, the effect depends in part on the relative money multiplier between the depository banking system and the system of collateral-based broker-dealers because the removal of the government bond reduces the supply of assets suitable as collateral for the creation of short-maturity loans.

See FSOC working paper on the shadow banking system and the money accounts. http://www.treasury.gov/initiatives/ofr/research/Documents/OFRwp2014-04_Pozsar_ShadowBankingTheMoneyView.PDF

“We argue that the monetary aggregates (M0, M1, M2, etc.) and the Financial Accounts of the United States (formerly the Flow of Funds) do not adequately reflect the institutional realities of the modern financial ecosystem, and should be updated to allow policymakers to better analyze and monitor the shadow banking system and its potential
contributions to financial instability. The monetary aggregates, used mainly to inform the aggregate demand management aspects of monetary policy, do not include the instruments that asset managers use as money, particularly repos.”

71 8 January 22, 2015 at 9:56 am

The modern monetary system is a credit system, but the Fed cannot print borrowers. QE will not generate inflation outside of asset prices. Should the US govt or other govt decide to circumvent the central bank and directly print money, the modern financial system would immediately hedge, spike interest rates and create a sovereign debt crisis as borrowers dump all sovereign debt.

The problem is too much debt, and the solution is not to create more debt and have the central bank buy it up. Yet that is what nearly every central bank is doing. The reason why no one wants to actually solve the problem is because it involves pain. To solve the problem is to “fail” in the eyes of economists, voters, businessmen and politicians. No one wants the solution, so it won’t happen until people are completely exhausted and fed up with the current situation, possibly due to a big war that forces government spending.

72 Matthew January 22, 2015 at 10:16 am

The Fed has a near-perpetual borrower in the US Government. Combine that with notion that the US Government is an entitlement machine, and you have a system not too dissimilar from printing money and giving it to people who add little to no value as a government employee and beneficiaries of the entitlement structure. If you believe that the US debt will never actually be paid back without monetization, then this about as close a structure that we could feasibly have to Helicopter Ben.

73 Albert January 22, 2015 at 10:00 am

All of these economic discussions bring to mind medieval theologians arguing how many angels can dance on the head of a pin or modern day cosmologists bravely explaining the Universe without knowing what 90% of the the Universe is made of.

And for the heck of it, I’ll throw in GlobalWarmingClimateChange theories and models VS observed reality.

74 Jon Rodney January 22, 2015 at 10:24 am

Lots of economists think inflation will erode real wages in the short term. That is implicit whenever they start talking about sticky nominal wages as a problem. They also think that in the long-term, higher inflation will not erode real wages, and may serve to increase them relative to an alternative monetary policy that results in a lower-employment equilibrium. It doesn’t seem like those two view are in contradiction to one another, and I don’t see any reason to assign blame for them.

75 The Engineer January 22, 2015 at 10:30 am

Arnold Kling is right: central banks control NOTHING. Not even short term rates.

Some day, you will admit, “We are all Kling-ians now” (Kling-ons?)

76 The Engineer January 22, 2015 at 10:32 am

On a more serious note, U.S. Steel just idled a plant because of a glut of steel imports from the “managed economies of Asia”. We are importing deflation.

77 Al January 22, 2015 at 11:34 am

And yet, economists have told us for decades that this kind of import is a good thing because consumers benefit from the lower prices on imported goods.

I imagine that, if consumers have to spend less on steel and oil, say, then they’ll have more leftover to pay their mortgages. So this kind of deflation is _good_.

Er, no, wait … Deflation is bad. What we need is more tariffs on imported goods so that we avoid a deflationary spiral to the point where no one can pay back their loans any more.

But, on the other hand, the banks are simply too big to be allowed to fail. The system won’t let it happen. We’ve seen this before. The Fed can and will back the banks to infinity by expanding its balance sheet by another three, five or even ten trillion dollars to buy up all of those shaky assets. It can even buy all that risky paper from the shadow banking world. This sort of thing has worked before. We can use this tactic forever.

Economics makes perfect sense. We know the way forward. Why is anyone worried?

78 Yankuba January 22, 2015 at 12:27 pm

The more I read this blog the less I understand. Like golf lessons

79 Daniel January 22, 2015 at 4:16 pm

Arnold Kling is right: central banks control NOTHING. Not even short term rates.

They control the money supply, moron.

80 John January 22, 2015 at 6:46 pm

And when we start seeing say 60% of all transaction occurring on credit cards — will they still control the money supply in any real meaning of the word “control” (i.e., determine)?

81 Daniel January 22, 2015 at 7:26 pm

Yes, moron.

82 rayward January 22, 2015 at 10:39 am

It’s folly when policy inflates the prices of your assets; it’s prudent when policy inflates the prices of my assets. It’s the natural order of things when policy deflates the prices of your assets; it’s an existential crisis when policy deflates the prices of my assets. Governments and central banks have spent the past six years pursuing policies that inflate the prices of some assets while deflating the prices of others. Why not change course and pursue policies that inflate the prices of the assets that have been deflated? Is it because there’s a tradeoff: inflate the prices of the deflated assets, deflate the prices of the inflated assets. Is it because economists are either left-brained or right-brained, favoring one category of assets over another?

83 Dan Hanson January 22, 2015 at 10:43 am

This appears to be Mr. Krugman making it up as he goes along. I would like to see some evidence that central banks don’t have higher inflation targets because ‘few voters wish to hear it’.

Ah, who can forget the last election when Mitt Romney was confronted by a mob yelling, “We don’t want no central bank inflation targets threatening our wage incumbents!”

The people might care about actual inflation, but since Krugman claims that a 4% target would result in 2% or 3% inflation, I doubt that the target itself is every going to be a political issue as 99% of voters have no idea what that even means.

This is an economist inside a bubble believing that everyone thinks like him.

84 Anon January 22, 2015 at 11:00 am

Don’t know about Europe and Japan , but “deflation” has certainly come to New England. Its a whole different ballgame.

85 mpowell January 22, 2015 at 11:12 am

This is a very refreshing look at the issue, but I am not sure that it is really gets it right. It is almost certainly true that the voting public and other institutional powers that the central banks answers to think of inflation as a bad thing, but I doubt it is really related to sweet deals for middle class workers. If you ask people what inflation is, they clearly have no idea. I cannot believe that they have this sophisticated level of understanding of how tenuous their current wage deal is. I also doubt most people actually have tenuous wage deals.

86 rayward January 22, 2015 at 11:16 am

In an earlier post today Cowen complimented the OECD for its recent report (“a good OECD report”) on policy changes that would overcome secular stagnation. To repeat, that’s “policy changes” that would overcome secular stagnation. And what might those policy changes be? A shift from monetary stimulus to fiscal stimulus. In other words, “change course and pursue policies that inflate the prices of the assets that have been deflated” rather than continue with the same policies that inflate the prices of the assets that have already been inflated. Here’s what the OECD said about monetary stimulus measures: “their effectiveness is not certain as they may also encourage excessive risk-taking and asset price booms that lead to financial instability and costly recessions”.

87 TallDave January 22, 2015 at 11:24 am

I would phrase the question as “Why are CBs allowing this happen?”

I always think about Mike Rowe and all the technical positions filled by H1Bs. I suspect higher living standards are an under-appreciated and significant driver of reduced labor supply.

At what intersection of numbers do people like marginal inflation better than marginal layoffs? Skeptical we’re on the inflation side of that equation.

We are no longer at the point where two percent inflation is easy to achieve in Europe or Japan. Central banks are doubted. To achieve two, they would have to shoot for four, and thus announce a target of four.

True, and a 4% target might not be a bad idea, but really they merely have to be credible about 2%, and that would be a better outcome. The fact is, some CBs prefer to miss low and everyone knows it. They see missing low as a win.

Suppose that the very slippery concept of “inflation” (to what precision can this really be known?) is also overstated, and TGR suddenly makes a lot of sense.

88 Randy B January 22, 2015 at 11:29 am

“3. We are no longer at the point where two percent inflation is easy to achieve in Europe or Japan.”

Nor in the United States, it seems.

89 collin January 22, 2015 at 12:07 pm


1) Most countries have labor market incumbents with sweet real wage deal…How about the older workers are more productive to cover this ‘sweet real wage deal’. When an organization cuts back work force, the older surviving workers do more and the company needs their extra efforts and can not afford to lose capable employees. Look at the US productivity increases in 2009 while the drop in productivity increases in 2013 & 2014. (FYI…Our office is losing productivity on-shoring some former Indian outsourcing data analysis as our organization needs to develop talent.)

2) We are still in global labor glut and with Chindia 2.5 B citizens entering the developed world and control wages and prices in rich nations. (Notice how much deflation there has been in consumer electronics controlling inflation.)

3) Inflation is exported to BRIC and commodity nations.

4) Look at the demographics of the population. How can you increase AD (or later AS) when the working population is decreasing. The Japanese baby bust started around 1970 and 30 years later has too little inflation. Europe Baby Bust started a little later and now 30 – 40 years inflation is too low. (Explains a lot of the inflation in the 1970s as well.) The impact of falling birth rates I think is bigger than economist give it credit for.


90 SPENCER January 22, 2015 at 12:11 pm

Add money and stir is what Milton Friedman favored as he assumed that monetary velocity was stable.

I calculate MZM velocity — nominal personal income/ zero maturity money. MZM = m1 plus money market funds.

It is amazing how MZM velocity moves with bond yields — rising from 1950 to 1981 and falling since 1981.

So maybe the structural problem is monetary velocity and what we need to do is figure out how to get velocity rising again.

91 A B January 22, 2015 at 12:43 pm

What is the opposite of ‘animal spirits’ in economics? It must be depressing to be a Japanese or European these days.

92 Yancey Ward January 22, 2015 at 1:45 pm


93 Al January 22, 2015 at 1:20 pm

Central banks should have police forces which they could use to carry out a policy of “confiscatory easing.”

This policy would take the form of armed central bank teams who visit residences and businesses and forcibly remove and destroy certain critical items (e.g. water faucets, prescription medicines, home HVAC systems, refrigerators, washing machines, windows, doors, pad locks, phones and tablets, computer monitors and cable modems, cash registers, dialysis machines — anything critical to living normally. Just don’t take people’s guns. That would violate the constitution).

Then we’d all REALLY HAVE TO go out and spend some money.

94 Dallas January 22, 2015 at 1:26 pm

Things I don’t understand. Why is deflation so bad?

With deflation, the government can’t steal money from savers and retirement accounts, when the interest rates can’t go below zero. Elimination of the government (central bank) creating negative real interest rates my be a good thing for the citizens.

We have lived with deflation in dozens of products and major sectors of the economy for decades. The government and political class loved as it keep the CPI from going crazy as everything from health care to bureaucratic costs have skyrocketed. Mores law is really a massive deflation creating technology.

With deflation, the cost estimates that continue to escalate on government jobs and contracts will be even more exposed for the fraud they were. With inflation, the “big dig” in Boston or the Calif Bullet train for Gov. Brown ego will look even more fraudulent.

With deflation, living standards go up at constant income. Is that bad?

Note that the assumption that people wouldn’t spend as they expect future prices would be less has been proved to be nonsense by all the area of the economy with massive deflation. For example, were computer and smart phone sales harmed by the rapid deflation, where you can buy a supercomputer for you pocket or a 2 T memory for a 100,000 times less money than half a century ago. Even if they doubled the strength of steel by a factor of ten (deflating the price per unit strength by 90%), people would still use much more steel with floating cities on the oceans becoming more viable.

Have products like information access, which have deflated 99.99999% in cost, decreased peoples willingness to obtain and even buy information or the creation of information and knowledge been harmed by people waiting for further future deflation? Yes, I can get a quantum mechanic course from the best in the world for almost free (the ultimate deflation), but has that harmed our society or the world or has it just make the accounting of value more difficult and posturing politicians less relevant.

95 glasnost January 22, 2015 at 1:44 pm

I’m going to pretend that this is an honest question, here in the swamp of ignorance and motivated reasoning that is this comment section.

The answer: Deflation is bad for these reasons:

1) When prices fall, firms make consistently less money upon selling the same amounts of their products. This encourages cost-cutting, since it is an obvious way to keep making money. This in turn encourages wage cuts and reduced headcount, i.e falling employment.

2) When prices fall, this increases hoarding behavior. Those who have assets put off making optional purchases in the expectation that they can get the object for cheaper, later. This further reduces economic activity, sales, and profits, leading to falling employment and wage cuts. Contrary to economist dogma, while a high savings rate can be nationally useful, the act of increasing a savings rate when income is falling or flat can be incredibly painful. And it’s not just short-term pain. Hysterisis means, basically, permanent productivity degradation in the workforce due to unemployment. It’s a real thing.

3) When prices fall, the real value of debt increases. Money is worth more. A given dollar value of debt costs more in relative purchasing power, and since income is declining due to the secondary effects of falling prices, it often costs more in total income (because your income is falling). Given the deep entrenchment of debt at every private level of our society, this leads to.. further reductions in consumption and spending by individuals and firms.

4) The value of most investments is seen as constantly falling in a world of declining prices. Why invest in anything?

In short, falling prices triggers a mutual hoarding process that makes actual economic activity scarce, which leads to further impoverishment, further hoarding, and additional deflation.

Also in passing, please note that the macroeconomic dynamics of deflation in a single industry, within a macroeconomy where prices are not generally deflating, are one hundred percent different from the dynamics of deflation when it is occurring systematically, i.e. everywhere at once. Sectoral deflation tends to shrink the industry, it’s profits, and the number of surviving firms, but that deflation is compensated for by rising demand because the products are cheaper. The sectoral deflation doesn’t imply that consumer income is falling, since other prices and wages may be rising.

Deflation basically never occurs without stagnant or falling wages/income, and when it is system-wide, people don’t buy more stuff just b/c it’s cheaper, because their income is falling.

Now you know.

96 Yancey Ward January 22, 2015 at 1:48 pm

He doesn’t need your bullshit answer- it was rhetorical and he provided the answer right there in the second paragraph.

97 glasnost January 22, 2015 at 1:51 pm

You are cordially invited to fuck off.

98 The Anti-Gnostic January 22, 2015 at 3:34 pm

The suggestion that the deflationary effects may be salutary–that they represent the correction of prior errors, that they allow consumers shelter in falling prices from a recessionary storm, that they free up capital to sustainable ventures–is the secular equivalent to insulting the Prophet. The deflationary hobgoblin is central to the credibility of the whole rotten scheme. Respected and lucrative careers are built on the premise that money and credit require planning by a central committee and that economies must always and everywhere be “growing.”

I really get the sense they’d outlaw contrarian views if they could.

99 Brian Donohue January 22, 2015 at 8:37 pm

Yikes! C’mon Yancey. Reread the above two comments with 1931 in mind. Bargains galore!

100 Chip January 22, 2015 at 6:00 pm

“When prices fall, this increases hoarding behavior. Those who have assets put off making optional purchases in the expectation that they can get the object for cheaper, later. This further reduces economic activity, sales, and profits.”

People didn’t hoard iPhone 4s after the 5 came out. That’s because the pressure on deflation doesn’t just occur with falling prices – it comes from getting more stuff for the same price.

Where is the inflation in camera prices now that the iPhone 6 takes killer photos?

So producers don’t necessairly engage in a price war in a deflationary market – they use accelerating tech to provide more value.

101 Matthew January 22, 2015 at 6:13 pm

I guarantee Dallas already knew (or should I say “could recite”) every single point you just listed. His points are above yours. Are they correct? That’s highly debatable, but at the very least, I guarantee to you that he has thought much more deeply and critically about the topic of deflation than you have.

102 glasnost January 22, 2015 at 1:50 pm

To put this another way, what you see is a question of thresholds. Deflation in a narrow area of economic activity is often a positive event for consumers and the surviving industry players. One falling price among many rising does not trigger systemic changes.

At a given threshold ratio of falling to rising prices, systemic effects are triggered, as more firms are losing money than are making them, and because hoarding behavior among consumers does not emerge when only one of a larger basket of goods is falling in price, but increases as more and more additional goods are also observed to be getting cheaper.

It is very common, maybe the norm, that any causal relationship you see for a phenomenon that is small relative to its environment, the causality changes when it becomes large. A simple metaphor is the human body, where small amounts of water ingestion serve useful biological functions/homeostasis, but sufficiently large amounts will kill you.


103 Al January 22, 2015 at 2:31 pm

What is the value of this “given threshold” for the ratio of falling to rising prices?

Also, what is the current value of the ratio of falling to rising prices, system wide? Does someone regularly compile this figure? Where can this figure be referenced on a day to day basis?

Thank you.

104 glasnost January 23, 2015 at 12:50 pm

“Also, what is the current value of the ratio of falling to rising prices, system wide? Does someone regularly compile this figure? Where can this figure be referenced on a day to day basis?”

The answer to this question is something called “the consumer price index”. Google it.

I don’t know the answer to the first question.

105 Jason Smith January 22, 2015 at 1:35 pm

Chronically undershooting inflation targets is an emergent property of economies. As economies get larger the marginal dollar (or Yen, or Franc, or Euro …) is more and more likely to be facilitating a transaction in a low growth market. Economies get ‘colder’ as they get older.


There is really no micro story behind it. It’s like trying to come up with an atomic force that causes diffusion. You can do it (it would be oddly dependent on the global density profile), but it’s not really what is happening.

106 Daniel January 22, 2015 at 4:18 pm

Again with the reading of the tea leaves.

107 msgkings January 22, 2015 at 4:42 pm

I’m extremely disappointed you didn’t call Jason Smith a moron. Step it up.

108 Anon January 22, 2015 at 5:37 pm


109 ladderff January 22, 2015 at 5:30 pm

Jason Smith: only guy around here with new ideas. Not quite sure how to interpret them yet.

110 Daniel January 22, 2015 at 5:39 pm

Yeah, too bad they’re nonsense.

Comments on this entry are closed.

Previous post:

Next post: