Who's Afraid of Deflation

Concerns about deflation - the phenomenon of falling prices of goods and services - in the wake of the financial crisis, have provided the intellectual cornerstone for central banks around the world - led by the Federal Reserve - to embrace unconventional policy measures, notably forward guidance and large scale asset purchases or quantitative easing. A recently published study by the Bank of International Settlements shows that episodes of goods & services deflation over the past 150 years have been associated with surprisingly small output losses, but asset price deflations – notably declining property prices – have led to significantly weaker GDP growth. I show that a simple demand-supply framework can be used to discriminate between good and bad deflations, and argue that the synchronized policy easings by many of the world’s central banks in early 2015 were designed to address the Great Disinflation associated with a persistent shortfall in aggregate demand globally. Even if the equilibrium global interest rate has declined, monetary policy still has an important role to play in reviving animal spirits. (VIEW LINK)