How Soon Will We Face Deflation? - Grasping Reality with Both Hands
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Grasping Reality with Both Hands The Semi-Daily Journal of Economist J. Bradford DeLong: Fair, Balanced, RealityBased, and Even-Handed Department of Economics, U.C. Berkeley #3880, Berkeley, CA 94720-3880; 925 708 0467; delong@econ.berkeley.edu.
Economics 210a Weblog Archives DeLong Hot on Google DeLong Hot on Google Blogsearch August 11, 2010
How Soon Will We Face Deflation? In the post-WWII United States, the rate of inflation has a very clear tendency to fall whenever the unemployment rate rises above 7%:
When the unemployment rate has been above 8%, the average fall in the annual CPI inflation rate over the next two years has been 4.5 percentage points. Our current annual inflation rate is about 1%: http://delong.typepad.com/sdj/2010/08/how-soon-will-we-face-deflation.html
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Does this mean that two years from now we can expect our annual inflation rate to be 3.5%--that we can expect fairly rapid deflation? The odds are very low. Patterns that apply to times when prices have always been rising cannot be extrapolated to inflation rates below zero. Firms are very loathe to cut nominal wage rates, and if nominal wages do not fall then firms cannot on average cut prices by more than 2% per year or so without facing bankruptcy. Does this mean that two years from now we can expect our annual wage inflation rate to still be between 0% and 2%? That is certainly the way to bet. Brad DeLong on August 11, 2010 at 11:42 AM in Economics, Economics: Macro | Permalink Favorite
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Comments F said... You have exactly 3 data points when unemployment is over 8%. Do you really want to draw a conclusion from that? Furthermore, I would guess that your trendline is being significantly distorted by your point at (7.6, -9).
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Reply August 11, 2010 at 12:13 PM Foppe De Haan said... How are you so sure of this? It seems to me that globalization has been ongoing throughout the period we're looking at, and it seems to me that the net result of this will be less correlation between in/deflation and unemployment, as more of the products sold in economies are imported from elsewhere, where they may not exist such a deflationary push (such as, say, in China). As such, it seems entirely likely that we'll be seeing wage deflation and (esp.) commodity price (e.g., because of negative externalities such as the russian weather, but also because of other reasons) inflation. Anyway, I suggest looking at more detailed analyses of 'inflation/deflation', as it's quite commonplace for the two to coexist, and it's only going to become more relevant once the recession ends for upper-income folks while continuing for the ignored classes in US society. Reply August 11, 2010 at 12:33 PM TJ said... " Firms are very loathe to cut nominal wage rates," Man, can I come live in your universe? Reply August 11, 2010 at 12:35 PM Sheri Combs said... Well, I work in manufacturing and have for the past 30 years. Our company, which is down to about 75 employees from a high of 130, instituted a 15% wage cut across the board last year. I am in purchasing and regularly talk to sales people from numerous manufacturers and distributors and I can report that wage cuts, whether 5% or 15%, are not at all unusual. I think deflation is a REAL possibility. Reply August 11, 2010 at 12:40 PM Androcass said... And we shouldn't forget that it's pretty easy to cut wages when you lay off a bunch of people, then hire another bunch later and pay them less for the same jobs. Companies are definitely not loath (not "loathe") to do that. Reply August 11, 2010 at 01:05 PM Jason Dick said... Since we've had about a year and a half of ~8% unemployment, wouldn't perhaps a better comparison be just the years since the crisis began? In that time, hasn't inflation dropped from ~2% to ~1%, meaning we might expect another 1% drop in the next year and a half? Reply August 11, 2010 at 01:18 PM Bloix said... My small firm cut staff wages 15% last year, after laying off five of 60 people. The possibility that the doors would close permanently was on everyone's mind. Reply August 11, 2010 at 01:37 PM mike said... It probably makes sense to look at countries besides the United States. Specifically, why is it that we are in better shape than Japan in the 90s? We could be worse since we don't have the equivalent of their safety net and so we have much higher unemployment. Yes, downward nominal wage rigidity is real. That helps a little. But I'd say a bet of -1% is better that 1%. We're already at 1% and it's certainly not going to go up from there http://delong.typepad.com/sdj/2010/08/how-soon-will-we-face-deflation.html
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while we sit at 9+% unemployment for another, what, two years? At least? I'd take an even odds bet that were going to be deflationary for at least one year. Reply August 11, 2010 at 02:37 PM Gaute said... But what if they cut total wages instead of individual wages? Would this increase in unemployment do the trick? Reply August 11, 2010 at 03:02 PM bakho said... There is nothing special about zero. Inflation expectations are built into the cost of borrowing. Inflation below expectations increases costs of credit beyond what was planned. Besides, credit card companies are still charging 18 percent. Inflation at 2 percent would at least knock that down to 16 percent. So borrowing is more expensive. Reply August 11, 2010 at 03:26 PM KJMClark said... "In the post-WWII United States" This would be a lot more convincing if you weren't leaving out the Depression-era US and Japan's recent history. I suppose you could say, "Except for periods of deflation, deflation is not likely." Reply August 11, 2010 at 07:02 PM Mattyoung said... That correlation constant does not translate into "clear tendency" to me. Reply August 12, 2010 at 12:49 AM Steve Hillyard said... Times have changed, and we should look at all the external pressures on the economy as well as past American employment vs. inflation data. I would be more confident in this prediction if Brad discussed the fact that we cannot compete on price with other manufacturing countries as evidenced by our balance of trade deficit. We seemed to have lost some of our comparative advantage particularly you might expect in the finance industry, and our educational system has not kept up with the competition. To keep our standard of living, we have borrowed to the hilt and worked too hard: two earner households and limited holidays as example. Add to this that the consumer is deleveraging and there is limited demand for the cash that the Fed has pumped into the system. Could it be that the American economy is one big bubble and house prices are just the beginning of the long slow deflation to a more sustainable standard of living? Is this what happened to Japan despite all of their efforts to re-inflate the economy? Reply August 13, 2010 at 08:35 PM Comments on this post are closed.
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First, Kill all the Pensions
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