America's Historical Experience with Low Inflation: Hoisted from 1999

Monday DeLong Self-Smackdown: DeLong (2000) Sees the Trees, But Overlooks the Forest as Far as the Macroeconomic Dangers of Low Inflation Are Concerned...


What a maroon this guy DeLong (2000) was!:

"The increased risk of deflation and depression in a low-inflation environment can be oversold..."

"Low inflation raises the chance that at some point the turning of the wheel of the business cycle will generate deflation. How great is this danger? How is it to be guarded against? The answer is: not very great. Low trend inflation does raise the chance that a contractionary shock might push goods-and-services price indexes down. But what we fear about deflation can be generated by asset price 'deflations' and foreign-currency debt 'deflations' as easily as by goods-and-services price index "deflations." A period of price stability certainly does not increase the chances of either of these alternative sources of contractionary shocks..."

"This credit-channel analysis of the macroeconomic dangers of deflation leads immediately to the conclusion that declining goods and services price indexes are not the only source of 'deflation.'... A large-scale asset price decline has similar destructive consequences for the credit channel. Indeed, to the extent that financial assets and real estate play a key role as collateral in the web of financial intermediation, there is much more to fear from a large stock- and real estate-market crash than from slow declines in goods-and-services price indexes.... For the United States today the risk of large-scale declines in goods-and-services price indexes is small, the risk of large-scale declines in stock-market values is large, and the interaction of harder-currency borrowing with exchange-rate depreciation is not a concern.... Inflation leads to an increasing degree of leverage in the financial system: more debt contracts, and a greater chance for falls in asset prices to set off contractions in the web of financial intermediation. Whether this increased degree of leverage springs from inflation alone or from the powerful interaction of inflation with a tax system that assess tax liability based on nominal income is not clear. But it is reasonably clear that even if a period of inflation lowers the danger of debt-deflation from a downward spiral in goods-and-services price indexes, it does not reduce--and may increase the potential danger from these other sources of pressure. Thus there is a case to be made that the most damaging effects of deflation, at least of asset-price deflation, are likely to be set up by a previous period of inflation. If true, then we would have to conclude that any effect that a low trend rate of inflation has in increasing the risks of a debt-deflation credit-channel downward spiral is presumably not a very large increase..."

"Confidence that low inflation is a goal worth pursuing has to rest on (i) the consequent reduction in tax-system distortions, (ii) a theoretical belief that removing managers' and workers' attention from the problem of forecasting inflation must be worthwhile, and (iii) from voters' and citizens' expressed preference for low rates of inflation..."

Lots of pieces of the analysis were smart and foresightful. The total effect... not so much... :-(