The Case For Deflation

After having been previously been obsessed with bashing Germany, Krugman has now started to bash Sweden, saying it has fallen into a “deflationary trap”.

But why should we really worry about deflation? When we go the store we get happy when we get lower prices and sometimes we substute to other goods because they’re lower prices. There is of course a good reason for this as lower prices raises our purchasing power.

At this point, some pro-inflationist might object that lower prices will lower nominal income too, and so not really raise our real income.

That is sometimes correct, but not always. Higher productivity could lower prices without lowering wages or profits. And lower prices can in fact cause that higher productivity by increasing volumes and so reducing fixed cost per unit. Furthermore, if lower consumer prices is caused by lower import prices, national nominal income won’t be lowered.

And in any case, if lower nominal income is the supposed problem, focus should be directly on that, not on the positive of a lower cost of living.

And contrary to a common misconception, deflation isn’t as bad for borrowers as is commonly believed because it reduces their costs as well as their income. If nominal income is reduced by $100 per month while rent is reduced by $50 per month and the cost of other purchases is reduced by $60 per month, it will be easier, not more difficult to pay debt payments. Only if income is lowered by more than the cost of living will it make things tougher for borrowers.

Another argument against deflation is that it could make consumers postpone purchases waiting for lower prices. But first of all, if nominal interest rates fall then this won’t affect this incentive.’

Second, this is exaggerated, as prices of electronics have long fallen, yet people have kept buying it as they want the stuff right now.

And thirdly, better incentives for saving, and against borrowing isn’t really all bad.

Indeed, the main problem with Sweden’s (likely short-lived) deflation is that it will provoke the Riksbank to follow Krugman’s advice and lower interest rates and so encourage excessive borrowing. But that is obviously not an argument for fighting deflation using Krugman’s means.

[This is a translated and slightly reformulated version of a post I wrote in Swedish earlier today]

Krugman’s New One On Swedish Monetary Policy

Paul Krugman asks “How do you say “nobody could have predicted” in Swedish?”. As a native Swedish speaker I can inform him and others that the answer is: “ingen kunde ha förutsett”.

Seriously though, it is obvious from the post that the question in the title was rhetorical and that he wasn’t really looking for a translation of that question to the Swedish language, but was trying to say that his former Princeton colleague Lars E.O. Svensson was right.

“Right” in the sense that Sweden’s CPI fell on a year to year basis in March. But first of all, like the low inflation numbers in many other countries, this drop is largely based on temporary factors that will soon go away, such as the fact that easter was in April this year instead of March like last year.

Secondly, to the extent the drop isn’t temporary it reflects positive supply side factors. GDP and employment is growing faster in Sweden than in most countries with higher inflation, so there is no indication that it is holding back growth.

Furthermore, asset prices are rising fast in Sweden, with house- and stock prices being at record high levels, not exactly what you would expect in what Krugman calls a “deflationary trap”.

Indeed, to the extent the low consumer price inflation in Sweden is a problem it is because it makes the Riksbank to try to counteract it with more inflationary policies, causing an asset price boom.

British Inflation Drop In Context

Many in Britain are now cheering that British inflation has fallen to a 5-year low of 1.6%. That however still means that inflation is highest in the EU as inflation has dropped just as fast elsewhere, which is remarkable considering the pound’s appreciation. Excluding the strong pound and the common factors that have pushed down inflation everywhere (including the effects of easter being in April this year instead of March as last year).

Nature Clip With A Message

The lesson that the male lion in this clip teaches us is “don’t harass and steal food from my women, or you might meet the same fate as the Hyena matriarch at 3:46”.

This illustrates that male lions aren’t quite as lazy as is commonly believed. While the females are responsible for both getting food and taking care of the kids, the males have a “military role”, i.e. protecting women and children from Hyenas-and other male Lions. With the latter task being usually a much greater challenge,

Is European Debt Refinancing Crisis Over?

The fact that even the most troubled and dysfunctional of the crisis countries, Greece, was able to sell long term securities with a yield of slightly less than 5% is a sign that the financing crisis of euro area countries is over-at least for now

The situation is even better for other troubled countries, with the yield gap being a few tenths of basis points for Spain, Italy and Ireland relative to the UK and US, and Portugal’s 10-year yield below 4%.

For the moment, the crisis seems to be over. What could resurrect it?

Well, the thing about debt panics is that they’re partially self-fulfilling prophecies. If most people wants to lend to someone, then they won’t have any trouble refinancing debt, regardless of how bad the fundamentals are. But if no one wants to lend to them, then even an institution with small debts will default on expiring debt securities.

So, as long as investors are optimistic no more debt refinancing crisis will arise. But since they could become pessimistic again it is possible that it could re-appear.

Most countries can shield themselves from it through the printing press-as long as they’re willing to ignore the inflationary consequences. Euro area countries can’t do that by themselves since the printing press has been outsourced to Frankfurt.

But if the ECB is willing to act towards national debts in the way that national central banks act towards their country’s debts then the crisis is clearly over.

That is good in the short-term, but not necessarily in the long term since it will weaken/remove the incentive to avoid deficit spending.

UK To Follow US In Raising GDP Without Raising NI

Britain will now follow the U.S.and consider spending on intellectual property as investment rather than cost of production.

It will also consider the accumulation of future pension rights as present income.

As I pointed out when the U.S. made those changes this will not really make the country richer as cashflows stay the same. It will at least in the long run raise consumption of fixed capital as much as it raises GDP, leaving net income unchanged.

The problem is that unlike the U.S., Britain doesn’t publish numbers over consumption of fixed capital and net income, at least not in the quarterly national accounts, so the distortion won’t be as obvious as in the U.S.

It remains to be seen if and when other European nations will make these changes. If they don’t then U.K. GDP numbers won’t be strictly comparable to GDP numbers in other nations.

This whole mess about how to define capital investments and therefore GDP illustrates how it would be much better to focus on net domestic product or national income.

The effect of counting pension rights as household savings will similarly not really raise national income or savings. If pension rights count as household savings, then they must start counting as dissaving for companies or governments issuing those rights.

These changes may make the U.K. economy look better, but don’t fool yourselves in to thinking that there has been any actual improvement.