Why Worry Only About Inflation but Not Deflation?

I continue to ping-pong between writing hair-on-fire columns about the end of (political) days and penning analyses of old-fashioned policy questions.  The latter continue to bubble up not only because I genuinely care about them but also because I need to preserve my mental health.  Last Thursday's column was a bit of both, as I discussed inflation as a matter of economics while also arguing the political point that Democrats should not shy away from telling people the good news that inflation is no longer a problem.

At one point in that column, I wrote this:

[A]nnual inflation through January was 2.5 percent ... [a]nd because the Fed's target rate of inflation is 2.0 percent (which is an arbitrary target that is in fact too low, but I digress), inflation is now essentially already back to where the Fed wants it to be.  Seriously, a 0.5% difference is nothing in this context, and people who would make a big deal about it are either dishonest or irrationally ultra-averse to even the slightest risk of accelerating inflation.  I cannot help but point out that such people do not publicly warn that being below 2.0 percent could get out of hand and tip us below 0.0 percent -- that is, into deflation, which can spiral out of control all too easily.  Why the asymmetry?

My answer to that question was twofold.  As a default matter, pundits (who generally lack even minimal expertise on policy issues) are forever trying to look serious, and being an inflation hawk seems serious (just as being a deficit hawk makes uninformed stooges think they sound serious) and is thus a safe haven for mediocrities.  More to the point of that column, I then noted the more recent conventional wisdom that Democrats must never, ever "tell people how to feel," or something like that.  That is what the silly "vibeflation" argument is all about, with Democrats and pundits trying to convince themselves that they should never try to convince voters of anything other than what they already believe.

I stand by that analysis -- and why not, given that I wrote it less than a week ago?  Even so, it is worth taking another crack at the question of asymmetric fears of inflation and deflation, because this is a very big problem.  In particular, it highlights the point that I referenced parenthetically in the block quote, which is that the Fed's target rate itself is too low.

By pure coincidence, I happened across a video from The Wall Street Journal (not my usual source of enlightenment, to say the least) over the weekend titled: "Why China’s Deflation Is More Dangerous Than High Inflation."  In last week's column, I had noted that deflation's dangers could most easily be seen in the US's Great Depression of the Thirties and its Great Recession fifteen years ago.  The Journal's piece described not only China's current danger of falling into a deflationary depression but also reminded viewers that Japan's Lost Decades starting in 1990 were a classic deflationary episode.

When inflation is too high, we want it to go back to its target range, which means that we only want disinflation, that is, a decline from a higher rate of inflation to a lower -- but still positive -- rate of inflation.  Recall that deflation is defined as falling prices, which is not what anyone wants.  Why is deflation bad?  If prices are actually falling, people will understand that they should wait as long as possible to buy anything that they need, because the longer they wait, the lower will be the price.  This causes a further collapse in demand, which makes prices fall further and faster and creates or deepens a recession, which can become a depression in short order.

Notably, however -- and somewhat contrary to what I wrote in the block quote above -- even a non-spiraling deflation can be disastrous.  The charts in the WSJ video show that Japan's economy stagnated for years while the inflation rate straddled the line between inflation and deflation.  It was often just a bit below zero and was never worse than negative 3 percent annually.  Even so, Japan's first bout of deflation in the mid-1980's set off an era in which Japan's economy stagnated for years, including a stock market crash in 1990 so steep and debilitating that stock prices did not return to their pre-crash highs until this year.  That is a tough thirty-plus years!

It is true that Japan's real economy did eventually recover, and a lot of that country's ongoing issues are caused by its aging population combined with a low birth rate and strict immigration controls.  Even so, those problems had not yet metastasized at the point that Japan's deflation wrecked the economy.  (As an aside, the Japanese government took on huge amounts of debt, more than double the levels that we have ever seen in the US -- yet Japan never experienced hyperinflation, degradation of the yen, nor default.  And the fiscal stimulus did in the end lead to the end of the economic pain.  Go figure.)  The key takeaway is that Japan's deflation was devastating even without spiraling downward, which is why people are now especially worried about China's situation.

But what of the upward spiral of inflation?  We often hear that the Fed must be vigilant against any increase at all in inflation, because otherwise the doors will be blown off as the country experiences ever higher and accelerating inflation.  Except that this is not at all a certainty.  Those of us who argued that the inflation early in Biden's presidency was a matter of post-Covid adjustment had the better of the argument in real time, mostly because the supposed cause of the inflation -- Biden's 2021 stimulus package -- had not been replicated in other countries even as those countries experienced higher levels of inflation than we ever saw in the US.

Because of the Fed's aggressively contractionary interest rate increases over the last few years, it is difficult to determine how much of the now-deceased inflation episode was about supply chains versus a hot economy, but at least we know that it did not require years of high unemployment -- that is, a very deliberately policy-engineered recession, which former Harvard President Lawrence Summers loudly insisted would be necessary -- to bring inflation down.  Moreover, the last forty years have seen plenty of short periods during which inflation went up and then down again, even though inflation-phobes warned of the inevitable upward spiral every time.

Where does that leave us?  Deflation is potentially disastrous even at low levels that do not spiral out of control.  Hyperinflation is potentially disastrous, but it in no way is inevitable when inflation ticks up, nor is it necessarily painful to bring inflation back down.  Yet the very serious people continue to freak out about inflation and inflation alone.

To a certain extent, this a matter of fighting the proverbial last war -- or more accurately, fighting a war that ended almost a half-century ago.  People like Summers (and every other economist of our generation) grew up on "stagflation" in the Seventies, and some people refuse to update their priors because of that one-off event.  Yes, it was hugely disruptive -- to say the least -- but we can now see that it truly (and thankfully) was a one-off.

One possibility, then, is that people of good faith (and of a certain age) could be motivated by something like PTSD, forever hearing the echoes of what they saw in the 1970's and early 1980's.  The current 2 percent target rate is arbitrary, but these perma-hawks imagine that allowing the Fed to increase the acceptable inflation rate would lead to disaster -- even though trying to hit something as low as 2 percent inflation necessarily flirts with an accidental plunge into deflation.

The other possibility, however, is that people who scream every time the inflation rate goes up -- or even when a policy is proposed that might cause inflation to rise -- are doing so malevolently.  The moneyed classes like to keep the labor market weak, and they are more generally against anything that can be described as "activist" economic policy.  Inflation, or the specter of it, is their friend, because even when it is not there, they can claim that it will show up at a moment's notice and RUIN US ALL!!

Maybe that will happen one of these days, but we do know that the US has a very good track record when it comes to dealing with occasional increases in inflation.  At a minimum, it would be refreshing if at least some people who currently try to sound serous about inflation would admit that there is a related danger of deflation, the consequences of which would be serious indeed.

Those people, however, are busy backing Donald Trump's efforts to end constitutional democracy, so they are kind of busy.  And that brings me back to the other side of the ping-pong table.