Fears that a battered global economic economy has never quite reached a sustained level of recovery have begotten new anxieties about the risk of deflation — a self-reinforcing spiral that drives down investment, spending, lending and employment.
Japan has been a case study of this kind of an economic straitjacket — at least until its recent aggressive monetary easing and stimulus policies known as ‘Abenomics,’ which only recently lifted the Asian nation into mild inflationary territory.
Many commentators, noting a disinflationary trend — where the price level continually decelerates toward zero — have suggested that monetary authorities and economic policymakers need to maintain easy money policies to thwart this danger.
Entering the fray with a dissenting view comes Bank of America chief economist Mickey Levy, who, writing on policy research site Vox, warns that broad assessments about deflation are misleading, and can lead to misguideded policies.
Levy notes the coincidence that the United States, Europe and Japan have presently converged around a very low inflation rate of around 1%, but stresses the importance of understanding just how different is the situation of these three economic powers.
All three have different stories that belie the assumption common to popular commentary that deflation is harmful and must be aggressively combated.
Yes, the U.S. has been experiencing disinflation — the core personal consumption expenditures index, for example, has fallen to 1.2% from 1.8% in the previous year.
Yet “far too little attention has been paid to the fact that the vast majority of the U.S.’s recent disinflation has resulted from technological innovations that raise economic performance and potential,” Levy writes. “This is very different from disinflation/deflation associated with insufficient aggregate demand.”
The Bank of America economist describes a largely positive picture of the U.S. economy, where second-half 2013 GDP grew at an annualized rate of above 5%, significantly higher than the previous year’s 3.1%. Together with an improving job market and rising home prices, Levy puts the probability of deflation in the U.S. at “near zero.”
In contrast to an economically strengthening U.S., Levy describes Europe’s weak economy as at a much earlier stage of recovery where weak aggregate demand is the key concern. Eurozone GDP rose an estimated 1% last year, up from just 0.7% the previous year. “Europe’s risks of deflation are nontrivial,” he writes.
Still, the economist does not recommend the ECB putting its foot on the easy-money accelerator, arguing that doing so risks encouraging Europe’s economic policymakers to further postpone reform of policies that got Europe into its present troubles.
Specifically, policies that have promoted uncompetitive wages need to adjust to economic realities, and as such “even temporary deflation along the road to recovery may be the best – albeit painful – path of adjustment from earlier excesses.”
Japan’s situation is even more distinct from the U.S. than that of Europe, having lived with deflation for two decades and finally emerged only recently to a low level of economic growth. Today nominal GDP is barely above its level in 1991 and 7% below Japan’s previous peak.
This prolonged bout of insufficient aggregate demand has stemmed from misguided monetary and economic policies, growth-suppressing regulation, and a shrinking and aging population and work force that have curtailed household and business spending, Levy says.
While Abenomics has to some extent lifted Japan out of this malaise, “it’s far too early to claim success,” Levy writes. He says that a weaker yen, stronger Nikkei, rising wages and increased confidence are likely to push core inflation above 1% but likely fall short of the Shinzo Abe administration’s 2% goal.
“Critics are correct,” Levy writes, “that failure to implement economic, regulatory and immigration reforms constrain long-run potential growth and drain confidence.”
Because of these widely varying stories, aggressive stimulus of the sort recommended by deflationistas may benefit Japan, but would be inappropriate for a Europe still in need of adjustment to downward price and wage pressures.
And a U.S. where economic expansion is gaining traction — personal income is growing faster than inflation and household net worth is at an all-time high, he says — worries over deflation are altogether misplaced.
“It is unclear why U.S. policymakers and commentators fear disinflation that stems from innovation-based price reductions amid accelerating aggregate demand,” the Bank of America economist concludes.