Should we fear deflation?

Several countries have been experiencing deflation. This means that prices, on average, have been falling. In the United States, there has been aversion to deflation, because it evokes the image of falling prices and falling wages from both depressions and recessions. Should we try to avoid it? NC State University economist Mike Walden answers.

“Well, we had widespread deflation during the Great Depression of the 1930s, and I think that is the image people have — prices going down, wages going down, and people out of work. We actually had one year recently of deflation, in 2009, that was at the height of the Great Recession.

“Now policymakers, particularly the Federal Reserve, think deflation is bad for the economy because, as I said, it does tend to cause both prices to go down and also incomes to fall. And it also motivates people to say, ‘Hey, I’m not going to buy now, I’m going to wait until later until prices are lower,’ which causes the economy to slow down.

“But we have a new study from the Bank of International Settlements that actually disputes some of these views. They argue there are really two types of deflation: one good and one bad. The one that is good is deflation that results from improved productivity, when we can make things at a cheaper rate. And we are seeing that and we have seen that for a long time in the electronics area. And that actually helps the economy because we are getting more from less.

“The kind of deflation that they fear is that that is due to asset bubbles and the implosion of those asset bubbles. … That means that we have an asset like stocks or housing prices that go way up in a short period of time, and then they tremendously fall. And that causes those prices to go down, it causes people to lose wealth, and that is a bad type, according to the Bank of International Settlements, of deflation.

“So when we hear that term, don’t immediately think bad, because there are two varieties good and bad. We want to try obviously to avoid the bad kind.”