Sunday, June 3, 2012

"deflation is not necessarily harmful"


I'm doing my homework -- reading the post Marcus Nunes recommended -- but I have to interrupt myself to voice a reaction. Nunes writes:

That deflation is not necessarily harmful is illustrated in figure 6 which shows what was happening in the US economy in the last quarter of the 19th century. While RGDP increased at an average rate of 3.8%, prices fell at 1.3% on average.

His Figure 6:

Source: Marcus Nunes

Pretty impressive. Prices trended gently down for a good long time, while output grew like gangbusters.

My reaction? I wonder whether Nunes' observation fits with my generalization, which is that excessive debt hinders growth. By my rule, debt would have to have been at a relatively low level in the last quarter of the 19th century, or we wouldn't have had such a good rate of growth. 3.8% is good growth.

Come to think of it, if there was a lot of debt at the time, then deflation -- even a mild deflation -- would have made the debt burden worse (because deflation only reduces income, and not debt). So again, I think accumulated debt must have been relatively low while the growth was good in the last quarter of the 19th century.

So I searched for Philippon on my blog and found this in mine of 4 April 2012:

Source: SSRN

Philippon looks at "finance" rather than debt. But I must presume there is similarity between the size of "finance" and the size of debt, because debt is the source of income to finance. So I look at Philippon's graph and see that debt was, indeed, relatively low during the 1860-1890 period.

It would have had to be.


Nunes' Figure 6 above looked familiar to me at first sight. Ah! I've seen something similar before, in his more recent post: “Three panics and a nonevent”.

In that post, Nunes provides a version of his Figure 6 that shows the 1872-1891 period. (This time, he ends the graph before the Panic of 1893. Note on Figure 6 that around 1893 the RDGP line gets choppy and prices drop more quickly; these are results of that 1893 panic.)

In the recent post, Nunes compares four time periods:


Upper left is the Panic of 1873, the same for which Nunes showed a long, mild decline of prices accompanied by a long, strong growth. The same for which I showed that the finance sector was relatively small, and accumulated debt relatively insignificant. This is Nunes' "nonevent".

The other three time periods are the Panic of 1893, the Panic of 1929, and the Panic of 2008. As Nunes points out, all three of these show sharp declines of nominal GDP associated with the panics. Nominal and "real" GDP both decline in those three periods; of the four, only the Panic of 1873 escapes that fate.

Yes. And look again at Philippon's graph. Finance was high during the Panic of 1893, and rising fast. It was higher during the Panic of 1929, and rising fast.It was higher yet during the Panic of 2008, and rising fast. Of the four periods Nunes shows, only the Panic of 1873 -- the "nonevent" -- was accompanied by a relatively low and stable accumulation of debt.

Nunes writes:

Bernanke should note that in the 1870s and 1880s the economy performed robustly in spite of a drawn out fall in prices, an ingredient of his worst nightmares!

Yes. And Nunes should note that in the 1870s and 1880s, the accumulation of debt was relatively low and stable. At every other period he considers, debt was relatively high and rising rapidly.

All four events satisfy my rule: excessive debt hinders growth.

Marcus seems to think we can prevent panics by printing enough money that NGDP never tanks. I think we can prevent panics by making sure the accumulation of debt is relatively low and stable. (Policy must accelerate the repayment of debt, and print money in proportion to the growth generated by the use of credit.)


Only the "nonevent" was accompanied by a relatively low and stable accumulation of debt. Oh! ...What was it Keynes said? Here it is:

The right remedy for the trade cycle is not to be found in abolishing booms and thus keeping us permanently in a semi-slump; but in abolishing slumps and thus keeping us permanently in a quasi-boom.

And now you know how to do it.

1 comment:

Woj said...

Great post. I also appreciate Nunes' thoughts but your comments have crystallized my own views to a great extent.

Don't know if you've seen this paper by Josh Mason and Arjun Jayadev yet, but I think you may enjoy it. Here's the blog post with link: http://rortybomb.wordpress.com/2012/02/23/guest-post-by-jw-mason-the-dynamics-of-household-debt/
The key quote is:
“that changes in borrowing behavior has played a smaller role in the growth of household leverage than is widely believed. Rather, most of the increase can be explained in terms of “Fisher dynamics” — the mechanical result of higher interest rates and lower inflation after 1980.”
Basically, the cost of consumption is increasing due to interest on debt. I think this supports the cost-push idea and highlights a need for policies specific to that problem.