So Why Aren’t We Worrying About Deflation?

Last week, you might have read about the stagnation of wages. If you didn’t, here’s Felix Salmon:

There’s no good news in today’s data from the Census bureau. Unless you’re the kind of person who worries about inflation, that is: in that case you’re probably reassured that real median household income fell 3.6% between 2007 and 2008, from $52,163 to $50,303. That’s a drop of over $1,800: real money.

David Leonhardt puts this in a broader context:

The typical American household made less money last year than the typical household made a full decade ago.
To me, that’s the big news from the Census Bureau’s annual report on income, poverty and health insurance, which was released this morning. Median household fell to $50,303 last year, from $52,163 in 2007. In 1998, median income was $51,295. All these numbers are adjusted for inflation.
In the four decades that the Census Bureau has been tracking household income, there has never before been a full decade in which median income failed to rise. (The previous record was seven years, ending in 1985.) Other Census data suggest that it also never happened between the late 1940s and the late 1960s. So it doesn’t seem to have happened since at least the 1930s.

Yet, during the stimulus debate, there were conservatives panicking about the possibility of inflation, even as wages were stagnating (and this ignores that many people were also facing reduced incomes). Of course, anyone paying to silly things like household income knew this was absurd. So why aren’t we worried about deflation? Because deflation would only help those with fixed payout assets like bonds and preferred stock.
Oh, never mind, it’s all clear now….

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10 Responses to So Why Aren’t We Worrying About Deflation?

  1. Scott says:

    Well, it sure sounds like the Fed (for one) is worried about deflation. However, there isn’t much the Fed can do once it’s lowered interest rates to zero.

  2. MattXIV says:

    Q: “So Why Aren’t We Worrying About Deflation?”
    CPI-U for 2009 thus far:
    Jan Feb Mar Apr May Jun
    211.143 212.193 212.709 213.240 213.856 215.693
    July Aug
    215.351 215.834
    It’s still negative over a 1-year span, but the major drops all occured from Oct 08 to Jan 09.
    5-Year US treasuries Current Yield: 2.34
    5-Year US TIPS Current Yield: 0.89
    That’s an estimated 1.45% inflation per year for the next 5 years.
    I also don’t see what the Salmon quote has to do with deflation – he’s talking about real wages, which are adjusted for inflation/deflation. Household incomes are highly dependent on unemployment levels, which are obviously elevated at the moment.

  3. Matt, I’d say that taking such a small sample in a noisy time-series makes for a specious induction. Things may be stabilizing (which, given the humongous increase in the monetary base, is hardly anything to write home about), but that doesn’t mean the danger is gone.

  4. (I’d also have to question whether noting that real wages are adjusted for inflation tells us much. That doesn’t preclude the fact that slow nominal wage growth indicates deflation, as wages are commodities just like anything else.)

  5. Kaleberg says:

    Inflation is just a code word for rising wages. It used to refer to rising prices, but it hasn’t been used that way since the 1990s. If you simply substitute “rising wages” for “inflation”, you’ll find it much easier to follow the commentary. Conservatives live in morbid dread of rising wages, but then again, they are always dreading something or another.
    Personally, I’ve been experiencing deflation. Prices are falling at the supermarket, at the gas pump, in real estate, for travel, and for toys and goodies. Having grown up in the 60s and 70s, I never expected to experience deflation in my lifetime, so, for me, it’s as good as a solar eclipse. Deflation hurts anyone who has to pay back a loan, just as inflation, by the archaic definition, hurts anyone who has lent money and expects to be repaid.

  6. “Deflation hurts anyone who has to pay back a loan, just as inflation, by the archaic definition, hurts anyone who has lent money and expects to be repaid.”
    You also have to account for the effects of price-stickiness. Deflation also harms employment.

  7. MattXIV says:

    Then what do you look at to estimate price level trends? CPI-U isn’t volatile – consumer goods prices are relatively stable. TIPS and treasury yields haven’t been up or down more than a couple dozen basis points all year. Even if you don’t like these indicators, what alternate indicator actually shows a deflationary trend? Every set of actual numerical data that reflects price levels that I’ve seen shows a mild inflationary trend.

  8. Matt,
    The CPI-U is as volatile as any econometric data is, which is why I said extrapolating trends from such a short period is specious.
    As to other metrics: for starters, you could look at M2, which shows a disturbingly decreasing derivative over the interval you’ve used.

  9. Here is a CPI-U graph (with lines for both food and energy included and excluded) that demonstrates my first point. I didn’t post it above because I didn’t want to get trapped in moderation.

  10. MattXIV says:

    M!=P MV=PQ. Notice how in late 2008, M2 was increasing rapidly but the CPI-U was declining – that meant falling velocity of money. Since the Fed can manipulate the money supply fairly easily but can’t act directly on velocity of money, declining velocity of money is where the risk of uncontrolled deflation is at. The reason M2 leveled off is because the aggressive expansion of M1 that occured last fall stopped. The fact that M2 leveled off without CPI-U falling indicates the decline in the velocity of money has levelled off – the fact that M2 leveled off rather continued to increase makes the case for mild inflation going forward based on the CPI-U data stronger, not weaker.

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