Coppola Comment

A version of this post appeared on Pieria in December 2013.  In my post “ The desert of plenty ”, I described a world in which goods and services are so cheap to produce that less and less capital is required for investment , and so easy to produce that less and less labour is required to produce them. Prices therefore go into freefall and there is a glut of both capital and labour. This is deflation. There are two kinds of deflation. There is the “bad” kind, where asset prices go into a tailspin and banks and businesses fail in droves, bankrupting households and governments and resulting in massive unemployment, poverty and social collapse. America experienced this in the Great Depression and narrowly avoided it in the Great Recession. More recently, at least one European country has felt the effects of this catastrophe. But there is also another kind. This is where falling costs and increasing efficiency of production create a glut of consumer goods and services.

Ah, those pesky words. They do not mean what we think they do. And sometimes we say one thing, but people think we mean another.  And so it is that David Glasner, in a beautifully crafted takedown of my previous post , has managed to miss my point entirely. I did, in fact, read carefully all of David's quotation from Ralph Hawtrey, though I did not quote all of it. Hawtrey's point is that what appeared to be destructive competitive devaluation as countries left the gold standard was in fact beneficial loosening of domestic monetary policy. His fishing fleet did indeed all come safely into harbour, eventually. This was also my point, and the reason why I highlighted Hawtrey's gold standard thinking. Hawtrey understood that in a gold standard system, loosening domestic monetary policy must involve deliberate devaluation versus gold. Indeed in any fixed currency peg system, monetary loosening requires explicit devaluation versus the commodity or foreign currency to whi

It's not often I disagree with David Glasner. Or, for that matter, with Ralph Hawtrey. But I fear I have to take issue with both of them over competitive devaluation. " Bring it on ", says David. No, please don't. It's a terrible idea. Hawtrey's pictorial explanation of why competitive devaluation is a good idea seems both charming and plausible: This competitive depreciation is an entirely imaginary danger. The benefit that a country derives from the depreciation of its currency is in the rise of its price level relative to its wage level, and does not depend on its competitive advantage. If other countries depreciate their currencies, its competitive advantage is destroyed, but the advantage of the price level remains both to it and to them. They in turn may carry the depreciation further, and gain a competitive advantage. But this race in depreciation reaches a natural limit when the fall in wages and in the prices of manufactured goods in terms

Daiwa Securities has forecast Armageddon. They say that over-investment in China in recent years has created a debt bubble so great that Chinese authorities would not able to manage its collapse, resulting in a debt deflationary spiral which would make 2008 look like a walk in the park. Such a meltdown would, in their words, "send the global economy into a tailspin". But they also outline another scenario, in which China's economy undergoes a nasty, possibly prolonged recession, from which it will emerge with lower growth. Which of these scenarios will play out? Well, as I discuss in my latest Forbes post, it really depends what Chinese authorities do. They insist that "everything is under control". But are they actually in the wrong trousers? Read my analysis and conclusions here . Related reading: Never mind Greece, look at China Lessons for China from Japan China's economy: no collapse, but it's serious and so are the politics - Georg

Via the FT's Robin Wigglesworth comes this chart: Greek RGDP fell by 28% between 2008 and the end of 2013. Since then it has increased by about 2%. This is recovery, apparently. The most recent inflation figures show CPI inflation at -1.68% and HICP (core) inflation at -1.8%. , Yes, that is deflation. Indeed Greece has been persistently in deflation for the last six years. Annualised growth figures show RGDP currently growing by 0.6%. Using either measure of inflation, NGDP is negative. The ECB's preferred HICP measure gives NGDP of -1.2%. I suppose, when you are starving, crumbs look like a square meal. Related reading: Celebrating the Spanish recovery  

"So tief im Abendrot, wie sind wir wandermüde.....is das etwa der Tod?" - R. Strauss, Four Last Songs, no. 4 " Im Abendrot " Japan  is in recession. Will it ever escape from its deflationary trap? Indeed, should it even try to? Or would it be better for it simply to accept that its future is gentle decline into a comfortable (and highly automated) old age? Is it becoming the land of the setting sun? My thoughts on this are at Pieria .

Inflation is falling fast in Germany. Today's figures show a fall in annualised CPI growth to 0.7%. And this is in the supposedly powerful core of the Eurozone. Out in the periphery, things are much worse. But whereas disinflation or even outright deflation in periphery countries has little effect on Eurozone aggregate inflation, German disinflation is an entirely different matter. Thomson Reuters has helpfully produced a chart showing the relationship between German and Eurozone inflation: Nicely correlated. In fact it is so well correlated that it is probably fair to say that ECB monetary policy is really determined by inflation expectations in Germany. In the last year there has been some divergence because of the awful performance of Spain and Italy and the stagnation of France, which has led the ECB to attempt to introduce a credit easing programme against the wishes not only of the Bundesbank, but of German politicians. But although disinflation in Germany doesn'

At the risk of sounding like a broken record, I'm going to say it again. The ECB is not doing its job . It is sitting on its hands and muttering about inflation while the Eurozone  sinks further into depression . Even the mighty Germany's economy is shrinking, France is on the floor, Italy is in a slump and Spain's once-promising recovery looks set to be curtailed as consumer prices slide. What is the ECB doing about it? This : The targeted longer-term refinancing operations (TLTROs) that are to take place over the coming months will enhance the accommodative monetary policy stance. These operations will provide long-term funding at attractive terms and conditions over a period of up to four years for all banks that meet certain benchmarks applicable to their lending to the real economy. This should help to ease funding conditions further and stimulate credit provision to the real economy. In other words - nothing. Apart from lending money to banks in the hope they wil

Over at Forbes, more on why the ECB won't do QE despite Spanish inflation having turned negative: Spain is in a mess. Over a quarter of its adult workforce is unemployed, and  according to CIB Natixis  it has lost 25% of its production, even more than Greece. Spain’s inflation rate has been falling steadily and has now turned negative: the most recent retail sales figures  show a fall  of 0.2%. Various people  anticipate  ECB easing monetary policy because of the growing threat of deflation in Spain. But this is to misunderstand the role of monetary policy in a currency union. The ECB sets monetary policy for the union as a single unit, not for its individual components. Deflation in Spain is a driver of ECB decisions only to the extent that it depresses Euro zone CPI. And I’m sorry if this sounds brutal, but Spanish unemployment is of no consequence, since the ECB does not have a mandate to target unemployment even at the Euro zone level, let alone in an individual country. T

Or anything else, for that matter. (But they might talk about it.) With forecasts like these, who needs action? H/t Frederick Ducrozet (@fwred on Twitter)

Scott Sumner argues that when the monetary base is fixed , low interest rates are deflationary. I've emphasised the fixed monetary base because it is an important condition. If the monetary base is NOT fixed then the relationship between low interest rates and deflation is much less clear. Logically, this makes sense. If the supply of base money is fixed, then falling interest rates indicate* rising demand for base money, increasing its value and therefore causing prices to fall. Aficionados of a classical gold standard will recognise this as "benign" deflation. Falling interest rates when the monetary base is fixed can be an indicator of healthy growth. Unfortunately the period that Sumner chooses as his example of falling interest rates and a fixed monetary base was anything but healthy. It was August 2007 to May 2008, which was the height of the subprime crisis and encompassed the failure of Bear Sterns. Strictly speaking, the monetary base was not "fixed&q;

The ECB continues to argue that there is no deflation risk in the Eurozone though many people   dispute this . Headline CPI has been steady at 0.8% for the last three months, and core inflation (which excludes volatile things such as energy prices, which have been falling) is inching upwards. And January's  M3 lending figures  for the Eurozone as a whole, though horrible, do show a slight improvement over December. But as is often the case, looking at Eurozone aggregates doesn't tell the full story. These charts from Natixis show the collapse of bank lending not only in periphery countries, but in Germany: (h/t @okonomia ) In an economy where the money supply depends principally upon bank lending, a credit crunch will become deflation unless the money supply is expanded by other means. For the last year, the ECB has allowed monetary conditions to tighten as banks repaid LTROs. It has justified its inaction on the grounds that the credit crunch (and associated deflation

In an economy where the money supply depends on the production of debt, deflation can never be a good thing. In fact as any cyclist can tell you, deflation means you aren't going anywhere. More on this  here .

My latest post at Pieria delves back into the history of the Long Depression in the 19th Century to find lessons for today's "secular stagnation". Persistent excess of supply over demand is anything but benign and surprisingly difficult to deal with. "In my post “ The desert of plenty ”, I describe a world in which goods and services are so cheap to produce that less and less capital is required for investment , and so easy to produce that less and less labour is required to produce them. Prices therefore go into freefall and there is a glut of both capital and labour. This is deflation. There are two kinds of deflation. There is the “bad” kind, where asset prices go into a tailspin and banks and businesses fail in droves, bankrupting households and governments and resulting in massive unemployment, poverty and social collapse. We have seen this in the past, in the Great Depression; we narrowly avoided it in the Great Recession; and there are currently places

I've suggested previously that QE could actually be deflationary. I looked at it from several perspectives - collateral effects, the monetary transmission mechanism , distributive effects , even Peter Stella's " deadwood " inhibiting bank lending. But I have to admit that the evidence in support of my deflationary hypothesis was thin and the case not proven. All I could demonstrate was that QE is not directly inflationary and whatever stimulative effect it has is weak at best. Until now, that is. Soc Gen have looked at QE.....and they have concluded that its effects may indeed be deflationary. Their reasoning is somewhat different from mine. Here's their argument in full (their emphasis): IS QE DEFLATIONARY?   QE is by design set to be inflationary, yet we were asked several times last week whether the opposite could hold true; i.e. that QE is in fact proving deflationary.   * No credit = no recovery In theory, a permanent increase in money supply resul

Yichuan Wang has a lovely post in which he uses apples to explain how goods markets work in a money economy. It is of course a deliberate over-simplification of a general equilibrium, and I am perhaps being a trifle unfair to Yichuan in picking it to bits. But I couldn't resist. Yichuan defines a recession as a "general glut of goods that aren't consumed", and goes on to suggest that this is because some people have apples but choose not to eat them. Indeed they do. Apples don't fall from the sky as Yichuan suggests, they grow on trees. Trees produce lots of fruit all at once, creating a glut, then none for the rest of the year, creating a shortage. So the market for apples is seasonal (for the purposes of this post I'm going to pretend that there is no international shipment of fruit to smooth out seasonal variation). Furthermore, in some years apple trees produce more fruit than usual, and in other years they produce less, largely due to weather condi

Inflation is dead . Well, in the US, anyway: What is curious is that the US is doing QE. Lots of it. Which is supposed to raise inflation, isn't it? Then there is Japan. Japan recently embarked on an extensive QE programme designed to raise inflation to 2%. Here's the path of Japanese inflation: It's very easy to see where QE started. It's when inflation fell off a cliff. Well, ok, it might have done that anyway, I suppose. Correlation doesn't equal causation, and all that. But it is curious. Japan has, of course, done QE before. A look at the inflation path for the period 2001-2006, when Japan was doing QE, doesn't suggest a close relationship between QE and inflation.   The initial impact seems to have been deflation, though again we could do with a counterfactual. But for the rest of the period QE seems to have had little impact on inflation. In fact  a researcher at the IMF  concluded that QE's effect on inflation was small. The UK do