Deflation

According to Ambrose Evans-Pritchard at the Telegraph, the Swedish Riskbank is worried about deflation.

Sweden has become the first country in northern Europe to slide into serious deflation, prompting a blistering attack on the Riksbank’s monetary policies by the world’s leading deflation expert.

Swedish consumer prices fell 0.4pc in March from a year earlier, catching the authorities by surprise and leading to calls for immediate action to avert a Japanese-style trap.

Lars Svensson, the Riksbank’s former deputy governor, explained that this falling prices are a problem, because they cause debt burdens to ratchet up in real terms. Swedish household debt is 170pc of disposable income

This is a bit rich. Creeping inflation has hurt savers for years, slowly wiping out the value of their hard earned savings. Now a 0.4 percent fall in pirces hurts bgorrowers, and the central banks get worried. It is clear whose side they are on.

Central banks have been rewarding borrowers and punishing savers forever. This contributed to weak risk assessments which contributed to the Global Financial Crisis.

Central Banks fear deflation. The most common argument is that if prices are falling people will stop buying and wait till prices get lower. This does not make sense. Technology prices have been falling for years, but people have not stopped buying.

Chis Casey explains the flaws in this fear in his article called Deflating the Deflation Myth.

In addition, the American economic experience during the nineteenth century is even more telling. Twice, while experiencing sustained and significant economic growth, the American economy “endured” deflationary periods of 50 percent.

This during a period of “sustained and significant economic growth”. But just think of all those poor consumers, having to make the best of constantly falling everyday low prices.

Deflation benefits consumers, because it increases their ability to buy things, without an increase in wages. The inflation of the last few decades has robbed consumers of reduction in prices that should have come through technology gains. These have been captured by people in debt.

Central banks believe deflation leads to depressions. Casey quotes a study completed by several Federal Reserve economists who found:

… the only episode in which we find evidence of a link between deflation and depression is the Great Depression (1929-34). We find virtually no evidence of such a link in any other period. … What is striking is that nearly 90% of the episodes with deflation did not have depression. In a broad historical context, beyond the Great Depression, the notion that deflation and depression are linked virtually disappears.