Deflation, disinflation, some definition: frbsf.org I recall some argument here with ahahaahha about what disinflation is. He, of course, was wrong, and slunk back to his cave where he can be KING OF THE HILL and reminisce about past glories teaching Milton economics.
<What's so bad about deflation?
First, let's talk about the difference between disinflation and deflation. Disinflation just means that the rate of inflation is slowing—say, from 3% a year to 2% a year. Deflation, in contrast, means that there's a fall in prices; and it's not just a fall in prices in some sectors—like the familiar falling prices of a lot of computer equipment. Rather, in a deflation, prices are falling throughout the economy, so the inflation rate is negative. That may sound good, if you're a consumer.
But, in fact, deflation can be as bad as too much inflation. And the reasons are pretty similar. For example, to go back to the case of the fixed-rate loan, a surprise deflation also redistributes wealth, but in the opposite direction from inflation, that is, from borrowers to lenders. The reason is that deflation raises the real burden of making a stream of payments whose nominal value is fixed.
A substantial, prolonged deflation, like the one during the Great Depression, can be associated with severe problems in the financial system. It can lead to significant declines in the value of collateral owned by households and firms, making it more difficult to borrow. And falling collateral values may force lenders to call in outstanding loans, which would force firms to cut back their scale of operations and force households to cut back consumption.
Finally, in a deflationary episode, interest rates are likely to be lower than they are during periods of low inflation, which means that the Fed's ability to stimulate the economy will be even more limited.
So that's why the other goal is "stable prices"?
Yes. Price "stability" is basically a low-inflation environment where people and firms can make financial decisions without worrying about where prices are headed. Moreover, this is all the Fed can achieve in the long run.
If low inflation is the only thing the Fed can achieve in the long run, why isn't it the sole focus of monetary policy?
Because the Fed can determine the economy's average rate of inflation, some commentators—and some members of Congress as well—have emphasized the need to define the goals of monetary policy in terms of price stability, which is achievable.
But the Fed, of course, also can affect output and employment in the short run. And big swings in output and employment are costly to people, too. So, in practice, the Fed, like most central banks, cares about both inflation and measures of the short-run performance of the economy.
Are the two goals ever in conflict? >
Meanwhile, Big Ben is about to ring the bell in his first big meeting and we shall see for whom the bell tolls.
Mqurice |
