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To: TobagoJack who wrote (38846)	9/25/2003 9:07:20 PM
From: elmatador	Respond to of 74559

Yesterday: <<Cuts, going down and decreasing have never been part of our mindset. It must be from now on. This is deflation time!>> Today in the Financial Time this man who "teaches economics at DePaul University, Chicago, and is a former research official at the Federal Reserve Bank of St Louis" writes: "Deflation isn't such a bad thing' Who's da man, who's da man in this Thread here? :-) Deflation isn't such a bad thing By Jon Tatom Published: September 25 2003 19:57 \| Last Updated: September 25 2003 19:57 For more than 10 years, the rate of price increases in Japan has been very slow. At times the country has even experienced deflation, especially in recent years. Since real gross domestic product growth has also been weak, numerous observers, including many US officials, have tied Japan's stagnation to its deflation and have chided Japan's leaders for not being more aggressive in ending deflation. But Japan's deflation has been a bright spot. It was intentionally brought about for sound reasons and has not been an obstacle to faster growth. It is vital that policymakers understand Japan's deflation, especially given recent concern that the US may also soon face deflation. Japanese inflation rose from 0.1 per cent in 1987 to about 3.2 per cent in 1991. By 1989 policymakers had become concerned and tightened monetary policy. As a result, inflation fell slowly, reaching zero in 1995. Over this period, Bank of Japan officials consistently argued that their goal was to reduce the pace of service price increases to zero, which would require a fall in the prices of goods and assets. Overall, this was a prescription for deflation. Japan's policy followed Milton Friedman's analysis, set out in his 1969 work Optimum Quantity of Money and Other Essays. He showed that optimal policy would stabilise wages and service prices, allowing the overall prices of goods and services to fall at a rate equal to the real rate of interest. Even so, some US analysts have argued that Japan's decade of slow growth was a result of these deflationary policies. But Japan did not achieve sustained deflation until 1998. The fact that Japan's real gross domestic product has risen at an average rate of only 1.1 per cent since 1991, interspersed with recessions, was not due to deflation. While inflation slowed from 0.9 per cent in 1991-98 to minus 0.7 per cent in 1998-2002, real GDP growth slowed little, declining from 1.2 to 0.9 per cent. The problem of weak output growth in Japan is structural. Organisation for Economic Co-operation and Development data show that, if Japan had achieved its potential output in 2002, real GDP would have been only about 2.9 per cent higher than it was; output growth would have averaged 1.3 per cent a year since 1991 instead of the actual 1.1 per cent rate. Even without cyclical weakness, Japan's growth would have been extremely slow. While explosive monetary growth has boosted output growth recently, it is also bringing deflation to an end. Deflation has slowed from 1 per cent at the end of 2001 to 0.5 per cent at the end of 2002 and was only 0.2 per cent in the year ending in July. Unfortunately, the current cyclical improvement in output will not reverse long-term stagnation. The OECD estimates that potential output growth will continue to decline. Another misconception about deflation is that it has damaged the financial sector. Some analysts have argued that deflation was the cause of the deterioration in banks' balance sheets. To the extent that they are correct, it is because regulators were negligent in not closing failed institutions in a timely fashion. Well capitalised financial institutions are net creditors. Unforeseen deflation, the kind that redistributes income and wealth, benefits net creditors in the same way that unforeseen inflation benefits debtors at the expense of creditors. If the pace of price change did damage banks, it is likely that it did so in a scenario reminiscent of the US savings and loan crisis. First, unforeseen inflation would have wiped out some banks' capital; then an unforeseen slowing in inflation would have further hurt those with negative net worth - in effect, net debtors. The latter force might also further decrease the net worth of institutions that had already been put under water by defaults arising from an underperforming economy. Deflation per se benefits financial businesses. It redistributes income to net creditors when it is unforeseen; and it boosts bank deposits relative to income and other assets because positive real returns accrue to depositors as a result of their holding money whose purchasing power increases. Any adverse cyclical developments that arise from an unforeseen slowing in inflation could increase the number of defaults on loans and damage banks' capital. But the deflation will work to offset those costs, as long as banks remain capitalised and net creditors. US policymakers suggest that deflation would be costly and that extraordinary efforts must be made to avoid it. This conclusion is not supported by Japan's policy experience or by monetary theory. Moderate deflation is good for the economy - and especially for financial institutions. Even inflation- targeting policymakers should broaden their notion of price stability to encompass that derived by Friedman and implemented by the BoJ. The writer teaches economics at DePaul University, Chicago, and is a former research official at the Federal Reserve Bank of St Louis