There has recently been a marked increase in concerns of a generalized decline in prices in both industrial and emerging market economies. With Japan, China, and several other Asian economies already experiencing declining prices, the worry has been that deflationary pressures could deepen, and even spread more widely. This is against a background of massive declines in global equity markets; significant excess capacity and widening output gaps; repeated disappointments over the pace of global recovery; geopolitical uncertainties; and the impact on activity of higher oil prices.
Seems like a document written for current times. Not really. Well, it has been picked from this IMF primer on deflation written in 2003. Further,
This is the second time in the past five years that widespread concerns about deflation have come to the fore—the first being during and in the aftermath of the Asian crisis. Public discussion in many countries, including the United States and Germany, has centered on risks of the onset of deflation, with increasing attention levied to such risks by policymakers. These developments are notable given that for over four decades markets and policy makers have been more concerned about inflation than deflation.
Replace the first emphasised ((Emphasis is mine)) line as – This is the third time in the past ten years that widespread concerns about deflation have come to the fore—the first being during and in the aftermath of the Asian crisis and second one in 2003 post dot-com crisis. And the document is as good as for 2008.
Of course the research methodology would change with data updated but am sure the conclusions are going to be very similar. It develops a deflation index for some select countries where Japan, Germany, Hong Kong and Taiwan are noted as the highest probable for deflation in 2003.
It also estimates the deflation via the output and unemployment gap. Under this it estimates how much the gap between output and unemployment between potential and current would have to be for deflation to occur. The findings are:
|Deflation Onset||Persistent Deflation|
|Unemployment Gap||Output Gap||Unemployment Gap||Output Gap|
|United States||2 – 2½||3-4||3½ – 4||5-6|
|Germany||1 – 1½||1-2||2½ – 3½||2 – 2½|
|France||> 3||4||> 5||> 6|
|United Kingdom||2 – 2½||2-3||2-3||4|
|Italy||5||5||> 6||> 5|
As seen, for deflation to onset in US in 2003, unemployment gap would have to be 2-2.5% and outpt gap by 3%-4%, For persistent the figures are 3.5-4 and 5-6 respectively. In Japan deflation had already set in 2003 and for persistent to set in figures are given. in 2003, Germany looked closest to deflation as it required a gap of 1-2% in both.
I haven’t come across any papers on how these countries avoided the deflation threat, except for this Bernanke paper. It shows how US could get out by simply communicating to the public that deflation would be avoided. This implies the threat was at best limited in scope and no where near the Japan’s case. I haven’t come across papers that show the experience of other countries. If visitors are aware of any such research, do let me know.
We are seeing a similar situation now. Be prepared for tons of suggestions/research on zero interest rate policy, whether monetary or fiscal policy should be used, etc etc. Infact quite a bit has already started.
All these events pose a lot of questions for economists and policymakers. Why do we see this deja-vu (see a discussion here as well). You have a crisis; Followed by steep rate cuts ; the steep fall in prices lead to deflation pressures; leads to discussions on zero interest policy/liquidity trap; the crisis eases; investors search for higher yield assets; the economy recovers and lessons of capital infows are forgotten; this leads to a bubble driving all to join the bubble; the bubble bursts and similar things occur.
What is the way out?