Download Historical Experience with Low Inflation

America's Historical Experience with Low Inflation
J. Bradford DeLong1
U.C. Berkeley and NBER
December 1, 1999
Department of Economics, Evans Hall, #3880
University of California at Berkeley
Berkeley, CA 94720-3880
(510) 643-4027 phone
(510) 642-6615 fax
[email protected]
http://econ161.berkeley.edu
2
Abstract
The inflation of the 1970's was a marked deviation from America's typical
peacetime historical pattern as a hard-money country. We should expect
America to continue to be a hard-money--low inflation--country in the
future, at least in peacetime. The low rate of future inflation that we thus
forecast changes the balance of macroeconomic risks and opportunities.
The risk of debt-deflation-mediated recessions is somewhat higher
because a low trend rate of goods-and-services price index inflation
somewhat increases the chances of deflation, but it does not raise such
risks as much as one might think. The failure of the Fisher effect to hold
empirically means that a low inflation era will in all likelihood be a high
real interest rate era. But such high real interest rates do not appear to
significantly discourage investment or growth.
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I. Introduction
The burst of inflation that struck the United States in the 1970s still shapes much
American thought about macroeconomic policy. The decade of the 1970s saw GDPdeflator inflation rates peak at nearly ten percent per year, and saw consumer price
inflation peak at rates three or four percent higher.
4
Such a rate of inflation was high enough to potentially induce significant distortions in
investment as a result of the interaction of inflation with our tax system, which is unable
to adequately adjust for the difference between nominal and real income. Such a rate of
inflation transferred substantial wealth from creditors to debtors. And it rendered
accounting statements constructed according to standard accounting principles
thoroughly untrustworthy.
Moreover, the inflation of the 1970s has cast its shadow upon forecasts of the likely
future of the American economy. Practically everyone's expectations of what inflation
might be in the future are to some degree or other influenced by the experience of the
1970s. During the 1970s, after all, the American price level rose by more than eighty
percent.
Yet a look back at history reveals that the sustained inflation of the 1970s was an
anomaly in American history.
It is certainly true that there had been previous peaks of inflation higher than or as high as
was reached in the 1970s. But the two biggest peaks had come during the emergencies of
World Wars I and II. One expects considerable inflation while one's country is engaged
in a total war. The third peak--the last one during which inflation peaked at levels higher
than reached in the 1970s--took place during the recovery from the mammoth deflation of
1929-1933. It did not rapidly and substantially raise the price level above marks that had
previously been considered normal. Instead, it restored prices to levels that had been
considered normal before the coming of the Great Depression.
5
In addition, these previous spikes of inflation had been very transitory. They lasted for a
couple of years, or at most for half a decade. They did not last for the decade-plus period
during which inflation was a principal economic policy concern which extended from the
late 1960s into the 1980s.
Most of all, however, these episodes of total wartime and deflation-rebound inflation
were clear exceptions to the rule. Aside from these three episodes, for the entire century
between the end of the Civil War and the late 1960s GDP-deflator inflation in the United
States had always been less than five percent per year, and had usually been less than
three percent per year.
Thus the century before 1968 reveals that in peacetime the United States was typically a
hard-money country.
There is no strong reason to think that the inflation of the 1970s marks a structural shift
away from this peacetime history as a low-inflation country. The causes of the inflation
of the 1970s were unique, and are unlikely to be repeated.2 More typical is that William
Jennings Bryan lost the election of 1896 when he campaigned on the platform of free
coinage of silver at a rate of 16-to-1.3 Neither the Republican nor the Democratic Party
sought at the end of 1970s to run on a platform of tolerating the "head cold" of ten
percent per year's worth of inflation in order to achieve the benefits of a high-pressure
economy.4 Both political parties today--save at their fringes--are eager to praise senior
Federal Reserve officials who have pursued monetary policies that have successfully
minimized inflation. It is the inflation of the 1970s that is the significant exception.
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Thus it is probably best to think of the current relatively low rate of inflation as a return
to a typical American pattern. Anyone forecasting the future from today has to be willing
to give long odds that the low levels of inflation America has experienced since the early
1980s will continue.
If it is the case that we are likely to be entering a prolonged era of very low inflation,
what should we expect that era to bring? What potential dangers does history tell us that
low inflation brings to the forefront?
The potential lessons of history are threefold. There are three sets of issues where
America's long-run historical experience with low inflation might be of help in
forecasting the future, or at least in aiding those of us who want to play the role of
Cassandra in pointing out potential dangers.
The first set of issues revolves around low inflation and the credit channel. The current
leading theory of the causes of the Great Depression stresses the destruction of the web of
financial intermediation by deflation between 1929 and 1933: the Great Depression
appears from today's perspective to be more of a credit than a monetary phenomenon.
Low inflation raises the chance that at some point the turning of the wheel of the business
cycle will generate deflation. How great is this danger? How is it to be guarded against?
The answer is: not very great. Low trend inflation does raise the chance that a
contractionary shock might push goods-and-services price indexes down. But what we
fear about deflation can be generated by asset price "deflations" and foreign-currency
debt "deflations" as easily as by goods-and-services price index "deflations." A period of
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price stability certainly does not increase the chances of either of these alternative sources
of contractionary shocks.
The second set of issues revolves around low inflation and real interest rates. All
economists believe deep in their bones in the theory of the Fisher effect: theory tells us
that if one changes the average trend rate of inflation, and if one then waits long enough,
nominal interest rates will adjust point-for-point (or possibly more than point-for-point
given the interaction of inflation and the tax system) to the change in the rate of inflation,
and real interest rates will return to equilibrium. Is this in fact the case? Or does low
inflation pose a danger in terms of being likely to generate persistently high real interest
rates?
The lessons of history here are double-edged. On the one hand, history teaches us that we
should not expect the Fisher effect to hold. On the other hand, there are no signs that the
failure of the Fisher effect to hold has any bad consequences other than (in a low inflation
era) a certain degree of wealth redistribution from creditors to debtors.
The third set of issues concerns inflation and productivity growth. The idea behind low
inflation is to remove some sand from the wheels of the price mechanism. In an
effectively-zero-inflation climate, people can have more trust that the real prices they see
are likely to persist near their current levels rather than being always in motion as some
(s, S) mechanism recurrently ratchets real prices of individual commodities to levels that
are temporarily high and then temporarily low. In an effectively zero-inflation climate,
people don't have to worry about inflation. Instead, they can devote their mental attention
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to worrying about other things--and we hope that some of that worry about other things
will translate into improvements in productivity.
But does low inflation in fact produce faster productivity growth? And if it does not, then
what is the rationale behind pursuing policies to guarantee low inflation--policies that
may incur substantial costs in terms of other objectives sacrificed?5
In the last analysis, confidence that low inflation is a goal worth pursuing has to rest on
(i) the consequent reduction in tax-system distortions, (ii) a theoretical belief that
removing managers' and workers' attention from the problem of forecasting inflation must
be worthwhile, and (iii) from voters' and citizens' expressed preference for low rates of
inflation.
II. Low Inflation and the Credit Channel6
Deflation and the Credit Channel
Does the absence of significant inflation increase the chance of significant deflation? The
price level no longer has a noticeable upward trend. Does this absence of inflation mean
that the chances of a sharp downward movement in prices--a deflation--are increased?
Certainly people who write articles for newspapers and magazine believe that it does. In
the first six months of 1999 major newspapers printed 467 articles that fall within the
scope of the keyword "deflation." A similar search records only 36 such articles in the
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first six months of 1997, and only 10 in the first half of 1990.7
John Maynard Keynes8 set out what was perhaps the first analysis of the damaging
effects of deflation working through the credit channel. Keynes argued that deflation was
damaging because entrepreneurs were inevitably short nominal assets:
…the business world as a whole must always be in a position where it
stands to gain by a rise… and to lose by a fall in prices…. [The] regime of
money-contract forces the world always to carry a big speculative
position, and if it is reluctant to carry this position the productive process
must be slackened…. The fact of falling prices injures entrepreneurs;
consequently the fear of falling prices causes them to protect themselves
by curtailing their operations; yet it is upon the aggregate of their
individual estimations of the risk, and their willingness to run the risk, that
the activity of production and of employment mainly depends…9
It was Irving Fisher, however, who argued that it was not the fear of falling prices but the
fact that prices had fallen that was the principal source of danger.10 Fears that past price
declines meant that the banks in which you placed your money were insolvent decreased
monetary velocity. Corporate bankruptcies also disrupted Fisher's equation of exchange.
Thus any decline in prices carried a severe decline in velocity along with it.
Others disagreed. Academics like Joseph Schumpeter and policy makers like U.S.
Treasury Secretary Andrew Mellon argued that periodic deflations were necessary for
economic growth. After all, anyone could make money during an inflation: only during
10
deflation could the collection of the economy's entrepreneurs be pruned through
bankruptcy which would release factors of production that could then be re-employed by
more skillful entrepreneurs during the next boom.11
Deflation was so dangerous in previous eras before World War II--or so we now think-because of the side effects of the principal-agent problem that confronts investors who
commit their funds to enterprises. The investor has very limited ability to monitor and
assess what is going on at the level of the operating business. Thus investors need to
structure their relationships with entrepreneurs so that they are forced to monitor the
progress of the business as little as possible, and a good way to do that is through debt. In
such a debt contract the investor receives a fixed sum negotiated ex ante in all states of
the world in which the entrepreneur can pay, and in those states of the world in which the
entrepreneur cannot pay his or her rights are extinguished in bankruptcy.12
In economic theory there is no reason that a debt contract has to be a nominal debt
contract, unconditioned on macroeconomic signals of production, price levels, and
unemployment. But in practice the economy has and has long had a lot of nominal debt
contracts.
Deflation destroys the ability of entrepreneurs to service their nominal debt obligations.
The existence of nominal debt contracts means that to the financial system deflation
appears to be a signal that entrepreneurs have failed, and that their enterprises need to be
liquidated. This makes deflation destructive: valuable organizations and webs of
intermediation are eliminated for no fundamental purpose. And there is significant
evidence that deflation has been at work, both before and since World War II.13
11
The Role of Monetary Policy
How fast can monetary policy act to influence the price level? The answer since Milton
Friedman stated that monetary policy works with "long and variable lags" has been "not
very."14 Monetary policy is powerful, but power and speed of action are two different
things.
Recent econometric estimates continue to bear out this assessment. Christiano,
Eichenbaum, and Evans (1998) are pleased that there is substantial agreement on the
qualitative impact of changes in monetary policy "in the sense that inference is robust
across a large subset of the identification schemes that have been considered in the
literature."15 But the time delay in the effect of a change in monetary policy is large: not
until some eight quarters after the initial interest rate shock has the impact of a change in
interest rates had anything near its long-run effect on the rate of inflation (or deflation).
According to Christiano, Eichenbaum, and Evans, a one percentage point upward shift in
the federal funds rate is associated with a less than one-tenth of one percent decrease in
the annual rate of inflation even ten quarters out.
Monetary policy is the stabilization policy tool of choice: other discretionary policy lags
are longer and more variable. But the ability of the Federal Reserve to offset shocks to
the price level at any horizon of less than three or four years is limited. And DeLong
(1999) reports calculations assuming a symmetrical distribution of price shocks that
suggest at least a one-in-twenty chance that the price level two-and-a-half years hence
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will be eight percentage points or more below today's best forecast.
.
30 -Mont h- Ahead
Change in Price Level
30%
Out come
20%
10%
Forec ast
0%
1950 .01
1960 .01
1970 . 01
1980 . 01
1990 .01
The biggest potential source of error in this calculation is, of course, the assumption of
symmetry. The high variance of the price level about its forecast is driven in large part by
the high upward spikes in prices during the inflation of the 1970s. Akerlof, Dickens, and
Perry (1996) have documented substantial downward nominal wage rigidity in today's
economy that would imply a substantial asymmetry in price shocks, and would reduce the
dangers of a deflationary spiral to a very low level indeed.
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Kinds of Deflation
Moreover, this credit-channel analysis of the macroeconomic dangers of deflation leads
immediately to the conclusion that declining goods and services price indexes are not the
only potential source of macroeconomic danger from the credit channel, and should not
be placed at the center of the focus. A large-scale asset price decline can have similar
destructive consequences for the credit channel and the web of financial intermediation.
This is one theory of the source of Japan's macroeconomic difficulties over the past
decade.
Another source of potential deflationary effects is harder-currency borrowing by banks,
companies, and governments with transactions are denominated in currencies that lose
value. When demand for a private business's products falls, it is natural for the business
to cut its price. When demand for a country's products--either its exports or its properties-falls, it is natural for the country to cut its price by letting its exchange rate depreciate.
But if its banks and corporations have borrowed abroad in harder currencies, then
depreciation looks like deflation: it writes up the home-currency value of their debts,
erodes entrepreneurial net worth, and sets the destructive credit channel in motion. The
credit channel effects we fear from deflation have more potential sources than simply a
fall in broad goods-and-services price indexes alone.
Thus there is a case to be made that the most damaging effects of deflation, at least of
asset-price deflation, are likely to be set up by a previous period of inflation. Inflation
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leads to an increasing degree of leverage in the financial system: more debt contracts, and
a greater chance for falls in asset prices to set off contractions in the web of financial
intermediation.16 Whether this increased degree of leverage springs from inflation alone
or from the powerful interaction of inflation with a tax system that assess tax liability
based on nominal income is not clear.17 But it is reasonably clear that even if a period of
inflation lowers the danger of debt-deflation from a downward spiral in goods-andservices price indexes, it does not reduce--and may increase the potential danger from
these other sources of pressure.
Thus the conclusion has to be that any effect that a low trend rate of inflation has in
increasing the risks of a debt-deflation credit-channel downward spiral is presumably not
a very large increase.
III. Low Inflation and Real Interest Rates
The end of moderate inflation in the United States in the early 1980s also saw a
substantial increase in real interest rates.
15
The figure shows estimated real interest rates on three-month and ten-year U.S. Treasury
securities since 1960. The real interest rate is estimated by subtracting the rate of inflation
over the previous twelve months from the nominal interest rate. It is thus a very imperfect
measure of changes in real interest rates in the short term. To the extent, however, that
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investors believe that changes in inflation are persistent and are unforecastable, it will
provide a reasonable guide to changes in real interest rates across decades.
The three most striking features of the figure are (i) the downward trend in real interest
rates from the 1960s into the inflationary 1970s, (ii) the upward jump in real interest rates
to what were (for the United States) extraordinary levels during the Volcker disinflation,
and (iii) the continued high level of real interest rates since. Real interest rates today are
some one hundred basis points higher at the short end and at least one hundred fifty basis
points higher at the long end than in the early 1960s.
The Fisher Effect
Back in 1984 when economists first noted this rise in interest rates, Olivier Blanchard and
Lawrence Summers attributed it to an increase in the return on capital springing from
deregulation and reductions in marginal tax rates.18 But the increase in economic growth
over the following decade that one would have expected to result from an investment
boom driven by an increase in the return on capital did not happen. Thus today it seems
much more likely that relatively high real interest rates in financial markets are a result of
some failure of the Fisher effect: investors appear to believe that there is a significant
chance of a renewal of inflation like that of the 1970s.
Historical experience tells us that such failures of the Fisher effect for prolonged periods
of time--generations--are not at all uncommon. Lawrence Summers (1983) argued that
there was essentially no evidence for the existence of a response of nominal interest rates
17
to changes in long-term trend rates of inflation back before World War II, and only a
partial response to changes in long-term trend rates of inflation since World War II.
In response to the criticism that pre-World War I rates of inflation were essentially
unforecastable--and hence that there was no predictable component to shifts in pre-World
War I inflation--Barsky and DeLong (1991) pointed out that the link under the gold
standard between mining and prices did provide a way to forecast pre-World War I
inflation.
18
Although the log of the pre-World War I price level is almost a random walk), there is a
component of future price changes that is forecast by changes in the world stock of gold.
The smooth gold production series picks up an important and forecastable low-frequency
component of inflation which is masked in univariate analyses.
Worldwide gold production was a well-known and closely-followed quantity at the time.
The correlation between pre-World War I rates of inflation and rates of increase in the
world gold stock was significant. Financial markets back before World War I could have
19
used the information implicit in gold mining to forecast in the years immediately after
1896 that the world economy was shifting from a regime of slow deflation to one of slow
inflation. Yet they do not appear to have done so.
Instead of a Fisher Effect, we have a pre-World War I Gibson Paradox. Interest rates
respond to the turnaround of the direction of movement of the price level around 1896 so
slowly and hesitantly that the nominal interest rate is correlated not with the inflation rate
but with the integral of the inflation rate, the price level.19
Irving Fisher himself attempted to reconcile his point-for-point adjustment of nominal
interest rates to inflation, and concluded that the failure of the nominal interest rate to rise
after 1896: "…must, in all probability, have been due to inadvertence. The inrushing
streams of gold caught merchants napping. They should have stemmed the tide by putting
up [nominal] interest… two or three percent[age] points higher…"20
It is clear that long-run historical experience gives us no reason to be confident that the
Fisher effect would hold. So why should we be surprised when the Volcker disinflation
of the early 1980s turns out to have had a significant and long-lasting effect on the level
of real interest rates?
Implications for Investment
Yet has the persistent rise in real interest had significant economic effects? Has it led to a
reduction in real investment below its counterfactual path? It is not at all clear that it has
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had any such effect. Untangling the causes of secular changes in savings and investment
rates is next to impossible because the changing composition of the capital stock has been
shortening its average lifetime. Gross investment as a share of GDP has certainly not
fallen since 1980. Net investment as a share of GDP may have fallen. And it is not even
clear which way we would expect a rise in the ex ante real interest rate to shift the
savings rate.
Thus the lesson of history for the effect of an age of low inflation on the real interest rate
is double-edged. First, do not expect the Fisher effect to hold: expect the real rate of
interest in low-inflation times to be relatively high. Second, do not expect this failure of
the Fisher effect to have any significant effect on the level of investment: the failure of
expectations to adjust fully to the low-inflation environment is, presumably, present on
both sides of the market. (There are, of course, substantial effects on the relative wealth
of debtors and creditors).
IV. Low Inflation, Productivity Growth, and Utility
Economists' faith that low inflation is a goal worth pursuing rests in the end on a belief
that low inflation is a source of higher real productivity and real material standards of
living. Yet this association appears to be surprisingly hard to document empirically.
Alesina and Summers (1993) showed that there is no evidence at all that independent
central banks that pursue low-inflation policies are sacrificing any other worthwhile
macroeconomic objective in the long run. But that is only half of what needs to be
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demonstrated. Rudebusch and Wilcox (1994) found striking correlations between
productivity growth and inflation, but could not convincingly show causation. After all, if
total nominal demand is predetermined then a strong correlation between high
productivity and low inflation is guaranteed by the identity that quantity times price
equals expenditure.
Here economic history is of no help. As long as inflation remains moderate, there is no
chance of teasing out of the data any convincing causal chain at the macroeconomic level
running from lower inflation to faster productivity growth.
Nevertheless, economists' confidence that it is there remains strong. Rates of inflation
low and stable enough that nobody has to worry about confusing overall changes in the
nominal price level with real changes in relative prices reduce the magnitude of the
problem economic agents have in interpreting the price signals they see. With one less
thing to worry about, the organizational time and effort that had gone into forecasting
inflation and interpreting news in an inflationary environment can be devoted to
analyzing other things instead--and at least some of those other things should raise
economic productivity. In the absence of convincing evidence to the contrary,
economists' priors will remain centered on the belief that low inflation is a source of
stronger economic growth.
But the case for pursuing and welcoming low enough inflation to be called "price
stability" does not have to rest there. Politicians welcome low inflation for a reason: they
believe that to come out against low inflation is electoral death.21 It was Arthur Okun in
the mid-1970s who popularized the "misery index"--the sum of the annual inflation and
22
unemployment rates. It proved an effective rhetorical weapon in the presidential
campaign of 1976 against Gerald Ford, and in the presidential campaign of 1980 against
Jimmy Carter.
Robert Shiller (1997) explored the reasons for people's distaste for inflation, and came up
with two broad conclusions. First, that the public believes that inflation is a sign that all is
not right with economic policy--it is a signal of a degree of incompetence on the part of
economic policy makers. Second, that the public finds inflation to be one additional
source of risk in an already risky world--moreover, a source of risk that they cannot
easily assess or understand without learning more about macroeconomics. Thus a distaste
for inflation appears to be in the utility function.
And if a distaste for inflation is indeed in the utility function, economists should
recognize that low inflation is an appropriate policy goal for that reason alone.
V. Conclusion
A look back at America's historical experience with low inflation carries at least five
potential lessons for the future.
The first is that we should recognize that the inflation of the 1970's was a marked
deviation from America's typical peacetime historical pattern as a hard-money country.
23
Thus we should expect that there is a good chance that America will continue to be a
hard-money--low inflation--country in the future, at least in peacetime.
The second is that the increased risk of deflation and depression in a low-inflation
environment can be oversold. A low level of trend inflation does make a downward spiral
in the goods-and-services price index slightly more likely. Such a spiral could be the
source of a severe recession. But such risks are lower than one might think: starting a
deflationary spiral in today's economic environment would be very difficult, and there is
probably more to fear from asset price "deflations" which are effectively unlinked to the
trend of overall consumer or producer prices.
The third lesson is that we should not expect the Fisher effect to hold. A low inflation era
will in all likelihood be a high real interest rate era. But we should also expect that such
high real interest rates will probably not significantly discourage investment or growth-even though they will transfer wealth from debtors to creditors.
The fourth lesson is that it is hard to tease out of the historical record any significant
macro causal link running from low inflation to faster growth. Economists' belief that low
inflation is good for growth continues to rest on our common theoretical priors.
And the fifth and last lesson is that history teaches us that voters dislike inflation.
Political parties that preside over episodes of significant inflation in industrial countries
have a good chance of getting bounced. The "misery index"--the sum of inflation and
unemployment--resonates at the political level. Whether voters and citizens dislike
inflation for what we economists would consider to be good reason may not be fully
24
relevant. A taste for low inflation appears to be in the utility function. To the extent that
low inflation reduces this potential for anxiety, it is a policy goal that is worth pursuing
for that single reason alone.
25
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of Economics 107:4 (December), pp. 869-903.
Glenn Rudebusch and David Wilcox, “Productivity and Inflation: Evidence and
Interpretations” (San Francisco, CA: Federal Reserve Bank of San Francisco xerox,
1994).
30
Robert Shiller (1997), "Why Do People Dislike Inflation?" in Christina D. Romer and
David H. Romer, eds., Reducing Inflation: Motivation and Strategy (Chicago:
University of Chicago Press), pp. 13-67.
Robert Shiller and Jeremy J. Siegel (1977), “The Gibson Paradox and Historical
Movements in Real Interest Rates,” Journal of Political Economy 85, pp. 891-907.
Henry Simons, “Rules versus Authorities in Monetary Policy,” in Henry Simons, A
Positive Program for Laissez-Faire and Other Essays (Chicago: University of
Chicago, 1947).
Herbert Stein (1984), Presidential Economics (New York: Simon and Schuster).
Lawrence Summers (1983), “The Nonadjustment of Nominal Interest Rates,” in James
Tobin, ed., Macroeconomics, Prices, and Quantities: Essays in Memory of Arthur
Okun (Washington: the Brookings Institution).
John Taylor, “The Great Inflation, The Great Disinflation, and Policies for Future Price
Stability,” in Adrian Blundell-Wignal, ed., Inflation, Disinflation, and Monetary
Policy (Sidney, Australia: Ambassador Press, 1992).
Robert Townsend, "Optimal Contracts and Competitive Markets with Costly State
Verification," Journal of Economic Theory Vol. 21, No. 5 (October, 1979), pp. 26593.
31
Edward Tufte (1978), Political Control of the Economy (Princeton: Princeton University
Press).
Paul Volcker and Toyoo Gyohten (with Lawrence Malkin, ed.) (1992), Changing
Fortunes: The World’s Money and the Threat to American Leadership (New York:
Random House).
1
I would like to thank Robert Barsky, Barry Eichengreen, Richard Grossman, Christopher Hanes, Christina
Romer, and Robert Waldmann for helpful discussions, and U.C. Berkeley's Committee on Research for
financial support.
2
See J. Bradford DeLong (1997), "America's Peacetime Inflation: The 1970s," in Christina Romer and
David Romer. eds., Reducing Inflation: Motivation and Strategy (Chicago: University of Chicago Press);
Herbert Stein (1984), Presidential Economics (New York: Simon and Schuster); Edward Tufte (1978),
Political Control of the Economy (Princeton: Princeton University Press); Donald Kettl (1986), Leadership
at the Fed (New Haven: Yale University Press); Alan Blinder (1982), “The Anatomy of Double-Digit
Inflation,” in Robert Hall, ed., Inflation: Causes and Effects (Chicago: University of Chicago Press).
3
See Lawrence Goodwyn (1978), The Populist Moment (Oxford: Oxford University Press).
4
Although there are some who believe that running on such a platform would have led to overwhelming
political victory. See William Grieder (1987), Secrets of the Temple (New York: Simon and Schuster).
5
See Olivier J. Blanchard and Lawrence H. Summers (1986), "Hysteresis and the European Unemployment
Problem," NBER Macroeconomics Annual 1, pp. 15-78.
6
For a more extended version of the argument of this section, see J. Bradford DeLong (1999), "Should We
Fear Deflation?" Brookings Papers on Economic Activity (Spring).
7
Moreover, many of the mentions back in 1990 are ironic: consider the last Financial Times Lex column in
1990. It talks of how in the year just past: "Recession and deflation were hardly on the agenda." See
Financial Times, December 31, 1990, Section I, page 12.
8
John Maynard Keynes (1924), A Tract on Monetary Reform (London: Macmillan).
9
John Maynard Keynes (1924), A Tract on Monetary Reform (London: Macmillan), pp. 40-42.
See Irving Fisher, "The Debt-Deflation Theory of Great Depressions," Econometrica Vol. 1, No. 4
(October, 1933), pp. 337-57. Irving Fisher (1926), "A Statistical Relationship Between Unemployment and
Price Changes," International Labour Review. Reprinted in the Journal of Political Economy 81:2,1
(March-April 1973), pp. 496-502. Fisher's language provokes occasional culture shock: consider his
statement that "…during the last three years in particular I have had at least one computer in my office
working almost constantly on this problem…" (p. 497).
11
See J. Bradford DeLong (1997), "American Fiscal Policy in the Shadow of the Great Depression", in
Michael Bordo, Claudia Goldin, and Eugene White, eds., The Defining Moment: The Great Depression and
the American Economy in the Twentieth Century (Chicago: University of Chicago Press, 1997).
10
12
See Robert Townsend (1979), "Optimal Contracts and Competitive Markets with Costly State
Verification," Journal of Economic Theory 21:5 (October), pp. 265-93; Douglas Gale and Martin Hellwig
(1985), "Incentive-Compatible Debt Contracts I: The One-period Problem," Review of Economic Studies
52:5 (October), pp. 647-63.
32
13
See Ben Bernanke, "Nonmonetary Effects of the Financial Crisis in the Propagation of the Great
Depression," American Economic Review Vol. 73, No. 2 (June 1983), pp. 257-76; Ben Bernanke and Mark
Gertler, "Agency Costs, Net Worth, and Business Fluctuations," American Economic Review Vo. 79, No. 1
(March 1989), pp. 14-31; and Ben Bernanke and Mark Gertler, "Financial Fragility and Economic
Performance," Quarterly Journal of Economics Vol. 105, No. 1 (February, 1990), pp. 87-114.
14
See Robert J. Gordon, ed. (1975), Milton Friedman's Monetary Framework: A Debate with His Critics
(Chicago: University of Chicago Press).
15
Lawrence Christiano, Martin Eichenbaum, and Charles Evans (1998), "Monetary Policy Shocks: What
Have We Learned and to What End?" (NBER Working Paper No. 6400).
16
See William English (1996), "Inflation and Financial Sector Size" (Washington DC: Federal Reserve
Fiannce and Economics Discussion Series 96/16).
17
Martin S. Feldstein (1983), Inflation, Tax Rules, and Capital Formation (Chicago: University of Chicago
Press).
18
See Olivier J. Blanchard and Lawrence H. Summers (1984), "Perspectives on High World Interest
Rates," Brookings Papers on Economic Activity (Fall), pp. 323-74.
19
See Shiller and Siegel (1977).
20
See Barsky and DeLong (1991), who note that this assessment by Fisher fits awkwardly with his
(earlier) arguments in The Rate of In terest for the Fisher effect:
"Foresight is clearer and more prevalent to-day than ever before. Multiples of trade
journals and investors’ reviews have their chief reason for existence in supplying data on
which to base prediction. Every chance for gain is eagerly watched for. An active and
keen speculation is constantly going on which, so far as it does not consist of fictitious
and gambling transactions, performs a well-known and provident function for society. Is
it reasonable to believe that foresight, which is the general rule, has an exception as
applied to falling or rising prices?"
21
Whether they are correct to believe that "soft money" political positions are vote losers is not clear. See,
among many others, Fair (1978) and Tufte (1978). Grieder (1987) adopts the position that voters' distaste
for inflation is a form of "false consciousness" that should be fought.