- Jun 3, 2009
- Reaction score
- Political Leaning
- Very Conservative
Here we examine the empirical relationship between deflation and depression in a broad historical context, including but not limited to the Great Depression. We use a panel data set on inflation and real output growth for 17 countries and more than 100 years. To focus on medium-term fluctuations, we break the time series on inflation and real output growth for each country into five-year episodes, and for each episode, we compute the average annual inflation rate and the average annual real output growth rate. For any episode, we define a deflation as a negative average inflation rate and a depression as a negative average real output growth rate. Throughout, we restrict attention to moderate inflations, those with average annual inflation below 20 percent.
Our main finding is that 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. Here we have made no attempt to distinguish anticipated from unanticipated deflations, while theory, of course, makes a sharp distinction. Optimal monetary policy in a broad class of models with nominal rigidities dictates engineering small anticipated deflations and avoiding unanticipated deflations altogether. To the extent that the deflation in the Great Depression is thought of as unanticipated, as in most existing theories, this episode is not relevant for evaluating the costs of anticipated deflation. Our finding thus suggests that policymakers’ fear of anticipated policy-induced deflation that would result from following, say, the Friedman rule is greatly overblown.
Is 5 years too long for this study to be valuable? Just thought it was an interesting find.