I don’t often get a chance to say that Paul Krugman is wrong, so I’ll use italics: Paul Krugman is wrong. Okay, technically speaking, he is right in a blog post today, Meanwhile, in Europe. In it, he noted that inflation in Europe is dropping fast. Core inflation is below 1% and it does indeed seem to be headed for deflation: negative inflation. But Krugman is wrong to imply that this is a big deal.
Dean Baker is generally right on top of this stuff, and if I had to bet, I’d put some money on his writing about it in the next day. The problem is that inflation is just a measure of the prices of a basket of goods. So to really simplify, if inflation were 0% it would indicate that roughly half of the goods had gone up in price and half had gone down. This also means that when inflation is low, there is a bit more upward pressure on prices than downward pressure. When deflation is low, it is simply flipped. In other words, nothing magical happens at 0% inflation.
Note what I am not saying. I am not saying that deflation is just fine. I’m saying quite the opposite. Deflation is very bad. But I’m also saying that low inflation is bad. In fact, it is bad in the exact same way that deflation is bad, just not to as big an extent. This is important, because some people (most notably libertarians) claim that deflation is not a problem, and may actually be good. The argument is, “So what if the value of cash in your wallet goes up over time? Would you mind that?” Well, no; all else being equal, I wouldn’t mind that at all!
The problem is that all else is never equal and it is especially so in this case. If people can depend upon the value of their cash going up, they have a real incentive to hang onto it. This results in demand for stuff going down, and that leads to economic stagnation and increased unemployment. So if you are like most people, you depend upon a job to continue filling your wallet with cash. But if you already have all the cash you want, then deflation is super cool. This is why the rich tend to be obsessed with inflation, although I think it is shortsighted for them as well.
My main interest is in people having jobs. Thus, deflation and low inflation are bad things. And I think it is dangerous to make a big deal out deflation, as though the only real harm from low inflation is that it might lead to deflation. Of course, Paul Krugman is far more aware of this than I will ever be. He was just being careless. But I think it’s an important issue.