Deflation: Economists sink into dementia

The recent intellectual derangements have been provoked by the descent of Japan and Europe into deflation, the related zero lower bound (ZLB), and the potential for the U.S. to do the same.

Yes, when interest rates hit zero and a nation is in recession, then central banks cannot cut rates to stimulate growth. Rogoff says then go to negative rates. The problem is cash, which neither pays nor deducts interest. So get rid of cash, and enter Rogoff World.

Of course, Market Monetarists know central banks still have quantitative easing, and history suggests a timid U.S. Federal Reserve used QE to good effect—though too little and too late—after 2008.

The Zero Percent Obsession

But QE, or NGDP targeting, or even higher inflation targeting (say 3% instead of 2%, or 1.5% in the case of the current-day Fed) hold little appeal for today’s freshwater economists.

Only deflation and negative or zero interest rates will do.

Thus, University of Chicago economist John Cochrane recently blogged a polite hearing to Rogoff World, ultimately only reserving kudos on libertarian grounds.

In Rogoff World, the state (after outlawing cash) would keep tabs on every electronic transaction (in addition to every e-mail and phone-call by present-day NSA snoops)—and thus many virtuous tax-evaders, who previously used trackless cash, would get caught in the federal e-web, posits Cochrane. (Actually, “Orwellian” hardly does justice to Rogoff World).

But overall, Cochrane gets rosy-cheeked at some aspects of Rogoff World.

“The optimum state of monetary affairs is a zero short-term rate, with slow deflation giving rise to a small positive short-term real interest rates,” Cochrane has blogged.

Amazingly, Cochrane has even cited Japan as an economy where much has gone right in the last 30 years, what with deflation the norm.

Moderate Inflation vs. Moderate Deflation

Evidently, Cochrane is unaware that in the deflationary 1992-2012 Japan economy, industrial output fell by 20%, real wages fell by 15%, equities and property cratered by 80%, and real GDP inched up by perhaps 1% a year. Japan went from world-beater to has-been in a generation.

Meanwhile, as a matter of practical observation, the U.S. economy expanded by a little more than 3% a year from 1982-2007, and ran inflation at just under 3%, on average.


Cochrane says economists must present models. My sentiment is models always “prove” the pre-existing politico-economic biases of the modelers.

I do not have a fancy model to explain the U.S, performance from 1982-2007. Marcus Nunes has explained, convincingly, that Fed Chief Alan Greenspan followed a proto-Market Monetarist approach through much of the 1982-2007 era, and essentially targeted a healthy nominal rate of growth for the US economy.

Remember, the 2008 debacle happened after Greenspan had left the Fed, and then-Chairman Ben Bernanke and FOMC board members such as Richard Fisher decided the rising global commodity prices imperiled U.S. prosperity, and had to be combated by domestic monetary policy. I wish I were making this up, as do millions of American workers and businesses who paid the price for a growing Fed fixation on microscopic rates of inflation.


But it could get worse—with some bad luck, and new appointments to the Fed, perhaps the next FOMC board will seek Rogoff World, or Cochrane’s nirvana of deflation.

The United States of Japan?

About the Author

Marcus Nunes
João Marcus Marinho Nunes is a partner of Phynance Estratégias Quantitativas e Investimentos and a professor of Economics at Fundação Getúlio Vargas in São Paulo, Brazil. He also blogs here:

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