In Switzerland, Tolerating Deflation isn't Cuckoo

good deflation, Switzerland, Brian Blackstone
Cuckoo clocks in Tiberg by Teicher (CC 4.0)

Cuckoo_clocks_in_TibergYesterday morning I was very pleased to encounter, in The Wall Street Journal, a report by Brian Blackstone on deflation in Switzerland.  In it Blackstone observes that the Swiss case appears to contradict the widespread belief among economists ("as close to an economic consensus as you can get," he says) that deflation is necessarily a bad thing.

Blackstone's report pleased me because, as many Alt-M readers will know, I've been banging the drum for "good" deflation for decades.  I started doing so with The Theory of Free Banking , when I imagined that I'd made a new discovery.  There I observed, among other things, "that a fall in prices in response to reduced per-unit costs is, not only consistent with, but essential to the maintenance of equilibrium" (p. 99) and that "What is needed is a policy that prevents price changes due to changes in the demand for money relative to income without preventing price changes due to changes in productive efficiency" (p. 101).   Not quite a decade later, in Less Than Zero: The Case for a Falling Price Level in a Growing Economy , I developed the same arguments, defending what I then called a "productivity norm" ideal for price-level movements, at much greater length.  By then I'd also learned that, despite the consensus to which Blackstone refers, the idea I was defending was anything but new: in fact, until the Keynesian revolution came along, economists who accepted it outnumbered those who didn't.[1]

Although the "long deflation" of 1873-1896 was roughly consistent with a productivity norm — albeit one adhered to more by accident than by design — and more specifically with "good" deflation, one rarely witnesses good deflation these days.  The Swiss case is a rare exception.  As Mr. Blackstone reports,

evidence of deflation’s pernicious side effects—recession, weak employment, rising debt burdens—is pretty much nonexistent in Switzerland.  Its economy is expected to expand this year and next, albeit slowly, in the 1% to 1.5% range.  Unemployment was just 3.4% in September.  Government debt is low.

Nor have Swiss wage earners had to tighten their belts:

Although wage growth has slowed in Switzerland, it was 0.6% on an annual basis in the second quarter, which combined with falling prices means strong real pay gains, boosting spending power.

Precisely.  Even if the number of Swiss Francs Switzerland's workers take home isn't increasing all that rapidly, the fact that prices are falling means that their real wages may be improving at a healthy clip.  And if prices are falling because unit costs are falling  — if cuckoo clocks, chocolate bars, and watches cost less but are also cheaper to produce than before — Swiss industry is none the worse for it.

Concerning the crucial distinction between "good" and "bad" deflation, Mr. Blackstone quotes Swiss economist Alexander Koch.  "You have to distinguish between good and bad deflation,” Koch told him. “There’s no crash, no strong increase in unemployment in manufacturing and as there are no bursting bubbles in other sectors, domestic demand and the labor market are quite resilient.”  A few B.I.S. economists, Blackstone notes, have also "challenged some of the conventional wisdom on deflation’s pernicious effects."

Toward the end of his article Mr. Blackstone asks, quite appropriately, "So why aren’t central banks embracing the Swiss example?"  "Analysts note," he writes in answering the question, "that it’s difficult to distinguish between good and bad deflation until it’s too late."  However, that answer simply won't do, because distinguishing between good and bad deflation is as simple as noting whether or not nominal spending (NGDP or domestic final demand or their equivalents) are growing at healthy rates.

Finally, Mr. Blackstone reports that it may not be easy for the Swiss to keep up their regimen of good deflation, and particularly so if the ECB further eases its own policy.  I hope he's wrong, or at least that the Swiss manage to keep their experiment going long enough to erase any lingering doubts concerning both the practical possibility of benign deflation, and its merits as a monetary policy objective.

[1] See my article, "The 'Productivity Norm' versus Zero Inflation in the History of Economic Thought." History of Political Economy 27 (4) (1995): 705-735).

  • JW Ogden

    Great title and picture.

  • wfoster

    While I have not steeped myself in the literature, neither I am all that ill-informed, but I have never understood how there evolved a worldwide consensus among central banks and economists that the optimal long-run inflation rate should be about two percent. "Less than Zero" discusses at length the opinions among economists favoring zero price inflation and that discussion is applicable, but maybe the notion that a universally, ever-rising CPI is a Good Thing needs a primer on its own. Perhaps I'm slow, but is there such a primer tracing the history of this idea – from an Alt-M perspective? I read such things as a relatively recent IMF working paper, "The Case for a Long-Run Inflation Target of Four Percent," by Laurence Ball, and I am amazed at the "epistemic closure" of the discussion. And the main argument seems to be merely based on the benefits of positive price-index growth on easing constraints on monetary policy arising from the zero bound on interest rates. That, and the contention that the costs of targeting some positive price inflation are small. You can forget about finding any trace of a distinction between "good" and "bad" deflation.

    And another thing – but again, maybe I am out of my intellectual depth, so bear with me – should not there be a difference between an optimal inflation target in an economy where the government has the luxury to possess the major reserve currency and issue its debt denominated in its own fiat money, and the optimal target in a country that buys the debt of the reserve currency issuer in order to inflate its local currency? Doesn't this whole unified, consensus system of a common inflation targeting mean that the US gets to spread the inflation tax across populations living under central banks that respond to US monetary policy by buying evermore US treasuries in order to inflate and thus weaken their own currencies? If a government like Brazil's retains for years and years some 200 billion or more in US debt that it accumulated in the competitive debasement race, hasn't it effectively just written a huge check to the US government in real resources, depriving its own citizens of cheaper traded goods? A skeptic might think that worldwide monetary policy consensus is at bottom a mechanism to hide paying tribute to the hegemon.

    • Zekester7659

      A guess: Economists have much less to do (i.e. less jobs, less grants, etc) if subjectively manipulating monetary policy is done away with. As well, politicians (who fund lots of economists) like inflation because it enables them to spend without taxing, with not 1 in a 1000 citizens realizing what is being done to them. And bankers (who influence politicians) like inflation because its root gives them more money to deal with and be 1st in line for.

      Also, it seems to me a general rule in soft sciences that once an academic point of view gains critical mass it becomes self-perpetuating … because there are few jobs and little $ for any iconoclasts.

  • William Bruce

    It's nice to know that there's a Swiss Selgin out there — just don't tell anyone that his surname is Koch. ;)

    • George Selgin

      No relation…I think!

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  • VivianDarkbloom

    Missing from the discussion:

    The effect of taxation. With "good deflation" wage earners get to keep more of their "real wage increases" than they do when real wage increases are combined with inflation.

    • George Selgin

      A good point, VivianD. Also, persons on fixed incomes enjoy productivity gains along with everyone else.

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  • Walker Todd

    I think what George Selgin says here about falling prices is right. To make deflation socially acceptable, however, the missing element might be to require indexation of debt contracts–otherwise, debtors would contract to repay at a higher price level than prevailed during the repayment period. Classic references to negative prices are in Mark Twain's "A Connecticut Yankee in King Arthur's Court" (debate between a protectionist and a free trader) and Ludwig von Mises, "Theory of Money and Credit," 1922 German edition, 1936 US translation. Walker Todd, Chagrin Falls, OH

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