I just saw a tweet from the Federal Reserve Bank of Atlanta (@AtlantaFed) noting that they publish daily deflation probabilities that it backs out of TIPS prices. There are many reasons why we should be worried about deflation in a Great Depression like event – here’s a good blog summary and here is the classic Irving Fisher paper on the Great Depression (Wikipedia summary). When people expect prices to fall they are less likely to spend now, which weakens demand. It’s difficult to get wages to decrease even though the price level has fallen.
And in a balance-sheet recession with debt overhangs, when you are at the zero-lower bound, as Amir Sufi noted, the “normal way you try to get real interest rates negative is through expected inflation, but the only way you can get expected inflation is if you force the current price level down, which is deflation. But the debt burdens are written in nominal terms. If you push the price level down, you get this vicious cycle where the borrowers cut their consumption by even more.”
So a higher chance of deflation means that there is serious worry about the economy getting much worse. Here’s something I don’t think everyone knows about deflation probabilities in the Great Recession – and let’s use it to pick on liberals. I’m charting the deflation probabilities and flagging two specifics days:
Starting in the spring of 2010 the market became very worried about an end of growth, a fallback into recession and a lack of improvement on the economic and employment front. Deflation probabilities shot up to 30% and hung there for a very painful summer. Then on August 27th, 2010 Bernanke gave a speech at the Jackson Hole conference laying out his case for why he wants to do QE2, and then on November 3rd, 2010 the Federal Reserve announced that they would be executing QE2.
Since conservatives appear to be running under the monetary policy orthodoxy of Ron Paul, the right-wing went into attack at QE2. Here’s a comment letter organized by Economics 21 at the time (“The planned asset purchases risk currency debasement and inflation, and we do not think they will achieve the Fed’s objective of promoting employment…we think improvements in tax, spending and regulatory policies must take precedence in a national growth program, not further monetary stimulus”) with a notable list of conservative economic thinkers signing on.
Since it is Friday, let’s use that graph to make two snarky comments about liberals instead.
1. It was a common argument among liberals that Obama needed to give a series of great speeches to start the process of fixing the economy. Obama needed to make the case to the people through engaging them in storytelling.
I’m not sure if Obama giving a speech would change the filibuster in the Senate – but I do know that Bernanke giving a single speech immediately collapsed the probability of a debt deflation spiral by 10%. And it’s not even a good speech – certainly not The West Wing Aaron Sorkin-style speech people imagine for Obama – and the great part is that it doesn’t have to be.
It could have been “Hi I’m Ben. If I could say a few words…I’d be a better public speaker! But seriously, deflation expectations are up and that’s hella dumb. I’m going to print money and buy things until that’s gone” – which is what the Jackson Hole speech was – and it would have been 1,000x more influential than the greatest Obama speech.
Drew Westen wrote that “Americans needed their president to tell them a story that made sense of what they had just been through, what caused it, and how it was going to end.” I agree with that if you replaced “their president” with “their Federal Reserve president” and strike out “had just been through, what caused it” – we need the Fed to tell us the endgame, and whether or not they’ll suffocate the recovery if inflation approaches 2% while unemployment is high and the output gap remains substantial.
2. For the writers on the left that are comfortable ascribing dubious motivations to the Federal Reserve, I’m surprised they didn’t go a different route. It was typical to write about QE2 as if it was a shadow, or not so shadow, bailout for Wall Street. A good example of this QE2 coverage is here: “When it comes to helping Wall Street and corporate America, the Federal Reserve spares no expense.”
Yet, what happened on November 3rd, 2010, the day that the Fed announced QE2 and immediately crushed deflation expectations an additional 10% – in essence, saying to the capital markets “there will be no double dip”? Why yes – it’s the day after the Republicans crushed the Democrats in the midterm elections based on the poor economy, and the day after the political possibilities in the country moved away from combating global warming and expanding a second round of stimulus investment towards how to take a chainsaw to social insurance while lowering corporate taxes. If you think the Fed is a conservative institution, salivating at the idea that the House could go from Speaker Pelosi to passing the Ryan Budget in a matter of months, why isn’t this the more obvious conspiracy?