Understanding Deflation: Treating the Disease, Not the Symptoms

Dimitri Papadimitriou and L. Randall Wray

Economics Working Paper Archive from Levy Economics Institute

Abstract: Deflation can be defined as a falling general price level utilizing one of the common price indices.the consumer price index; the GDP deflator or other, narrower indices as the wholesale price index; or an index of manufactured goods prices. Falling indices of output prices can be the result of several mechanisms: productivity increases, quality increases and hedonic imputations of prices, competition from low-cost producers, government policy influences, or depressed aggregate demand. Falling output prices, in turn, can have strong effects, especially on the ability to service debts fixed in nominal terms; depending on the level of indebtedness of households and firms, they can set off a classic Minsky-Fisher debt deflation spiral. In this paper, we argue that deflation can and usually does generate large economic and social costs, but it is more important to understand that deflation itself is a symptom of severe and chronic economic problems. This distinction becomes important for the design and implementation of economic policy.

Date: 2003-10
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