Yesterday 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 readers will know, I’ve been banging the drum for “good” deflation for decades. I started doing so with The Theory of Free Banking (1988), 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 appears to be 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.
