For those of you looking for clues about the economic future and what's on the menu — inflation or deflation — for the next ten years or so, Paul Krugman points to this "remarkable" graph from Mary Daly of the San Francisco Fed.
That "History suggests" comment in the graph is not just Krugman's point; it's Mary Daly's as well. If our experience continues to parallel Japan's, we're looking at core CPI between +1% and –1% out past 2015. Energy costs will boost some prices, but that looks like it. A remarkable graph indeed.
Now, per Krugman from a few months ago, here is why deflation is bad:
[W]hen people expect falling prices, they become less willing to spend, and in particular less willing to borrow. After all, when prices are falling, just sitting on cash becomes an investment with a positive real yield...
And when that happens, the economy may stay depressed because people expect deflation, and deflation may continue because the economy remains depressed. That’s the deflationary trap we keep worrying about.
A second effect: even aside from expectations of future deflation, falling prices worsen the position of debtors, by increasing the real burden of their debts...
Finally, in a deflationary economy, wages as well as prices often have to fall – and it’s a fact of life that it’s very hard to cut nominal wages — there’s downward nominal wage rigidity. What this means is that in general economies don’t manage to have falling wages unless they also have mass unemployment, so that workers are desperate enough to accept those wage declines.GP
