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Sunday, January 24, 2016

Irrational Fear of Deflation? There Is No Correlation between Inflation/Deflation and Growth

Central bankers and the financial press worry about deflation. They aim for a moderate amount of inflation and then worry when their “inflation targets” are not met. Deflationophobes link deflation and recession. They point to stagnant Japan as an example of the ravages of deflation. The modern macroeconomics of rational expectations – for which a number of Nobel prizes have been granted – teaches another story: Only unanticipated inflation/deflation is supposed to affect the real economy.

Few economic writers bother to look at numbers, which are now easy to gather with a substantial number of easily accessible data bases. In the four diagrams below, I plot scatter diagrams of the annual rate of inflation versus the annual real GDP growth rate. Three are for the long run (1909 to present) excluding World War I and II.  One correlates inflation with growth. Another correlates expected inflation (a 3-year moving average) with growth. A third correlates inflation/deflation with growth for the postwar period. A fourth looks at growth and "price surprises." None seems to show a relationship between price changes and economic growth.

Note that these are simple diagrams. There is no econometrics or fancy statistics, but usually simple approaches will pick up strong relationships.

As is evident from the data, it is hard to detect any correlation between inflation and growth.

Perhaps our central bankers and economic pundits should reexamine their views.







2 comments:

  1. Very interesting reading, as always from you.
    Please post the charts.
    I would love to have a look.
    J. Buhagiar.
    Malta

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