Deflate Your Enthusiasm

William Pesek argues in an opinion piece in Bloomberg that deflation in Japan is - contrary to popular belief among most economists - actually a good thing. Pesek's reasoning is that Japan's population is disproportionately composed of elderly pensioners living off of fixed income whom would benefit from falling prices. Furthermore, as prices in Japan rose too high during the 1980's, deflation "has acted like a stealth tax cut for households and restored some sobriety to costs." Lastly, the Japanese government has amassed mountains of debt, and deflation - "which lowers nominal bond yields" - "makes that burden easier to service."

This piece is a bit of a ridiculous #slatepitch. Deflation is not good. Deflation is very bad - and most every economist knows this. It is generally agreed upon by both conservative and liberal economists that deflation is one of the main culprits behind the severity of the Great Depression. This is because deflation reduced earnings and increased real debt burdens, leading to mass-scale defaults. We see the same forces at play in Japan (the depressed earnings - not the mass-scale defaults). The following graph shows private sector earnings in blue and the CPI in red. Falling earnings track pretty well with falling prices.

In other words: deflation does not occur in a vacuum - my falling costs are your falling earnings and vice versa.

But how does this affect elderly pensioners? 1) Falling earnings put pressure on private pension systems. If earnings are not sufficient enough to fully fund pensions, then pensions may need to cut their benefits; 2) Falling earnings put pressure on public pension systems. Falling earnings mean depressed tax revenue. If public funds can not sufficiently fund the pension system, then benefits may need to be cut; 3) Falling earnings mean falling stock prices. This reduces the wealth of stock holders (a group that contains a not insignificant number of pensioners). All of these negative effects will be especially felt by near-future and future pensioners.

The worst part of the article, however, is the claim that deflation makes the government's debt easier to service via lower nominal interest rates. Low nominal interest rates (and deflation) are generally a sign of an anemic economy which translates to lower tax revenue. Lower tax revenue means that the government will have a tougher time paying off debt. Furthermore, deflation not only does not ease the burden of debt, it actively increases the burden of debt by increasing the debt's real value.

But let's assume I'm wrong about all of this (which I'm not) and deflation really is a boon to elderly pensioners. Do you really want to use the well-being of pensioners (25% of the population now, projected 40% in 2060) as your benchmark of success for a national economy?