US price deflation on the way (John Muellbauer)
US price deflation on the way (John Muellbauer). It is an important piece. So, he noted:
A key element of the models is the long run adjustment in consumer prices to costs and other prices. Unit labour costs in the US are central to the model and have remained low despite higher goods price inflation. House prices have a powerful effect in the model but enter with a long lag. Part of the reason for their importance lies in the role of rents in the consumer price index, but they may also reflect other macroeconomic influences. House price falls have offset some of the recent inflation from higher oil and food prices and will now be a major deflationary force. Since oil and food prices are falling sharply and have further to fall, while unemployment shoots up, US consumer price inflation must fall at record rates over the next 6-12 months. It is entirely credible that the US inflation rate measured over 12 months will become negative within the next 18 months.
This fits with market expectation reflected in bond yield. An important lesson is as follows:
Then the debate about whether monetary policy can stem deflation and whether the zero lower bound on interest rates is a constraint will really begin. These were the issues mistakenly raised in 2001-3 when the strong US response of credit, the housing market and consumer spending to lower interest rates should have made the debate redundant. Influenced by a misreading of Japanese experience, this led to excessive protection against the ‘tail risk’ of deflation and helped to fuel the credit and housing bubble whose collapse triggered the current recession.
Well, Greenspan might have regretted this, and Bernanke must have got the lesson. An important caveat, though:
Paradoxically, the faster oil prices now fall and boost household budgets, the shorter will be the period of deflation that follows. The lessons from the Japanese experience of the ‘lost decade’ about the need to refinance the banking system have been learnt. This and important differences between the structure of the Japanese and the US economies make a ‘lost decade’ for the US most unlikely.
So, what are the differences? Here is what he said one year ago at Jackson Hall.
So, against his optimistic interpretation about the future, the correct reading of his paper could be that if US financial system one year from now functions as well as two years ago, the escape from deflationary period will be quick. Are we sure about that?
Another interesting finding is income effect dominates substitution effect as for the real interest rate's impact. Surely, Democratic Party of Japan guys must have read this paper in calling for the raise in interest rate for the households. A very interesting finding.
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