One of the most powerful explanations for Japan’s deflationary lost decade is that the Japanese, for structural reasons, wanted it.As Morgan Stanley recently pointed out, Japan chose deflation because it was a boon to its ageing seniors on a fixed income.
This insight is crucial to the argument that we won’t have deflation in the US since, it doesn’t benefit the US in the same way. This is the argument put forth by GMO’s Edward Chancellor.
Our society isn’t as old for one thing. Our homeowners, most of whom have fixed-rate mortgages, would benefit from increased inflation.
And yet, it’s still possible that the seniors would win out.
In his latest NYT column, Tyler Cowen explains what would happen if Bernanke got serious about increasing the inflation target, as many of his critics would like to see:
Part of the credibility problem stems from the political environment, especially in Congress. Imagine the day after the announcement of a plan for 3 per cent inflation. Older people, creditors and workers on fixed incomes — all connected to powerful lobbies — would start to complain. Republicans would wonder whether they had found a new issue on which to campaign, namely, opposition to inflation. And Democrats would worry about what position to take. Presidents of some regional Fed banks would probably oppose the policy publicly.
Those who might benefit from such a move don’t have such powerful lobbies.
In the New Yorker, James Surowiecki also examines the persistent unpopularity of inflation:
So why is inflation unpopular? The biggest reason, Shiller found, was simply that people believe higher prices reduce their standard of living and make them “poorer.” This is obviously true for people living on fixed incomes or off their savings, but for everyone else, as many studies have shown, inflation translates into higher incomes as well as higher prices, and it typically doesn’t have much of an effect either way on people’s standard of living. (After all, we’ve had 60 years of inflation in the postwar era, yet we’re much more prosperous than we were in 1950.) That’s not how it feels, though: myopia leads us to focus on how much more we have to pay, rather than on how much more we earn. Inflation also sets off other alarm bells. It often increases uncertainty, which most people are averse to, and, because it can be described as “weakening” a country’s currency, it affects morale. Shiller found that people associated rising inflation with dwindling social cohesion. There’s also a moral dimension: we connect inflation to a lack of discipline and failure to live within our means. The most striking thing about Shiller’s study was that no one surveyed mentioned any possible benefits of inflation, even though to Americans currently besieged by debts it would be a lifesaver.
So the bottom line is that although on net, our economy might be better off with inflation than deflation, between the powerful lobbies for creditors and seniors, and the general psychological aversion to inflation, deflation may be what we get.