Are People Happier Under Inflation or Deflation?

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Cassandra takes what she admits to be a flier at a topic worthy of deeper examination:

Do you think The People are less discontented under an inflationary regime or a deflationary regime?

She reaches a conclusion, no doubt colored by her deep association with Japan, that deflation is not as bad as it is touted to be. If she is right, that thought has some pretty ugly implications for Dr. Bernanke. All he should be worried about is preventing a depression, not mere deflation.

From Cassandra:

To get the discussion going, I will put to you that under an inflationary regime the vast majority of the people suffer from Hamster Syndrome whereby they are running inside the wheel faster and faster but never getting anywhere, or worse from “Up the Down-Escalator Dilemma” (Do you remember the Chameleons?) where it feels like (or IS) almost impossible to make any headway in the direction one desires. This is because real wages are falling whether people consciously know it, and income inequality and Gini’s are growing. On the other hand, unemployment IS [temporarily?!?] lower than it otherwise would be, which is a high-intensity diminishing of the downside to those that otherwise wouldn’t be employed. In sum, most people feel worse off with low intensity, whereas a few people feel better off with high intensity.

Under a deflationary regime by comparison, I will put to you that the vast majority of people don’t feel as worse-off as they would under an inflationary regime, since real wages tend to be more stable, and income inequality and Gini’s tend towards diminishment making one feel less worse off (relatively speaking) – and importantly it is the relative that counts most in human behaviour with respect to contentedness. However, the downside is that unemployment tends to be higher than otherwise would prevail under an inflationary regime, and so a smaller minority percentage of the workforce feels [rightly] to be worse-off and feels so with a high intensity.

Let me say first off that none of my assertions have been researched or proved. Secondly, I am aware of some economists’ arguments that, for purely behavioural reasons, mild inflation is deemed positive for economic growth. I have tended to accept these arguments, though they too are mere assertions, like mine. Thirdly, there ARE externalities under both regimes, and we cannot ignore them for they are integral to the feedback loop of happiness or less discontentedness (note: these are NOT the same thing) and future well-being. Lastly, IF this were – more or less – true, then does it mean we, as a society, are better-off in terms of GNH (Gross National Happiness) by choosing the less-inflationary route, and redistributing to cushion the downside of those unfortunate high-intensity displaced souls, than conferring a dull ache upon the majority?

One final thought: Might globalization have an unspoken role here? “Up the Down-Escalator Dilemma” is a reflection of global wage convergence, while inflation is the political way of attempting to fight or mask an otherwise unpleasant reality: if you want to go upstairs, you might have to expend some reasonable energy and take the steps…

The amusing bit is that politicians are in the business of getting reelected, and one would think that unwittingly promoting policies that make people as a whole unhappy is not in their best interest. But if they are under the sway of the idea that high employment is always and ever better than the alternatives, you can get choices that are suboptmal.

Note that Cassandra mentions in passing that more equal income distribution makes people happier. That happens to be a reasonably well supported view, despite America’s almost doctrinaire acceptance of Calvinist “the more you make, the better a person you must be.” And in keeping, the reporting on this overseas sees that notion as not terribly controversial, while it is contested in the US.

Indeed, more even income distribution leads to longer lifespans. Note that finding is pretty robust, and comes from public health researchers, not left-leaning economists. That too doesn’t get reported much in the US.

But let’s consider the other aspect. I would submit that high inflation, although it may initially lower unemployment, cannot do so in the long run. There is good reason for Volcker having had to inflict as much pain as he did to wring it out of the US. and economists remaining leery of creating an inflationary spiral (note that caution is being thrown to the winds a generation and a half after the last episode. No doubt that reflects fading to non-existent personal and institutional memories).

Having suffered briefly from learning inflation accounting, inflation leads to underinvestment. High inflation leads to high discount rates and very high uncertainty as to what your financial statements mean, in particular whether you are making money on a real basis (the problem is that many line items inflate at different rates; how finely do you adjust? And what do you do about depreciation, when your book values of assets are far lower than replacement values?). Both problems discourage investment. They also happen to suppress equity prices, which makes capital raising more costly, and debt by definition is expensive in nominal terms (and often in real terms too, since fixed income investors demand high spreads to compensate for the very real possibility that inflation can get even worse). And underinvestment saps growth.

As for deflation, the topic seems to be taboo and therefore may not have been considered with sufficient rigor. Yes, the Depression has been studied ad nauseum, but less severe versions of deflation do not appear to have not been considered as policy options (for instance, the US experienced mild deflation during most of the 1800s). Western economists look at Japan’s lost decade with horror, yet the Japanese themselves do not appear to have fared badly in terms of quality of life. And note that it is in Japan’s interest to portray itself as a basket case. Unlike China, no one is going after Japan demanindg that it do something about its trade surpluses.

Yes, Japan no longer has lifetime employment, many young people work for companies in temporary jobs (not as ephemeral as US temps, but they are second class citizens with an uncertain tenure). But that was almost certain to be a casualty independent of the deflation.

Cassandra admits to not having the answer, and I certainly don’t have one either, but the subtext of her post is that the example of Japan has been misunderstood and therefore bears further examination.

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  1. Timothy

    I have long thought that the reason Japan had deflation whilst it was unlikely in America was what suited the voters.

    In Japan the majority of voters were savers who benefited from deflation; even more so when one notes that the Japanese regard housing mostly as a consumption good rather than an investment so falling house prices were generally regarded positively.

    In American the average voter is highly indebted and heavily invested in housing as such they would prefer inflation to deflation and that is what they will get.

  2. jm

    A minor point, but …

    I’m 99.999% sure that the person who blogs as “Cassandra” is a he.

    Love your blog.

  3. Jim Driscoll

    There’s a basic flaw in the above logic – that only those who are unemployed are deeply effected by deflation. This is of course not true.

    In a world that has 30% or more unemployment, everyone is deeply effected. If your brother-in-law cannot find a job for two years, then your sister’s family will end up living in your house. And if you lose your job as well, then all of you go hungry.

    Talk to anyone who was alive during the last US deflation, and you’ll probably hear a story that starts as “Well, we didn’t have it so bad…” and then talks about eating Spam stew.

    Japan’s deflation, while persistent, was also mild. That’s pretty unusual, historically.

  4. Anonymous

    What has happened thus far in the U.S. doesn’t really fit the definition of deflation or inflation, does it?

    The prices of some things are going down, while at the same time the prices of other things are going up. Wages seem to be pretty much stagnant.

    Is there an equivalent situation anywere in history? The Great Depression certainly doesn’t fit the bill, because the prices of everything fell then, which was undoubtedly deflation.

    Could it be we’re entering into a new era where a totally new paradigm is needed? Where the old definitions just don’t work anymore? Perhaps the consumerist model, which has overwhelmingly dominated American values, attitudes and beliefs since the 1890’s, is now obsolete. Could the day come when increasingly greater and greater consumption–what we call “growth”–is viewed as being bad?

    We think consumerism is hard wired. But is it really? There was, afterall, a time when it was a dissident belief system. As Jacques Barzun points out in “From Dawn to Decadence:”

    “…a group of economists sought another kind of reform, one that despots might not favor: free trade. In the 17C one Boisguilbert had disputed the dogma of Mercantilism: piling up gold by spurring exports and deterring imports was short-sighted. It pleased kings but harmed the kingdom. Prosperity depended on the greatest possible production and exchange, with only one tax imposed on the producers. In England too a Dutch doctor named (Bernard) Mandeville (1670–1733) had written a popular tale, ‘The Fable of the Bees,’ in which he argued that consumption and even luxury and waste were good for the country–his maxim was: private vices–public benefits.”

    The thoughts of these early theorists were later taken up by Adam Smith and became the basis of “liberal economic” doctrine, which now dominates modern day thinking so completely that most economists cannot imagine things being any other way. But is the drive to consume really immutable human nature? Or is it taught behavior?

    Habermas argued that knowledge conceived as a body of facts and truths exisiting apart from human purpose is a myth.

    Marx elaborated his theory that much of the ideological thinking of his era mirrored the special interests of the dominant social classes.

    Freud argued Marx’s orientation was overly restrictive. Freud believed the critique of ideology should also examine unconcious motivations unrelated to the clashing economic interests of the social classes.

    Perhaps it is time for some dissident economists to do some thinking outside the box. Perhaps “liberal economics” is not sciene at all, but a dogma–a religion–that was first imposed on Western culture, and now is being imposed upon the rest of the world.

    This is not to say that the religion of liberal economics has not served the United States well. It has. But the world changes. Paganism served the Roman empire well. Christianity served the medieval kingdoms and great European monarchies well. Objectivism (of which liberal economics claims to be a part) has served the modern Western democracies well.

    But perhaps we are entering a new era where the tenets of liberal economics also need to be questioned.

  5. Yves Smith


    Actually, mild deflation has other precedents. England experienced it in the 1800s.

    However, the reason it appears not to have been too painful was that England was a creditor….not the boat we are in.

  6. Scott Finch

    Though this comment is slightly off topic, over at there was a paper written on domestic debt. I don’t have the paper on hand and I don’t remember the title. The words “Domestic Debt” were in the title however.

  7. Yves Smith


    The notion the price pattern being more complex is a real issue. In the last episode of inflation, the 1970s, it was clear cost-push inflation.

    We again have commodities inflation, but it a setting where (at least in the US) labor has no bargaining power. Thus (in the absence of a price break) it may not propagate through the economy at the same rate, but can (wlll?) squeeze worker real incomes. (Ironically, that is what has happened in Japan with its deflation) And with consumers overlevered, any squeeze will lead to even greater real declines in consumption (although that appears not to have kicked in yet), which is recessionary. This pattern may be a worse version of stagflation, or per your comments, it may turn out to be sufficiently different in its effects to be a new phenomenon.

    And I do agree with your”end of an era” sentiments, and that economics has certain embedded assumptions that have propagated through the culture and bear examination. A wee book from the 1980s, Robert Heilbroner’s Behind the Veil of Economics, looks at some of the ways prevailing schools of economic thought obscure certain assumptions and issues.

  8. Anonymous

    There was a pronounced deflation in the US in the 19th century, and it did not lead to mass unemployment:

    This post cites other examples of “minor deflation” although it argues that it sets up speculative bubbles that then led to more serious deflation, Ironically, in 2003, the author is speculating “this time is different”:

    I don’t buy that this is inevitable, given the lack of a convincing rationale as to why mild deflation leads to a subsequent bubble.

  9. River

    Perhaps an economic model based on an infinite amount of resources will not work on a planet with finite resources? Malthus, among many others, came to that conclusion long ago.

  10. Anonymous


    I visited Wikipedia and read what they had to say about John Malthus.

    Was he a “prophet of doom” as his critics allege, or a very clairvoyant man a couple of centuries ahead of his time?

    From perusing these blogs, and especially the comments of the Peak Oilers vs. the believers in the magic of science and technology, it appears the debate rages on.

  11. Vijay

    We can’t achieve a mild deflation like Japan. Japan was net creditor when their economy began sliding. They were a MASSIVE creditor. On the other hand, we’re a MASSIVE debtor nation. Our situation bares more resemblance to Argentina than to Japan. The only thing that has prevented a massive collapse in our currency is that we happen to have acquired the status of reserve currency for most international trade transactions. The important question is whether that status can remain as the dollar continues its slide. If it cannot, we’re in for a horrific denouement to this economic crisis.

  12. Yves Smith

    Agreed with the comments “we aren’t Japan, therefore we can’t have an end game like Japan.” I’ve in fact made comments along those lines in prior posts, that a big difference (due to the savings rate) was that Japan could resolve its bubbles (by objective measures worse than ours) internally, while we are dependent o the continued forbearance of our creditors. And I’m not sure how much longer they will be patient (as in this crisis will take longer to work through than most want to acknowledge, and domestic pressure to Do Something about their inflation in our major creditors ex Japan is rising.)

    Even if it is economically irrational for our creditors to slow down buying of our assets, since they would incur further losses on their existing dollar based holdings due to greater dollar depreciation, the prime objective of any government is to stay in power and keep domestic unrest at an acceptable level. We shouldn’t kid ourselves, we will be cut off if continuing to support our debt habit becomes too big a political threat to our funding sources).

    The reason I raise the deflation question, even if it appears to be a red herring, is our policies for dealing with the crisis are based on obsessive study of one example, the Great Depression. I may be being simplisitc, but it is dangerous to generalize from one data point.

    And another pattern than concerns me is the unacknowledged inconsistency in the approach to this crisis. Bernanke is absolutely out to prevent deflation, no matter if it means losing our reserve currency status (and like other readers, I am worry that the implications of that have not been thought through deeply enough, and the possibility of a dollar crisis has been assumed away) and that we are in parallel taking Japan-like “validate the asset value” measures via the Fed’s various facilities and the homeowner rescue measures before Congress. If there were a theory behind this, I’d feel better, but my sources have said the Fed is desperately improvising.

  13. James

    I think there was very real evidence last week that the side effects of bernakes policies may be causing considerable harm. Data showed rising cpi inflation, declining wages, and surging borrowing. That is a recipe for social unrest.

    That doesnt seem to be a way to resolve the housing situation.

  14. vijay

    The Fed cannot prevent the deflation that’s occurring because they can’t force banks to lend and people to borrow. They could eventually start printing (once they exhaust their reserve of treasuries), but that is the road to hyperinflation.

    What we are seeing today is the major readjustment that MUST occur before we can return to normalcy. We can no longer consume the products of other nations and simply send them IOU’s in return. We will have to reduce our consumption, increase our savings and begin to create products worth exchanging again.

    This is going to lead to a meaningfully lower standard of living for the median American.

    Yves, you’re right that the constant comparison to the Great Depression is wrong-headed. But then, it would still be wrong headed even if we had 10 or even 30 different depression data points to work on. Each economic situation is unique and will play out in its own special way.

    Unfortunately most classical economists do not acknowledge the major flaw in the methodology of their dismal science. That historical event are not like repeatable experiments where models can be created an falsifiable counter-evidence can be observed. This is why economics is a laughing stock among natural scientists. And rightly so.

    It’s tangential, but I recommend reading this article and this comment
    on the article.

  15. Yves Smith

    James, Vijay,

    Agreed. No one wants to face up to the fact that we HAVE to get our consumption down and our savings rate up, and that means either prolonged very low growth or a recession (more likely, nominal growth and negative real growth since that for some bizarre reason is politically more palatable, assuming of course that than can be engineered). There is tremendous denial of the fact that any way out of this mess means pain.


    Second your point re the unacknowledged limits of economics. It’s one of my pet peeves. But having said that, the study of more data points would likely lead to more theories about causes and remedies. Competing viewpoints would hopefully lead to more caution and humility about prescriptions.

  16. Anonymous

    ☺☺vijay said…

    “Unfortunately most classical economists do not acknowledge the major flaw in the methodology of their dismal science. That historical event are not like repeatable experiments where models can be created an falsifiable counter-evidence can be observed. This is why economics is a laughing stock among natural scientists. And rightly so.”

    Agree and disagree.

    Agree that Economics certainly has a strong element of scientism, the attempt to use scientific method in a domain where it does not belong. The third voyage in Gulliver–to Laputa, the Floating Island–deserves attention for its early depiction of this phenonomen. The Laputans have an Academy where “projectors,” stuck on one idea, work for years in vain. They toil to extract sunbeams from cucumbers and seal them in bottles; they want to replace silkworms with spiders and endeavor to make clothes by trigonometry. That Swift was no enemy of progress, science, or invention is shown by his famous maxim that the greatest benefactor of mankind is he who can make two blades of grass grow where one grew before. But make-believe never escaped his lash.

    Disagree with this insane modernist notion that science has a monopoly of truth. As per comments above concerning Malthus, mankind may very well be entering into a new era where science and technology have finally met their match. Postmodernist disillusionment may pale in comparison to what lies in the future. If so, the cachet of love and ambition, poetry and music may be greatly enhanced.

    Economics is in no way less important than science, it’s that economics tried to be something which it is not. As can be seen in Rabelais and Montaigne, the caution was given: do not reduce all experience to formulas by reason: leave room for impulse and intuition, those acts of the whole being that are often called “nature,” or again, “the heart,” both by contrast with “the mind.” Wisdom lies not in choosing between them, but in knowing their place and limits.

  17. marcion

    This is going to lead to a meaningfully lower standard of living for the median American.

    I’m not exactly sure of what that means. More to the point, it probably has more to do with how you define “standard of living” than anything else. What consumption will be curtailed, and what impact will that have?

    If we’re talking about education and medical care, that’s bad. If we’re talking houses with less square footage, less spending in Starbucks and chain restaurants, and less 200$ jeans, then perhaps the standard hasn’t been lowered all that much after all.

    One of the things we need to re-consider is what exactly is the standard?

  18. Anonymous

    I think the next inflation bout will be torture for Average Joe, because Joe doesn’t have a union to drive wages higher to match inflated prices. We’ll have price inflation without wage inflation. Ouch.

  19. Vijay

    Anon: I do not wish to convey the impression that economics is an endeavor devoid of merit. Rather, I think it’s among the most valuable fields of human inquiry. I simply take issue with the methodology of classical economics. The methodology of Friedman and Krugman (Quelle surprise! They practice the same methodological approach). I subscribe to the praxeological method described in most detail in Human Action. I think economics should rightly be treated as a deductive science, not an empirical one, because humans, unlike atoms, have purpose and aren’t amenable to repeatable experiments in the manner used in the natural sciences.

    Marcion: I meant the purchasing power of the median American is
    going to be greatly diminished. They will be able to purchase less education, less health care, less energy and less food.

    This process is occurring before our eyes. Drive to a grocery store and you will observe the diminished purchasing power first hand. The decline of the dollar is the most important signal that our aggregate purchasing power is being decimated.

  20. David Merkel

    >>despite America’s almost doctrinaire acceptance of Calvinist “the more you make, the better a person you must be.”<< Look, I’m a Calvinist. There is nothing in Calvin’s writings that remotely reflects this. Capitalism is a secularized offshoot of some of the ideas in Calvinism, but lacks the compassion, and the focus on what is truly important in life… it’s not our material well-being, but our relationships to Jesus Christ and our fellow man. Calvin, and most of his followers taught against greed, and the corrosive effects it has on our spirits. Any prosperity we have should lead to greater thanks toward our Creator; if not, it only does us harm.

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