Deflation and Monetary Policy

26 Pages Posted: 16 Oct 2015 Last revised: 22 Mar 2016

See all articles by Barry Eichengreen

Barry Eichengreen

University of California, Berkeley; National Bureau of Economic Research (NBER); Centre for Economic Policy Research (CEPR)

Date Written: October 16, 2015

Abstract

Deflation has replaced inflation as the principal challenge for monetary policy in many countries. But influential voices question whether deflation is properly seen as a problem for economic growth and financial stability. They question whether recent experience with deflation is more than a transitory phenomenon associated with the aftermath of the financial crisis and record-low oil prices. And they doubt whether monetary policy can be used to address the deflation problem without creating even more serious risks.

Historical experience as I read it generally confirms that deflation is a problem whose solution should be a priority for central banks. Japan’s experience in particular suggests that deflation problems do not solve themselves.

The jury is still out on whether, once deflation is underway, concerted monetary policy action can return inflation to its positive target levels. My own view is that it can. If the policies to date have not achieved their goal, then the central bank or banks in question need to do more. If doing more threatens financial stability, then tools other than monetary policy ― so-called macroprudential tools ― are appropriate for addressing these risks. If a central bank runs out of government securities to buy or worries about dangerously reducing the liquidity of the government bond market, then it can buy other assets.

The policy response to deflation is straightforward. The only question is whether the relevant authorities will pursue it.

Keywords: Deflation, Quantitative easing monetary policy

JEL Classification: E50, E52

Suggested Citation

Eichengreen, Barry, Deflation and Monetary Policy (October 16, 2015). Bank of Korea WP 2015-25, Available at SSRN: https://ssrn.com/abstract=2674973 or http://dx.doi.org/10.2139/ssrn.2674973

Barry Eichengreen (Contact Author)

University of California, Berkeley ( email )

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United States

National Bureau of Economic Research (NBER) ( email )

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Centre for Economic Policy Research (CEPR) ( email )

London
United Kingdom

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