Tuesday, December 31, 2013

"Defeating" Deflation Is Not Good Directly

As expected, given the yen's sharp drop, Abenomics has caused price deflation in Japan to end and turn in to inflation (while at the same time causing disinflation elsewhere as exchange rates are a zero sum game), causing some pundits to write about "a defeat" of deflation that is good news for Japan.

But even assuming that the theories of the negative effect of deflation on real growth are really correct (which they aren't, at least not at the low levels Japan has experienced) using a turn from deflation to inflation as a measure of success is wrong.

That is because given a certain level of nominal income, higher prices implies a lower real level of income. Indirectly, inflation is of course likely to imply a higher level of nominal income, which could mostly, entirely or even more than entirely offsett the higher price level, but the point is that an increase in the price level is not a standard of success since it all else equal implies a lower real income level.

Looking at the nominal change would be less bad since that at least all else equal implies a better real change. But the proper gauge is of course to look at real growth (adjusted for population change in many contexts).


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