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28 Cato J. 363 (2008)
Aggregate Supply - Driven Deflation and its Implications for Macroeconomic Stability

handle is hein.journals/catoj28 and id is 371 raw text is: AGGREGATE SUPPLY-DRIVEN DEFLATION AND ITS IMPLICATIONS FOR MACROECONOMIC STABILITY David Beckworth Deflation is generally considered to be inconsistent with macro- economic stability. Any sustained decline in the price level is widely believed to be associated with weak to negative economic growth, a lower bound of zero on the policy interest rate, and an increase in financial disintermediation. However, a number of recent studies examining both historical, cross-country experience with deflation and more recent developments find that these concerns are not nec- essarily associated with deflation (Selgin 1997, 1999; Cleveland Federal Reserve 1998; Stem 2003; Bordo and Redish 2004; Bordo, Lane, and Redish 2004; Bordo and Filardo 2005; Borio and Filardo 2004; Farrell 2004; King 2004; The Economist 2004, 2005; White 2006). They show that the deflationary experiences that shape the modem economic psyche, the Great Depression in the 1930s and Japan in the 1990s, are not truly representative of all deflation out- comes. These studies contend that a broader, historical perspective reveals a more nuanced view of deflation, one that requires taking seriously the possibility of both a malign deflation, a deflation origi- nating from a collapse in aggregate demand, and a benign deflation, a deflation originating from an increase in aggregate supply Some of these studies further argue that not only is aggregate sup- ply-driven deflation real, but it may be optimal. They contend that by avoiding all deflations instead of avoiding only the harmful form, Cato jounal, Vol. 28, No. 3 (Fall 2008). Copyright @ Cato Institute. All rights reserved. David Beckworth is Assistant Professor of Economics at Texas State University 363

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