Working Paper: NBER ID: w9623
Authors: Willem H. Buiter
Abstract: After an absence of almost half a century, the spectre of deflation is once again haunting the corridors of central banks and finance ministries in the industrial world. While preventing or combating deflation poses some unique difficulties not present in preventing or combating inflation, deflation can be prevented and, if it has taken hold, can be overcome, using conventional instruments of monetary and fiscal policy. These include open market purchases of government securities and monetary financing of government deficits caused by expansionary fiscal measures. Base money-financed tax cuts or transfer payments -- the mundane version of Friedman's helicopter drop of money -- will always boost aggregate demand. Unconventional monetary and fiscal measures are also available. These include open market purchases of private and foreign securities, negative nominal interest rates (through a carry tax on currency) and temporary tax measures aimed at shifting private consumption from the future to the present, by tilting the intertemporal terms of trade. An example is a cut in VAT today coupled to the credible commitment of a VAT increase in the future. Deflation results from a combination of bad luck and poor economic management, including the failure to coordinate monetary and fiscal policy. Sustained unwanted deflation is evidence of policy failure. Both the knowledge and the tools exist to prevent unwanted deflation.
Keywords: No keywords provided
JEL Codes: E31; E62; E63; F41
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| conventional monetary and fiscal policy tools (E63) | aggregate demand (E00) |
| deflation (E31) | financial distress among borrowers (G51) |
| poor economic management and bad luck (N16) | deflation (E31) |
| monetary policy (E52) | inflation rates (E31) |
| fiscal policy (E62) | aggregate demand (E00) |
| negative nominal interest rates and temporary tax shifts (E43) | deflationary pressures (E31) |
| coordinated monetary and fiscal policy (E63) | prevention of deflation (E31) |