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Inflation, Deflation

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Inflation, Deflation

Inflation, Deflation

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Robert Smith, you know where I grew up.


San Diego.

GOLDSTEIN: We've talked about this - San Diego - the suburbs of San Diego. And, you know, the thing people always say when I tell them I'm from San Diego is, oh, right, San Diego - perfect weather.

SMITH: I have been there - mid-70s, sunny.

GOLDSTEIN: And one thing that happens when it's like that is you sort of forget that weather is even a thing. You know, you're not hot; you're not cold. You just think about whatever other problems you have in your life and sort of forget about weather altogether.

SMITH: As you might expect, this is not really a discussion about the weather. This is a metaphor...

GOLDSTEIN: It's a metaphor.

SMITH: ...For something that's been going on in the U.S. economy for decades. In the U.S., over the past 35 years or so, we have all but forgotten about two huge economic problems. We have not had deflation, when the economy cools and prices and wages fall for years and years at a time, and we've not had high inflation, when the economy overheats and prices go up and up and up.

GOLDSTEIN: Yes. Obviously, some things have gotten much, much more expensive - health care, college tuition. Also, some things have gotten much cheaper - cellphones, computers, TVs. But on average, prices in the U.S. have gone up just like 1%, 2%, 3% a year, year after year, decade after decade. We have had the perfect suburban San Diego weather of low, stable prices.

SMITH: Which is sweet. Deflation and high inflation have these kind of boring economic names, but having the price of things change dramatically all the time is traumatic for all of us trying to live our normal lives.

GOLDSTEIN: Deflation is terrible for those of us who are in debt. It makes those debts harder and harder to pay off. Inflation is terrible for people, say, who are retired, who are living on a fixed income. It makes it harder and harder for them just to survive.

SMITH: Imagine all the things you worry about now - will I get fired from my job; how can I afford a house or a car or children? - and add to that worry, how much is everything going to cost next year?

GOLDSTEIN: These problems, deflation and high inflation, they don't come out of nowhere. They happen at moments when there are big, dramatic shocks to the economy, like, say, right now.


GOLDSTEIN: Hello, and welcome to PLANET MONEY. I'm Jacob Goldstein.

SMITH: And I'm Robert Smith. Things are so uncertain, so unstable right now - tens of millions of people out of work, the government pumping trillions of dollars into the economy. But economists are worried about both inflation and deflation. They're worried that if one doesn't get us, then the other one will.

GOLDSTEIN: Today on the show, why deflation and high inflation are both really bad, and what signs we should watch to see if one or the other is going to come mess us up.


GOLDSTEIN: Here's how the show's going to go. First, we're going to tell you a story about inflation. Then we're going to talk about deflation. Then we're going to talk about where we are now and how to think about the future.

SMITH: First up, the story of inflation. When economists worry about inflation in the United States, what they worry about is something like what happened here in the 1970s. We wanted to find someone who could both explain the economics of that kind of inflation and who also lived through it.

GOLDSTEIN: Can I ask - you were - I don't know - a grown-up at this time, yes? I don't want to put too fine a point on it.

ALAN BLINDER: I was a grown-up.

GOLDSTEIN: I mean, you were an economist then.

SMITH: I love how hard you're trying not to just ask him how old he is. He's old. Painful for me to hear. Just ask him how old he is.

GOLDSTEIN: This is Alan Blinder. He was a grad student in economics back in the late 1960s when inflation started going up in the U.S.

SMITH: The government was spending a lot of money on social programs and fighting the Vietnam War. And unemployment was low, so ordinary people were also spending a lot of money.

BLINDER: And when there's too much spending relative to the economy's ability to produce, you tend to get inflation, and we did. So the...

GOLDSTEIN: So just pause there for a sec. That is just such a lovely textbook moment. When there's too much spending relative to the economy's ability to produce goods, you tend to get inflation. Why?

BLINDER: Oh, because people are scrambling to get the limited supply of goods, and they're willing to bid up prices. There's an old cliche about inflation being about too much money chasing too few goods, and that's basically right in this case. It's too much demand chasing too little supply.

SMITH: Too much demand chasing too little supply. We usually talk about supply and demand for specific products. Nobody wants avocados, so the price goes down. Or there's a drought and there's not enough avocados, so the price goes up. But what Blinder is talking about here is demand for and supply of everything. And just like when demand for avocados exceeds supply, the price of avocados goes up. When demand for everything - aggregate demand, as it's called - exceeds the supply of everything, the price of everything goes up.

GOLDSTEIN: And by the early '70s, prices are rising by 6% a year, and people are furious. It gets so bad that the president of the United States goes on live TV and says it will be illegal for companies to give their workers raises or increase prices for the next 90 days.

SMITH: But prices kept going up. This was particularly bad if you lived on a fixed income, getting the same amount of money every month. If you're retired, say, have a pension. As prices go up 6%, you are suddenly buying 6% less stuff. Your income is staying the same, but you are getting poorer every day.

GOLDSTEIN: For people who are working, overall, on average, their wages were going up to match inflation, but it didn't really feel that way.

SMITH: Because when you get a raise, when you see your paycheck has gone up, you don't think, oh, that's too much money chasing not enough goods and aggregate demand - blah, blah, blah. No. You think, I am so good at my job. I am killing it.

GOLDSTEIN: I totally deserved it.

SMITH: But then you go to the grocery store, and you see that prices there have gone up, and you think, God, I'm getting killed here.

BLINDER: People believed, and I think they would still believe if we had any inflation to speak of today, that they were being robbed of their just desserts.

SMITH: Right around this time, Alan Blinder, now a young professor at Princeton, buys his first house. This may sound random and digressive, but it is not because inflation does strange things, and Blinder's first house is a perfect example.

BLINDER: The house was a small ranch house. It was probably around 1,100 square feet, but it had a nice backyard.

GOLDSTEIN: And more or less, how much did it cost?

BLINDER: This I do remember. It cost $43,000.

GOLDSTEIN: Blinder borrows money to buy the house. He gets a mortgage. The interest rate is around 5%. His payment is about $200 a month. And then right after he buys that house, inflation starts going up again. An embargo from the Middle East drives up the price of oil. By 1974, the inflation rate is 11%.

SMITH: Year after year, prices are going up a lot. And for most people, including Alan Blinder in his new house, wages are also going up.

GOLDSTEIN: And your wage is going up. And what's happening to your monthly mortgage payment?

BLINDER: That's solid as a rock. It's not changing by a penny.

GOLDSTEIN: It's the same. It's like 200 bucks a month, month after month.

BLINDER: Whatever it was.

GOLDSTEIN: And so in your case, inflation was good for you.

BLINDER: It was.

GOLDSTEIN: And so who is the loser here?

BLINDER: The creditors.

GOLDSTEIN: Like, the people who had loaned you the money to buy the house and said...


GOLDSTEIN: ...You can pay it back at 5% interest.

BLINDER: That's correct. There was a bank that was getting the 5% interest, and that was looking like a worse and worse deal for the bank.


BLINDER: As inflation went up to 10%, 12%, they would've loved to get out of that mortgage.

SMITH: This gets to the heart of what is so damaging about inflation. Whenever you make a contract with someone - I will pay you back for this house, or I will buy your products next year - you agree on a payment. And inflation starts screwing with the value of that deal.

GOLDSTEIN: And screwing in a directional way, right? The people who owe money, like, say, Alan Blinder with his mortgage payment that stays the same every month while his wage goes up, those people are winners. They get richer because of inflation, because the money they're paying is worth less than it was when they made the deal. The people who are owed money, like the banks or like those retirees who get a monthly pension check, they are the losers, right? They're getting money that's less and less valuable.

SMITH: In the late 1970s, inflation spikes even higher. Now America's in this, like, high inflation universe. Prices are rising, so people get raises and companies increase prices to pay for those raises. And everyone starts to expect that this will continue forever. We live in Inflation World. It is now baked in.

GOLDSTEIN: Obviously, we eventually got out of Inflation World. We don't live there anymore. But what we had to do to get out of it was really quite brutal.

SMITH: Remember what Alan Blinder said was the fundamental driver of inflation?

BLINDER: It's too much demand chasing too little supply.

SMITH: So the solution is to reduce demand, get people to buy less stuff. The Federal Reserve raised interest rates, made it very expensive to borrow money. And it worked. People stopped borrowing money and stopped buying stuff. It also meant that the U.S. fell into a recession. Millions of people lost their jobs. It sucked.

GOLDSTEIN: But inflation had fallen to 3%, and it has stayed low ever since.

SMITH: All right, I am sufficiently scared of inflation, and I am even more scared of the cure.


GOLDSTEIN: After the break, deflation - just like inflation, but the opposite and maybe worse.


SMITH: Now, you'd think that deflation is just the opposite of inflation.

GOLDSTEIN: You'd more or less be right.

SMITH: But it has a different set of economic and, dare I say it, psychological problems.

GOLDSTEIN: Deflation has not happened in the United States for almost a hundred years now. It hasn't happened since the Great Depression. But we don't have to go back to the Great Depression to talk about deflation. There's actually a really interesting example of deflation that happened much more recently than that. It happened in Japan.

TAKATOSHI ITO: This is Ito - Takatoshi Ito speaking. Thank you for calling.

SMITH: Takatoshi Ito is a professor at Columbia University. He says the problem started in 1997, when Japan had a banking crisis. Banks stopped lending. That meant companies couldn't get money, so they started laying people off, and people stopped buying stuff.

GOLDSTEIN: You know, this is something like the opposite of what happened in the U.S. in the late '60s when inflation started, right? That was when people buying more stuff - more demand - led to rising prices. In Japan in the late '90s, people buying less stuff - falling demand - led to falling prices.

SMITH: Now, how do you see this? Like, if you are - if you're in Japan and you're looking around, do you see signs that say 5% off, 10% off, 15% off? Do you see desperate retailers out on the street handing out coupons?

ITO: It's not that kind of acute crisis. It was more gradual suffocation.

SMITH: Suffocation?

ITO: Yeah. We have the expression in Japanese that you suffocate with a cotton scarf.

SMITH: Suffocate with a cotton scarf - the economy was slowly running out of oxygen.

GOLDSTEIN: Prices weren't falling dramatically. It was, like, half a percent a year. But it went on year after year after year. And people started to just expect, to assume that prices were going to keep falling. And that expectation was part of the reason that prices did keep falling.

SMITH: Yeah, Japanese businesses expected prices to keep falling. And they thought, if we invest a lot of money now to develop a new product or build a new factory, the price we're able to sell at is going to get lower and lower over time. Why even bother? So they started to move factories to other countries and invested less in Japan.

GOLDSTEIN: Ordinary people expected falling prices and thought, why buy now? Stuff will be cheaper in the future. Japan's whole economy just kind of got stuck. Why bother? Wages and prices stagnated year after year after year.

SMITH: It was like the bizarro world mirror to '70s America. Remember how Alan Blinder got a mortgage and bought a house before inflation set in and made out like a bandit? Think about people in Japan who borrowed money to buy houses before deflation set in.

ITO: So house prices go down, but you have to make the same payments to the banks. Then you are screwed, in a sense.

GOLDSTEIN: You're screwed.

ITO: Yeah.

GOLDSTEIN: Because your wage is also falling, right?

ITO: Yeah. And then your house is worth much less than when you bought it, so you are sort of bound to debt.

GOLDSTEIN: That sounds bad.

ITO: That sounds bad. That was bad.

GOLDSTEIN: There is a way to fight deflation. Not surprisingly, it's the opposite of the way you fight inflation. You lower interest rates. You create more money and hope people spend that money to push prices higher.

SMITH: And as the years pass, the central bank of Japan, it just goes bananas trying all these crazy things to push money into the system. But part of the problem, and this is where the psychology comes in, is that people in Japan expect prices to go down every year, so it's hard to break them out of that feeling that they should never ever pay more for something.

GOLDSTEIN: When we asked Ito about this, he told us a story about this famous restaurant chain.

ITO: Yeah. So one - this is a yakitori...


ITO: ...Chain - yakitori chain.

GOLDSTEIN: So yakitori is like a grilled meat on a stick, basically.

ITO: Yeah, grilled chicken. They raised the prices, I think, two years ago.

SMITH: And, Jacob, I've seen the ads for this restaurant. They are famous for their cheap beer...


SMITH: ...And all these cheap sticks of meat.


SMITH: Delicious. But they hadn't raised prices in years and years, and they wanted to pay their workers a bit more, so they thought, we can increase the prices by just a few yen.

ITO: Yeah. So the store increased the price of one skewer from 280 yen to 298 yen.

GOLDSTEIN: Which is like - which is, in dollars, roughly like $2.80.

ITO: Two dollars, 80 cents to $2.98.

SMITH: So 18 cents more.

ITO: Eighteen cents more.

SMITH: And people went ballistic. Prices don't go up. Prices only go down. People stopped coming to the restaurant. Sales plunged, all over a mere 18 cents. The company's stock fell by 50% at one point.

GOLDSTEIN: Eventually, maybe grudgingly, people finally agreed to pay 18 cents more for their chicken on a stick.

ITO: So it took about one year, one whole year, that the customers start to come back. And they endured and stick with the higher prices. So it's - I don't know - happy story. I don't know.

GOLDSTEIN: (Laughter) Yes, yes. I am going to go with happy story, Robert. This is the story of, you know, Japan fighting its way out of deflation, right? And, in fact, in the past few years, the country has finally barely gotten out of deflation. Prices have been rising like - I don't know - half a percent a year. But clearly, people still expect that prices are going to stay the same or go down.

SMITH: I don't know. I don't want to put too much of a happy ending on this. The deflation was long and scary, and it messed up people's minds. Just like in America, where we got stuck in this inflationary mindset expecting prices to go up, in Japan, they got stuck in the deflationary world. They lived there years after years after years. It was a world where a company that just wanted to give employees a raise had to have a near-death experience to hike the price of a meat stick by 18 cents.


SMITH: And so now we confront the present moment.

GOLDSTEIN: What does that look like? It's like you're sitting there. The present moment is sitting there facing you.

SMITH: Right across, 6 feet away. This is the COVID recession world we live in. Are we going to go with door No. 1 - the full 1970s American inflation - or door No. 2 - 1990s Japan deflation? Or, as implausible as it might seem, door No. 3 is we go back to the utopian world of stable prices we've enjoyed for 35 years.

GOLDSTEIN: Which door are we going to go through? How do we know what's happening? We called up Susan Schadler.

SMITH: She's an economist who recently wrote this article in Barron's that we found really insightful.

GOLDSTEIN: Are you right now worried about both deflation and inflation?

SUSAN SCHADLER: Yes, I absolutely am. It seems like it should be impossible.

SMITH: To be clear, she's not saying they would happen at the exact same time, but still...

GOLDSTEIN: You tell me we should be worried about inflation. OK, maybe. Or - OK, you tell me we should be worried about deflation. OK, maybe. But how could it be that we have to worry about both?

SCHADLER: Well, that's right. Exactly.

GOLDSTEIN: Surely we should only have to worry about one.

SCHADLER: Right. Yeah. So in order for me in my own head - to get at that question and why I worry about both is I have to back up.

SMITH: Schadler says it helps to think about the COVID recession in terms of both supply and demand. When the pandemic hit, businesses and restaurants shut down, and that was what's called a supply shock - a reduction in the supply of tattoos and margaritas and Ford F-150s and everything else.

GOLDSTEIN: But there was also what economists call a demand shock. Tens of millions people lost their jobs. Millions more were afraid of losing their jobs. On top of that, everybody was just afraid to go out. So suddenly, people were spending much less money - much less demand.

SCHADLER: So we got a one-two punch of supply and demand shock.

GOLDSTEIN: And that's where we are now - right? - I mean, to some extent.

SCHADLER: That is where we are right now.



SMITH: And what happens next, whether we have high inflation or deflation or neither, depends on how both supply and demand recover. You could tell different stories about how that recovery might go. One story leads to deflation, the other one to inflation. So let's start with the deflation story.

SCHADLER: Deflation story - so firms and businesses start producing more goods and services, but the demand for them is just not there.

GOLDSTEIN: Millions of people are still unemployed, buying less stuff. Stores are open, but not many people are going inside. And even people who have jobs are still scared.

SCHADLER: So that's when you start seeing the natural market reaction is prices start to fall because there isn't enough demand for the goods that's now being produced.

SMITH: And that's the classic thing you don't want. It seems to me most macroeconomists are more afraid of deflation than of inflation.


GOLDSTEIN: And you think that might happen?

SCHADLER: Oh, I think it's a definite possibility. Yeah.

SMITH: OK. What about inflation?

GOLDSTEIN: Tell me the story of how we get relatively high inflation in the U.S. in the not too distant future. How does that story unfold?

SCHADLER: So people start feeling freer to go out and buy stuff. They are spending because they haven't spent for three or four or five months, and they have pent-up demand. And so they say, yeah, I mean, I got to go out and refresh my wardrobe. And businesses start thinking, wow, so we're going to get a recovery here. And they start investing, but supply is still hobbling along. Texas has COVID right now. Are they going to start shutting down some factories there?

SMITH: Yeah.

SCHADLER: If they do - fewer goods.


SCHADLER: Are there going to be more outbreaks of COVID in meatpackers?

SMITH: Even places that do open are going to be limited. Restaurants will have to spread out their tables and serve fewer customers. Socially distanced hair salons will have to leave some chairs empty. If demand comes back, people will be clamoring for restaurant meals and haircuts that are now harder to come by.

GOLDSTEIN: If factories overseas have to shut down again, supply of all kinds of stuff will start to fall.

SMITH: At the same time, Congress and the Federal Reserve have kept putting trillions of extra dollars into the economy to encourage people to keep spending to keep demand up.

GOLDSTEIN: So even if demand just gets back to where it was in February, we won't be making enough stuff to meet all that demand.


GOLDSTEIN: And what will be the effect of that?

SCHADLER: Inflation.

GOLDSTEIN: Inflation.

SCHADLER: So prices would go up.


SCHADLER: That's the inflation scenario.

SMITH: So it is a fascinating moment right now. There are so many things broken in the economy that our future depends on which one of them gets better first. If demand picks up first before supply, you get inflation. And if supply is raring to go but there's no demand, we might get deflation. And if we've learned one lesson from Japan or from the United States in the 1970s, it's that once inflation or deflation takes hold, it is really hard to get out of.

GOLDSTEIN: And yet that fact, the fact that price changes tend to have inertia, that whatever is happening tends to keep happening - that is one thing we do have in our favor right now - that 35 or so years of steady San Diego weather prices we've had, that 1 to 3% inflation we talked about at the beginning of the show. It has trained us to expect that that's going to continue. And, you know, over the next, say, several months or a year, we might have wild price swings in one direction or the other. But the fact that most people in the U.S. cannot remember what deflation or high inflation is like; the fact that as a result, people just assume that we're going to have low, stable inflation - that may be enough to help us muddle through.


GOLDSTEIN: If you are thinking to yourself right now, what I really...

SMITH: Don't let it stop. I want more. Come on.

GOLDSTEIN: More - I got more for you. We did a show in 2015. It was called The Great Inflation. It was all about inflation and the Fed chairman Paul Volcker, who brought it to an end.

SMITH: As always, we love to get your emails. We're planetmoney@npr.org. We are also on Facebook, Instagram, Twitter and TikTok - all @PlanetMoney. Also, looking for our next intern - it's paid, and you can work from home. It's the dream job. If you're interested, go to npr.org/internships.

GOLDSTEIN: Today's show was produced by Darian Woods. Alex Goldmark is our supervising producer, and Bryant Urstadt edits the show.

SMITH: I'm Robert Smith.

GOLDSTEIN: I'm Jacob Goldstein.

SMITH: This is NPR. Thanks for listening.

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