A January 19th report from Deutsche Bank Research advances the argument that deflation is not necessarily the economic bogeyman most economists and the mainstream media make it out to be.

Author Bilal Hafeez explores the ins and outs of deflation, both historically and in the current context, and suggests that perhaps a more nuanced approach is needed. “Simply trying to avoid deflation at any cost, which seems to have been the mantra of central bankers in recent decades, may not be the most prudent course.”

Deflation Does Not Have To Mean Low/No Growth: Deutsche Bank

Why deflation is bad

The main argument against deflation is that it typically leads to wage stickiness (employees refusing to take pay cuts) which eventually leads to unemployment. The Great Depression is held out as the cautionary tale of how deflation leads to unemployment. However, Hafeez points out that other instances of deflation in countries including Japan show that in the workers today do grudgingly accept wage cuts when faced with unemployment.

The other argument is that those with the most debt (typically the young and the poor) see their debt burden rise when prices fall. If wages go down long with prices, it is more difficult to pay off fixed mortgages or loans. Inflation on the other hand reduces debt by the reverse logic, hurting who save and lend. Hafeez comments on this apparent conundrum: “Hence, the choice between inflation and deflation can be cast as a political debate over redistribution. Neither inflation nor deflation is likely to harm all segments of society equally.”

Deflation can lead to growth

Hafeez highlights that in some cases, deflation can actually lead to growth. In recent history, for example, Europe has experienced higher growth during deflationary periods (1.7%) than inflationary periods (1.4%) He points out that the “negative correlation between prices and growth is particularly pronounced in Germany. Here the difference is not only the largest in Europe, with growth of 2.6 per cent during deflation against a measly 0.6 per cent during inflation, but also stable across the 19th and 20th centuries.”

In fact, according to Hafeez, Belgium, Finland, Greece, Spain, and Sweden, as well as the whole of Latin America, have seen often positive growth with deflation over the past two centuries.

Good deflation and bad deflation

In concluding, Hafeez argues that there is both “good deflation” and “bad deflation”. He explains his perspective: “Going back to economics 101, there are two ways to get lower prices: an increase in supply or a decrease in demand. The former could lead to good deflation if it reflects some boost in productive efficiency, higher real wages and robust demand for profitable assets. A negative demand shock would also lead to lower prices, but this would likely lead to bad deflation, where debt problems increase and asset prices fall against a background of slumping profits and high bankruptcy rates.”