The Conventional Wisdom on Deflation is Dubious

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Here’s a letter to the Wall Street Journal.

Editor:

Your reporter Matt Grossman repeats the conventional wisdom that “deflation is bad news when it spans the whole economy” (“The Era of Cheap Stuff Was Already Ending. Now Comes the Tariff Threat.” March 30).

This conventional wisdom is dubious, both theoretically and empirically. Deflation – that is, a falling price level – was the norm in the U.S. from the end of the Civil War until the start of the 20th century; in 1901 the price level was down by almost 50 percent from its level in 1865. Yet during those years industrial output grew at an average annual rate of 5.4 percent.* The norm since the end of WWII, of course, has been inflation; in 2024 the price level was 17.5 times higher than it was in 1945. But since the end of the war U.S. industrial output grew at an average annual rate of 2.7 percent – just half the pace of growth experienced in the latter third of the 19th century.

Debates can be had over why the growth in industrial output was slower over the past 80 years than it was in the late 19th century. Part of the explanation points to a positive development: as we Americans became richer, our demand for physical outputs rose more slowly than did our demand for services. But another part of the explanation might be inflation, which distorts price signals and discourages savings and investment.

Whatever the reason, there’s neither good theory nor empirical evidence to justify the claim that “deflation is bad when it spans the whole economy.” As economists Andrew Atkeson and Patrick Kehoe concluded in a 2004 study, “A broad historical look finds many more periods of deflation with reasonable growth than with depression, and many more periods of depression with inflation than with deflation. Overall, the data show virtually no link between deflation and depression.”**

Sincerely,
Donald J. Boudreaux

Professor of Economics
and
Martha and Nelson Getchell Chair for the Study of Free Market Capitalism at the Mercatus Center
George Mason University
Fairfax, VA 22030

* Calculated using data from Joseph H. Davis, “An Annual Index of U. S. Industrial Production, 1790-1915,” Quarterly Journal of Economics 119, November 2004: 1177-1215.

** Andrew Atkeson and Patrick J. Kehoe, “Deflation and Depression: Is There an Empirical Link?” American Economic Review 94, May 2004: 99-103. The quoted passage is found on page 102.

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