Should We Fear Deflation?

DEFLATION IS BACK. In the six months from October 1998 to March 1999, some 438 articles about deflation appeared in major U.S. newspapers, compared with only 36 in the first half of 1997 and 10 in the first half of 1990. For sixty years, ever since the middle years of the Great Depression, deflation was a nonissue. Next to no one worried about it. Next to no one viewed a general decline in the price level as even a remote possibility. Now people do. And now people worry about it. One reason to worry about deflation is that today the rate of inflation in the United States is quite low, less than 2 percent per year. But that is not the whole story. The post–Korean War 1950s and the early 1960s saw measured rates of inflation as low as those of today (figure 1). Yet back then people worried not about deflation, but about inflation. Why is it that, in the late 1990s, inflation of 2 percent per year or less calls forth the fear of deflation, where it did not in the 1950s and 1960s? The principal reason why the low inflation of the 1950s and 1960s did not create fears of deflation was that economists in those days believed that economic institutions had a bias toward inflation, a legacy of the Keynesian revolution. Today that belief in an inflationary bias is gone, or at least greatly attenuated. What has happened to that belief, and to that built-in