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Deflation: Prevention and Cure

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  • 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.

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Paper provided by National Bureau of Economic Research, Inc in its series NBER Working Papers with number 9623.

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Date of creation: Apr 2003
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Handle: RePEc:nbr:nberwo:9623

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Cited by:
  1. John H. Cochrane, 2009. "Comment on "On the Need for a New Approach to Analyzing Monetary Policy"," NBER Chapters, National Bureau of Economic Research, Inc, in: NBER Macroeconomics Annual 2008, Volume 23, pages 427-448 National Bureau of Economic Research, Inc.
  2. Joerg Bibow, 2004. "Fiscal Consolidation Contrasting Strategies & Lessons from International Experience," Macroeconomics, EconWPA 0402014, EconWPA.
  3. Gauti B. Eggertsson, 2011. "Fiscal Multipliers and Policy Coordination," Working Papers Central Bank of Chile, Central Bank of Chile 628, Central Bank of Chile.
  4. Claudio Morana, 2004. "The Japanese Deflation: Has It Had Real Effects? Could It Have Been Avoided?," ICER Working Papers, ICER - International Centre for Economic Research 29-2004, ICER - International Centre for Economic Research.
  5. Taimur Baig, 2003. "Understanding the Costs of Deflation in the Japanese Context," IMF Working Papers, International Monetary Fund 03/215, International Monetary Fund.
  6. Eckhard Hein & Thorsten Schulten & Achim Truger, 2004. "Wage trends and deflation risks in Germany and Europe," Macroeconomics, EconWPA 0412008, EconWPA.
  7. Romain Veyrune, 2005. "Le prix de la fixité : Application à l'Union monétaire des Caraïbes orientales et à la Zone franc," Mondes en développement, De Boeck Université, De Boeck Université, vol. 130(2), pages 63-76.
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