We had falling price levels in the entire second half of the 1800s as we grew to become a world economic power. So slowly falling prices aren't so destructive. You'll often hear the line, "People won't buy a car today because they expect the price to be lower tomorrow." But you can't find much evidence of that, because the rate of decline is usually pretty moderate. We shouldn't be worried about deflation, really. We should be worried about a severe long lasting depression with sustained unemployment.

When one hears about deflation, one expects to then hear an example about Japan's lost decade or decades. After all, Japan's nominal GDP today is equal to its 1993 GDP. Are we following in their footsteps?

The magnitude of the financial crisis in Japan was even worse than the one that hit the United States. They had a deeper financial disaster, the government didn't act to get the bad debt out of the banking system, the banks spent a decade de-leveraging, and business firms saw their wealth wiped out and wouldn't spend on capital goods. They had a bigger asset bubble that we did, and a much bigger collapse.

How would you sum up the U.S. crash?

The U.S. is a country that for over a decade knew we were in the midst of a consumption binge, running huge external deficits [more money flowing out of the country in exchange for imports than money flowing in via exports]. There was just way too much consumption and way too few exports. Households lived beyond their means and they took a big hit. Now, people aren't spending and businesses don't want to do anything new.

How would you assess our reaction to the recession through monetary and fiscal stimulus?

Monetary action was helpful to resolve the liquidity crisis. But I'm not sure these measures of purchasing private debt will stimulate more spending. We can't use monetary policy for stimulus, so we advocate fiscal stimulus.


The problem is fiscal policy in most of the industrial world is paralyzed by the fear of accumulating debt. After Greece, the developed world returned to normal fiscal policy way too soon. That was a bad mistake promoted by the IMF at the G20 meeting.

How should we try to redesign our economy for the next decade?

Countries that have financial crises recover by having an export led recovery. It's the case for all the Asian recoveries in the late 1990s. We have to reduce our demand and export more. But that's not easy to do in a world in which everybody wants to have an export led recovery.

How do you do boost exports?

Normally, you'd decline the value of the dollar. But the dollar has gained value against currencies like the Euro recently. In the short run, you get into unconventional measures, like taxing foreign deposits in U.S. financial institutions.

I think we need greater emphasis by firms themselves on trying to be exporters. Instead, what's the model of the best performing american company? It's Apple. Apple does not produce a single thing in the United States. Everything is produced abroad. All it does is sell. That kind of behavior is very successful for Apple. But it doesn't create export jobs here and now.
How afraid should we be of deflation, a vicious cycle of falling prices and declining economic activity? I didn't know, so I asked Barry Bosworth, a senior fellow at the Brookings Institution. He dismissed the idea that deep and double-digit deflation was realistic and explained that the only the only way out of a deep financial crisis has historically been an export-led recovery. Easier said than done when every developed country in the world is trying to sell more to the world than they buy.

This is an edited transcript:

Should we be scared of deflation?

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