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.
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.