## Transcript of an IMF Economic Forum: Should We Be Worried About 'Deflation'?

_IMF News, May 29, 2003_

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## Bibliographic details
- Published: May 29, 2003

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### Overview and context
- Event date and location: May 29, 2003; Washington DC.
- Panel participants: Kenneth Rogoff (Moderator), Manmohan S. Kumar, Laurence Ball, Vincent Reinhart, Kim Schoenholtz.
- Motivation: Rising concerns about deflation amid falling inflation rates, massive declines in global equity markets, widening output gaps, and geopolitical uncertainties.
- IMF staff study referenced: "Deflation: Determinants, Risks and Policy Options" (interdepartmental task force; lead author Manmohan S. Kumar).

### Key findings on incidence and measurement
- Share of industrial and large emerging market economies experiencing episodes of declining prices (country months relative to total) increased:
  - from around 1 to 3 percent in the first half of the 1990s
  - to 8 to 15 percent in the past 5 years.
- Measured inflation of less than 1 percent may already be close to price stability or reflect declining prices (given upward bias in measured inflation).
- Conclusion: Mild deflation may be affecting an even higher proportion of countries than direct deflation counts imply.

### Causes, channels, and costs of deflation
- Causes:
  - Demand shocks: severe cyclical downturns, bursting asset-price bubbles, excessively tight policies.
  - Supply shocks: large positive supply shifts from technological innovation or productivity growth that raise output while prices decline.
- Expectations: Once prices decline, expectations can reinforce downward pressures, potentially creating a self-enforcing deflationary spiral.
- Costs of sustained deflation:
  - Redistribution from debtors to creditors, depressing demand.
  - Real wage increases if nominal wages are inflexible, reducing profits and employment.
  - Nominal interest rate floor (zero) curtails conventional monetary policy effectiveness.
  - Distortions to credit intermediation as collateral values fall.

### Historical evidence
- Most extreme case: worldwide deflation and catastrophic collapse in activity in the late 1920s and early 1930s.
- 19th-century deflation episodes: associated with rising debt burdens, bankruptcies, social and political unrest, financial crises, significant output volatility.
- Japan: recent deflation associated with subpar performance over several years; forecasts systematically overestimated inflation during onset of deflation.

### Indicators, vulnerability assessment, and model results
- Framework: indicators include price variables, output gap / excess capacity, credit and monetary indicators, asset market conditions, structural factors, and policy flexibility.
- Aggregation: estimated contributions from prices, output gap, asset markets, credit and monetary factors combined into an overall index of deflation vulnerability (early 1990s to present); a financial/credit-weighted index computed as well.
- Results and country rankings:
  - Increased vulnerability to deflation in a number of industrial and emerging market economies.
  - Highest vulnerabilities: Japan (already in deflation), followed by Hong Kong SAR and Taiwan Province of China (all three have deflation).
  - United States: score indicates a low risk.
  - Europe: risks of mild deflation low in major countries except Germany (higher vulnerabilities reflect weak demand and credit growth and financial sector strains within limited policy room).
- Phillips Curve / gap estimates for G-7 (supplementary analysis):
  - United States: unemployment gap would have to increase by 2 percentage points or more for onset of mild deflation.
  - Germany: unemployment gap increase of 1 to 1.5 percentage points would be required.
  - Japan: already has deflation; unemployment gap would have to increase by 1 percentage point for deflation to get worse (defined as an increase in deflation of 2 percentage points).

### Country-specific assessments and notable statistics
- Japan:
  - Already in deflation; risks of intensification emphasized.
  - Historical policy mix and weak financial intermediation contributed to persistence.
  - Observed policy actions (e.g., monetary base expansion) have not yet restored robust recovery: example cited monetary base growth of 30 or 40 percent a year in Japan without full success.
  - Surveys: households typically anticipate prices to fall for two or more years ahead.
- Germany:
  - Elevated vulnerability driven by weak demand, constrained fiscal room (Stability and Growth Pact), limited monetary maneuver (monetary policy set for the euro area).
  - Germany reported into its third year of growth well below 1 percent.
  - Nominal domestic demand shrank last year, the first drop in over 3 decades.
  - Potential adjustment dynamics: low German inflation or deflation could restore competitiveness but at the cost of potential damage to growth and the financial system.
- United States:
  - Viewed as low risk for sustained deflation.
  - Federal funds rate cited at 1.25 percent (concern about limited room for conventional policy).
  - Risks mitigated by aggressive fiscal and monetary stimulus already in place (panelists noted large policy stimulus and actions to shape expectations).
  - Market moves cited: broad equity market jumped by more than 20 percent; trade-weighted dollar dropped more than 10 percent versus major currencies; surveys of long-term inflation expectations show annual increases of 2.5 percent or more.
- China:
  - Deflationary pressures linked mostly to transitory and longer-term supply-related factors.
  - GDP growth averaged about 7 percent for several years.
  - Transitory effects expected to ease; longer-term capacity expansion and excess labor could continue to weigh on prices.
- Transmission and international considerations:
  - No compelling evidence of international transmission of deflation in normal floating-exchange-rate regimes; each central bank retains primary influence over its domestic price level over time.
  - However, a deflationary spiral in a major economy could trigger shocks elsewhere via trade or financial channels (e.g., capital repatriation), and correlated business cycles raise the risk that localized deflation signals broader weakness.

### Policy recommendations: prevention and response
- Prevention (preemptive action in low-inflation environment):
  - Adopt a clear communication strategy highlighting policymakers' ability and commitment to contain deflation.
  - Monetary policy regime design:
    - Inflation-targeting regimes should aim for an adequate buffer zone above zero; avoid targeting inflation "too low" (examples and views cited: ECB target perceived near 1 percent criticized as too low; Bank of England targeting 2.5 percent viewed as more appropriate; suggestions that higher targets, e.g., 3–4 percent, would reduce zero-bound risk).
  - Fiscal policy: tailor fiscal measures credibly to boost aggregate demand when needed.
  - Exchange-rate regime: flexible rates afford greater protection from imported deflation than fixed regimes.
  - Structural reforms: credible, well-articulated package of reforms can raise growth potential and support demand expectations.
- Dealing with deflation once set in:
  - Credible commitment to end deflation is essential.
  - Monetary measures:
    - Conventional: lower short-term rates (constrained by zero lower bound).
    - Unconventional / balance-sheet tools: purchase long-term bonds, widen asset purchases (equities, foreign-currency assets), alter composition and size of central bank balance sheet, shape expectations via conditional/unconditional commitments to future policy paths.
    - "Shaping expectations": conditional commitments (e.g., hold rates low until "Y" happens) and unconditional time-bound pledges can influence longer-term rates and asset prices.
    - Risks and caveats: operational challenges, uncertain impacts, potential need for very large scale operations, possible market distortions, credibility concerns if words do not match deeds.
  - Fiscal measures: when monetary policy constrained, fiscal expansion is the textbook cure; sequencing and credibility matter (Japan and Germany face constraints that limit fiscal options).
  - Communication and credibility: central bank rhetoric and demonstrated willingness to act are central to influencing expectations and preventing entrenchment.
- Policy priorities:
  - More symmetric attention to risks of falling as well as rising prices.
  - Preventing deflation is preferable to fighting entrenched deflation; if deflation takes hold, aggressive policies to eradicate deflationary expectations are essential.

### Panel debate — contrasting perspectives
- Laurence Ball:
  - Emphasizes liquidity trap (large output gap + zero nominal rate) as the main hazard rather than modest falling prices per se.
  - Advocates higher inflation targets (e.g., above 2 percent) to create policy room and favors fiscal policy as the decisive tool in a liquidity trap.
- Vincent Reinhart:
  - Argues central banks can still influence economic conditions at low nominal rates by shaping expectations and using balance-sheet tools; stresses communication credibility and the Federal Reserve's toolkit.
  - Notes costs of very low rates (market segmentation, mistaken perception of policy impotence).
- Kim Schoenholtz:
  - Stresses that risk of sustained deflation rises where credible commitment to price stability is lacking (examples: Japan constrained by perceived asymmetry and weak intermediation; Germany constrained politically and institutionally).
  - Emphasizes that aggressive policy to influence expectations can halt deflation; central banks ultimately have the unlimited ability to create money, but willingness to act matters.
- Consensus points:
  - Japan is of greatest concern; Germany presents notable risks; United States is at lower risk though limited policy space is a concern.
  - Communication, credibility, and timely preemptive policy are critical to preventing and combating deflation.

### Illustrative numerical and factual items (preserved exactly as stated)
- Dates: May 29, 2003.
- Incidence increases: "from around 1 to 3 percent in the first half of the 1990s to 8 to 15 percent in the past 5 years."
- Measured inflation threshold: "less than 1 percent may already be close to price stability or even reflect declining prices."
- Unemployment gap estimates to induce mild deflation:
  - United States: "would have to increase by 2 percentage points or more."
  - Germany: "1 to 1.5 percentage points."
  - Japan: "unemployment gap would have to increase by 1 percentage point for deflation to get worse, as defined as an increase in deflation of 2 percentage points."
- U.S. federal funds rate referenced: "1.25 percent."
- Example of monetary base growth in Japan cited: "30 or 40 percent a year."
- Equity market movement cited: "broad equity market has jumped by more than 20 percent."
- Trade-weighted dollar movement cited: "the trade-weighted dollar has dropped more than 10 percent versus major currencies."
- Long-term inflation expectations cited: "surveys of long-term inflation expectations continue to show annual increases of 2.5 percent or more."
- China: "GDP growth has averaged about 7 percent for several years."
- Germany: "currently into its third year of growth well below 1 percent." and "Nominal domestic demand shrank last year, the first drop in over 3 decades."

*Transcript of an IMF Economic Forum: Should We Be Worried About 'Deflation'? (May 29, 2003).*

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## References

- [Germany and the IMF](http://www.imf.org/external/country/DEU/index.htm)
- [Japan and the IMF](http://www.imf.org/external/country/JPN/index.htm)
- [United States and the IMF](http://www.imf.org/external/country/USA/index.htm)
- [Transcripts](https://www.imf.org/en/news/searchnews)
- [Deflation: Determinants, Risks, and Policy Options—Findings of an Interdepartmental Task Force](https://www.imf.org/external/pubs/ft/def/2003/eng/043003.htm)
- [PRESS CENTER](http://presscenter.imf.org/)
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