deflation post with graphs
TRANSCRIPT
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There has been a lot of debate over whether or not deflation is good for an economy. The two most important
eriods of deflation in modern history are the Great Depression and Japan's Lost Decade. These have already been stu
great detail, so I am not going to discuss them here.
Many people, such as the folks at Mises.org have pointed out that price deflation was much more common in
800's, and did not always result in lower GDP growth. In this blog I will try to examine the relationship between yeahanges in the consumer price index (CPI), and yearly changes in real GDP. This data was downloaded from Measur
Worth. I will attempt to compare and contrast the years from 1790-1913, with years of the post-Federal Reserve era:
914-2009.
First I want to mention that the relationship between CPI and GDP can be seen very cleary, if nominal GDP i
ed instead of real GDP. But I am not going to discuss these graphs because I believe that would be misleading. If
ominal GDP increases by 3%, but the CPI also increases by 3%, then we haven't really gained anything in terms of urchasing power. So I will stick to real GDP for my analysis.
rst, here is the modern period shown in Figure 1: A timeline of the yearly percentage changes in both CPI and realDP, from 1914-2009.
5.00%
0.00%
-5.00%
0.00%
5.00%
10.00%
15.00%
20.00%
25.00%
1910 1920 1930 1940 1950 1960 1970 1980 1990 2000 2010 2020
CPI % Change Real GDP % Change
ow, we can contrast this with Figure 2, which shows the same data, for 1791-1913:
15.00%
10.00%
-5.00%
0.00%
5.00%
10.00%15.00%
20.00%
25.00%
1780 1800 1820 1840 1860 1880 1900 1920
CPI % Change Real GDP % Change
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have also divided this graph into three smaller parts, which lets us see it more clearly:
gure 3: Timeline, 1791-1830
15.00%
10.00%
-5.00%
0.00%
5.00%
10.00%
15.00%
20.00%
25.00%
1785 1790 1795 1800 1805 1810 1815 1820 1825 1830 1835
CPI % Change Real GDP % Change
gure 4: Timeline, 1831-1871
5.00%
0.00%
-5.00%
0.00%
5.00%
10.00%
15.00%
20.00%
25.00%
1825 1830 1835 1840 1845 1850 1855 1860 1865 1870 1875
CPI % Change Real GDP % Change
gure 5: Timeline, 1872-1913
5.00%
0.00%
-5.00%
0.00%
5.00%
10.00%
15.00%
20.00%
25.00%
1870 1875 1880 1885 1890 1895 1900 1905 1910 1915
CPI % Change Real GDP % Change
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or a quick history lesson, here are some key events which correspond with some of the various peaks and valleys of
ese graphs:
812-1815 - War of 1812
817 - NYSE founded
819 - Panic of 1819 (some other panics can be seen here)861-1865 - American Civil War
873-1879 (approx.) - Depression of 1873–79, AKA the "long depression"
893-1897 - Depression of 1893
907 - The Panic of 1907.913 - Creation of the Federal Reserve
here are a lot of ups and downs here, so rather than trying to squint at these graphs, I have made several scatter plothich allow us to analyze the data more easily.
or each of these plots, I am also going to give the Pearson Coefficient (to 2 decimal places). This is a way of measure degree of correlation between two variables using a scale of -1 to +1. Basically, a value of zero is randomness/no
lationship. A value of +1 is a perfect 45-degree line: "/", and a value of -1 is a 45-degree line going the other directi
".
gure 6: CPI % Change vs Real GDP % Change, 1791-1913
earson = 0.18
-15.00%
-10.00%
-5.00%
0.00%
5.00%
10.00%
15.00%
-20.00
%
-10.00
%
0.00% 10.00
%
20.00
%
30.00
%
CPI % Change
Real GDP % Change
1791-1913
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We can contrast this with the more modern era:
gure 7: CPI % Change vs Real GDP % Change, 1914-2009earson = 0.18
-15.00%
-10.00%
-5.00%
0.00%
5.00%
10.00%
15.00%
20.00%
-20.00
%
-10.00
%
0.00% 10.00% 20.00% 30.00%
CPI % Change
Real GDP % Change
1914-2009
s interesting that the correlation came out exactly the same for both time periods. It's not the strongest correlation in
orld, but what it means is that there tends to be greater real GDP growth in years with larger CPI increases.
ext, I split up the data from Figure 6 into three parts: inflationary years, deflationary years, and neutral years (believ
not there were 18 years where the CPI stayed exactly the same).
gure 8: Inflationary Years, 1791-1913
earson = 0.13
-15.00%-10.00%
-5.00%
0.00%
5.00%
10.00%
15.00%
20.00%
0.00% 10.00% 20.00% 30.00%
CPI % Change
Re
al GDP % Change
1791-1913
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gure 9: Deflationary Years, 1791-1913
earson = 0.13
-15.00%
-10.00%
-5.00%0.00%
5.00%
10.00%
15.00%
20.00%
-20.00% -15.00% -10.00% -5.00% 0.00%
CPI % Change
Real GDP % Change
1791-1913
gure 10: Neutral Years, 1791-1913
earson = N/A
-5.00%
0.00%
5.00%
10.00%
15.00%
-10.00% 0.00% 10.00%
CPI % Change
Real GDP % Change
1791-1913
gain we see the exact same degree of correlation in figures 8 and 9, which indicates that these numbers might actuaean something! More inflation (or, less deflation) generally results in higher GDP growth. Although I should point
at the correlation value of 0.13 is not very high.
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o illustrate a point that I made earlier, I will post one plot that uses nominal GDP growth instead of real GDP growt
gure 11: CPI % Change vs Nominal GDP % Change, 1791-1913earson = 0.85
-20.00%
-10.00%
0.00%
10.00%
20.00%
30.00%
-20.00
%
-10.00
%
0.00% 10.00% 20.00% 30.00%
CPI % Change
Nominal GDP
% Change
1791-1913
his shows us conclusively that price inflation tends to increase the growth rates of both the CPI and the nominal GDsulting in a much larger degree of correlation than what we saw in the real GDP plots.
verages:
his seems like as good a time as any to throw some numbers at you, so here they are:
verage CPI % change, 1791-1913: 0.23%verage real GDP % change, 1791-1913: 3.85%verage real GDP % change, 1791-1913 (during the 50 inflationary years): 4.64%
verage real GDP % change, 1791-1913 (during the 54 deflationary years): 3.39%
verage real GDP % change, 1791-1913 (during the 18 neutral years): 5.50%
verage CPI % change, 1914-2009: 3.41%
verage real GDP % change, 1914-2009: 3.37%verage real GDP % change, 1914-2009 (during the 82 inflationary years): 4.06%
verage real GDP % change, 1914-2009 (during the 13 deflationary years): -1.18%
verage real GDP % change, 1914-2009 (during the 1 neutral year): 6.05%
able prices seem to be the best possible scenario for high real GDP growth. Inflation is the second-best option, and
eflationary years produce the worst results.
ooking Ahead:
ow, I will examine the effect that inflation has on future GDP growth. Fig. 12 shows the CPI % change for the currear, compared to the real GDP % change for the next year. Fig's 13-15 compare current-year CPI changes to the ave
nnual GDP growth over the next 3, 5, and 10 years:
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gure 12: Current Year CPI % Change vs Next Year's Real GDP % Change, 1791-1913
earson = -0.04
-15.00%
-10.00%-5.00%
0.00%
5.00%
10.00%
15.00%
-20.00
%
-10.00
%
0.00% 10.00
%
20.00
%
30.00
%
CPI % Change
Next Yea
r's Real GDP %
C
hange
1791-1913
gure 13: Current Year CPI % Change vs Next 3 Year's Real GDP Average % Change, 1791-1913
earson = -0.23
-15.00%
-10.00%
-5.00%
0.00%
5.00%
10.00%
15.00%
-20.00
%
-10.00
%
0.00% 10.00
%
20.00
%
30.00
%
CPI % Change
Next 3 Year's
Real GDP
Average % Change
1791-1913
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gure 14: Current Year CPI % Change vs Next 5 Year's Real GDP Average % Change, 1791-1913
earson = -0.30
-15.00%
-10.00%
-5.00%
0.00%
5.00%
10.00%
15.00%
-20.00
%
-10.00
%
0.00% 10.00
%
20.00
%
30.00
%
CPI % Change
Next 5
Year's Real GDP Average
% Change
1791-1913
gure 15: Current Year CPI % Change vs Next 10 Year's Real GDP Average % Change, 1791-1913
earson = -0.23
-5.00%
0.00%
5.00%
10.00%
-20.00
%
-10.00
%
0.00% 10.00
%
20.00
%
30.00
%
CPI % Change
Next 10
Year's Real GD
P Average
% Cha
nge
1791-1913
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nd I did the same thing for the post-1914 era:
gure 16: Current Year CPI % Change vs Next Year's Real GDP % Change, 1914-2008earson = -0.03
-15.00%
-10.00%
-5.00%
0.00%
5.00%
10.00%
15.00%
-20.00
%
-10.00
%
0.00% 10.00
%
20.00
%
30.00
%
CPI % Change
Next Year's R
eal GDP %
Chan
ge
1914-2008
gure 17: Current Year CPI % Change vs Next 3 Year's Real GDP Average % Change, 1914-2006earson = -0.12
-15.00%
-10.00%
-5.00%
0.00%
5.00%10.00%
15.00%
-20.00
%
-10.00
%
0.00% 10.00
%
20.00
%
30.00
%
CPI % Change
Next 3 Year's Rea
l GDP
Average % Cha
nge
1914-2006
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onclusions:Comparing the two time periods (1790-1913 and 1914-2009), I have not found many fundamental differences
eflation has become much less common since, 1914, but the behavior of the economy seems very similar. In both
eriods, higher inflation generally correlates with higher real GDP growth in that year. Periods of high growth and hiice inflation are generally followed by periods of slower growth, or even negative growth.
Bear in mind that these are just correlations, so if you try to draw conclusions, it leads to a lot of chicken-or-th
gg types of problems. Is GDP influencing the CPI, or is it the other way around? Probably both, and sometimes may
either. Two variables can show a correlation if certain events influence both of those variables in a similar way. Butoesn't mean that the two variables are necessarily influencing each other.
Even when you look at the correlation between current-year inflation and future GDP growth, that still doesn'
ecessarily mean that high inflation is the cause of lower GDP growth in the future. It just illustrates that boom-and-bycles are a real phenomenon; if the economy is growing at a high rate in one year, then it will probably grow at a slo
te over the next few years (and vice versa). In future blogs I'll try to dig deeper and hopefully gain a better
nderstanding of causality. That's it for now.