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Perils of Price Deflations: An Analysis of the Great Depression

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If a central bank adopts a zero inflation target, it would, in practice, occasionally deviate from that rate up and down, and the economy would experience episodes of mild inflation and deflation. Is deflation—a decrease in the level of prices—a cause for concern? Deflation can cause output to decline, but to what extent? This Economic Commentary explores how much of a problem deflation might be for modern economies by estimating the effect that massive price declines had on output during the Great Depression. We find that while deflation can cause output to decline, mild episodes of deflation are unlikely to be a problem.

If a central bank adopts a zero inflation target, it would, in practice, occasionally deviate from that rate up and down, and the economy would experience episodes of mild inflation and deflation. Is deflation—a decrease in the level of prices—a cause for concern? Deflation can cause output to decline, but to what extent? This Economic Commentary explores how much of a problem deflation might be for modern economies by estimating the effect that massive price declines had on output during the Great Depression. We find that while deflation can cause output to decline, mild episodes of deflation are unlikely to be a problem.


Suggested citation: Carlstrom, Charles T., and Timothy S. Fuerst, 2001. "Perils of Price Deflations: An Analysis of the Great Depression," Federal Reserve Bank of Cleveland, Economic Commentary, 02.15.2001.

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