Bryan Cutsinger on the What the History of Growth Driven Deflation Can Teach us about a Potential AI Boom

Episode Summary

Executive Summary: Brian Kutzinger argues that late-19th-century gold-standard economies show supply-driven deflation can coincide with strong growth, stable or slightly higher nominal rates, and no financial disintermediation crisis. Using cross-country VARs, he contrasts benign productivity-led deflation with harmful demand-driven deflation and draws policy lessons for AI-era growth, favoring symmetric monetary responses and a broader focus on nominal income or r-star.

Main Topics: Supply-driven vs. demand-driven deflation (Priority: 5/5): The central distinction is that productivity-led deflation can accompany growth, while demand-driven deflation typically depresses output, interest rates, and intermediation. Cross-country gold-standard evidence (Priority: 5/5): The paper studies 12 core gold-standard countries from 1880-1900 using GDP, price levels, short-term rates, and a money-multiplier proxy for financial intermediation. Results from sign-restricted VARs (Priority: 5/5): Positive supply shocks raise output and lower prices on impact, but do not meaningfully lower nominal rates or damage intermediation; demand shocks produce the opposite, harmful pattern. Ben Bernanke and deflation interpretation (Priority: 4/5): The discussion revisits Bernanke’s warning against deflation and his footnote acknowledging supply-side deflation as a possible, potentially boom-associated case that should not be conflated with recessionary deflation. Postbellum U.S. deflation as a historical analogue (Priority: 4/5): Beckworth uses his own work on 1866-1897 U.S. deflation to reinforce that long periods of mild deflation can coexist with strong growth and rising living standards. AI-era policy implications (Priority: 5/5): The conversation applies these lessons to potential AI-driven productivity growth, arguing for policy frameworks that tolerate falling prices when growth is strong and avoid offsetting benign deflation. Nominal income targeting and adjustment frictions (Priority: 4/5): Both speakers favor letting real gains show up in lower prices or stable nominal income, while reducing labor-market frictions so workers can move toward new opportunities.

Key Arguments: Supply-driven deflation is not inherently harmful; if productivity rises, lower prices may simply reflect higher output and higher real returns. Nominal interest rates need not fall materially under supply-driven deflation because lower inflation expectations can be offset by higher real rates. Financial disintermediation is not mechanically triggered by productivity-led deflation; in the historical sample, the money multiplier was roughly flat or slightly positive. Demand-driven deflation remains dangerous: it lowers output, prices, nominal rates, and financial intermediation in persistent ways. The late-19th-century gold standard provides a clean setting because central banks were not actively offsetting supply shocks, making it useful for identifying these effects. The historical record suggests positive supply shocks explained a meaningful share of fluctuations in output, prices, rates, and intermediation, not just a theoretical curiosity. Trying to offset all productivity-driven deflation with inflation targeting may create credit booms, misallocate resources, and weaken the political visibility of good policy. A better framework may be nominal income targeting or an r-star-consistent approach that lets the central bank follow the neutral rate upward in a boom. Policy should also reduce labor-market and housing frictions so people can relocate and retrain when growth disrupts industries.

Data Points: Countries in sample: 12 - Gold-standard economies analyzed in the cross-country VAR study, including the U.S., U.K., Canada, Germany, and several European countries. Sample period: 1880-1900 - Main cross-country dataset for the supply-driven deflation paper. Average real GDP growth: 2.5% - Mean growth across the sample during the late-19th-century gold-standard period. Average price-level growth: -0.2% - Average mild deflation across the sample over 1880-1900. Average short-term nominal interest rate: 3.8% - Mean nominal rate in the sample, used to assess whether deflation pushed rates to the lower bound. Average financial intermediation growth: close to 2% - Broadly positive money-multiplier growth across the sample. Output variance explained by positive supply shocks: 20% - Estimated share of output fluctuations attributable to positive supply shocks over 10-year horizons. Output variance explained by demand shocks: 17-18% - Estimated share of output fluctuations attributable to demand shocks. Price variation explained by positive supply shocks: 15% - Share of price-level fluctuations explained by supply shocks. Short-term rate variation explained by positive supply shocks: 16% - Share of nominal interest-rate fluctuations explained by supply shocks. Financial intermediation variation explained by positive supply shocks: 14% - Share of money-multiplier fluctuations explained by supply shocks. U.S. postbellum deflation average: just over 2% per year - Beckworth’s cited long-run U.S. deflation from 1866-1897. U.S. postbellum growth average: 3.7% - Real growth over 1866-1897 in Beckworth’s discussion of postbellum deflation. Early postbellum deflation (1866-1879): 4% deflation with 4% growth - Beckworth’s summary of the earlier part of the post-Civil War period. Later postbellum deflation (1880-1897): 0.8% deflation with 3.4% growth - Beckworth’s summary of the later part of the post-Civil War period.

Pivotal Quotes: "What we want to do is we want to say, look, there's been a number of papers that have shown... that the link between deflation and poor economic performance historically is not very strong." — Brian Kutzinger: Explaining the motivation for distinguishing harmful demand deflation from benign supply-driven deflation. "A supply-side deflation would be associated with an economic boom rather than a recession." — Ben Bernanke: Quoted from Bernanke's 2002 speech and used as a key conceptual anchor for the paper. "If you think about something like supply-driven deflation, the key keeping in mind is that the neutral rate is, we tend to think of it as being somewhat pro-cyclical." — Brian Kutzinger: Explaining why nominal rates may not fall much when productivity gains drive deflation.

Implications: For AI-era growth, policymakers should not assume falling prices are bad. Benign productivity-driven deflation can coexist with prosperity, so the Fed should be symmetric, avoid offsetting good supply shocks, and consider nominal income or r-star-based frameworks.