There is a common belief among keynesians that a situation of a falling prices will result in a recession, that is, the business cycle is related to the fluctuations in prices. The periods running from 1873 to 1879 and 1879 to 1896 show a huge increase in GNP per capita, see Rothbard (2002) "A History of Money and Banking in the United States" (see pages 360-361, 400-403, 154-155, 159-161, 164). He explains that deflation causes unemployment when wages are held constant by labor unions. See also Selgin's book "Less Than Zero" (pages 49-53).
Was economic growth more rapid during the earlier period of declining prices or during the later period of rising prices? Unfortunately, the readily available figures do not yield a simple, clear-cut answer. Kuznets' aggregate net national product in constant prices rises at the rate of 3.7 per cent per year from 1879 to 1897, and at the rate of 3.2 per cent from 1897 to 1914. This implies a rise in per capita net national product of 1.5 per cent a year for the earlier period, of 1.4 per cent for the later. However, the results of such a calculation are extraordinarily sensitive to the choice of dates: the use of 1880, 1896, and 1913, instead of 1879, 1897, and 1914, gives a rise in aggregate net national product of 2.6 per cent per year from 1880 to 1896 and of 4.4 per cent from 1896 to 1913. Inspection of the graph of net national product (see Chart 8, below) suggests little significant change in the rate of growth over the period as a whole, but rather a sharp retardation from something like 1892 to 1896 and then a sharp acceleration from 1896 to 1901, which just about made up for lost time. If this be right, generally declining or generally rising prices had little impact on the rate of growth, but the period of great monetary uncertainty in the early nineties produced sharp deviations from the longer-term trend. This evidence reinforces the tentative conclusion reached in the preceding chapter that the forces making for economic growth over the course of several business cycles are largely independent of the secular trend in prices.
Kuznets' figures for the United States give no clear indication whether output per capita grew more or less rapidly during the generally deflationary period before 1896 than during the generally inflationary period thereafter; the result obtained depends critically on the particular initial and terminal years used for comparison (see Chap. 3 below). According to available estimates of income per head in constant prices for the United Kingdom, the deflationary period was characterized by a definitely higher rate of growth than the later inflationary period.
Perhaps the most interesting feature of the comparison, as in our earlier comparison of the first two periods, is the difference between the behavior of money and real magnitudes during the periods of moderately stable growth. The rate of growth of real income, both total and per capita, was very similar; of prices, highly varied. Wholesale prices declined by 3½ per cent per year in the first period, rose by over 1½ per cent in the second, and declined by nearly 1 per cent per year in the third. Implicit prices declined by 2 per cent in the first period, rose by 2 per cent in the second, and were roughly unchanged in the third. Yet in all three stable-growth periods, total real income grew at a rate close to 3½ per cent per year and real income per capita at a rate between 1.3 and 2.0 per cent per year. These results reinforce our earlier conclusion that there seems to be no necessary relation between the direction of movement of prices over a period covering several business cycles and the corresponding secular rate of growth of real output. Apparently the steadiness of the price movement is far more important than its direction.
Historically, benign deflation has been the far more common type. Surveying the 20th-century experience of 17 countries, including the United States, Atkeson and Kehoe (2004, p. 99) find “many more periods of deflation with reasonable growth than with depression, and many more periods of depression with inflation than with deflation.” Indeed, they conclude “that the only episode in which there is evidence of a link between deflation and depression is the Great Depression (1929-1934).”
[...] There have in fact been other 20th-century instances in which deflation coincided with recession or depression in individual countries over shorter time intervals. In the U.S. this was certainly the case, for example, during the intervals 1919-1921, 1937-1938, 1948-1949 (Bordo and Filardo 2005, pp. 814-19), and, most recently, 2008-2009. It remains true, nonetheless, that taking both 19th and 20th-century experience into account, it is, as Bordo and Filardo (ibid., p. 834) observe, “abundantly clear that deflation need not be associated with recessions, depressions, and other unpleasant conditions.”
Although the classical gold standard made deflation far more common before the Fed‘s establishment than afterwards, episodes of “bad” deflation were actually less common under that regime than they were during the Fed‘s first decades (ibid., p. 823). Benign deflation was the rule: downward price level trends, like that of 1873-1896, mainly reflected strong growth in aggregate supply.
When it comes to rebuild, import and implement existing technologies, there is no uncertainty about the way forward, the point of arrival is known. Investments to accomplish and their relative importance are visible and consensual ... (-my translation-)
My reply is here:
The idea that there is “a common belief among Keynesians that a situation of a falling prices will result in a recession” is simply not true, if by that we mean that academic Keynesian economists think that price deflation always results in recession. On the contrary, any Keynesian with a decent knowledge of economic history knows about the long period of deflation in the Western world from 1873–1896, during which there was in fact real output growth.
A long time ago , I noted that
"It is certainly the case the price deflation was not in general the cause of gold standard depressions. ....
In the 19th century, there was a period of sustained deflation that lasted from 1873 to 1896. The period, however, was not one of continuous economic contraction: there were internal periods of economic growth and contraction (expansions and depressions). The entire period from 1873–1896 was not a “depression” in the accepted sense, but a period where prices showed a general trend towards deflation .... it must be admitted that the idea that deflation only occurs during depressions or recessions is a myth."
"As pointed out before, across the whole OECD, 1946-1973 won out as the better period in terms of per capita GDP growth"
"The US was not invaded or damaged during the war in the way the European economics were. Thus there was no “war reconstruction” in the US as there was in Europe. Instead, what occurred was the reconversion of the US economy from its wartime command structure to a peacetime consumer economy. That was certainly accomplished by 1950. So even if we were to subtract the 1946–1949 period, it is obvious that a comparison of 1950–1973 with an equivalent period in the late 19th century (say, 1873–1896) should be perfectly justifiable."
"The entire period from 1873–1896 was not a “depression” in the accepted sense, but a period where prices showed a general trend towards deflation .... it must be admitted that the idea that deflation only occurs during depressions or recessions is a myth."
"It is quite likely the economy in both 1870s and 1890s experienced some degree of debt deflation, so that the deflation was the cause of economic malaise."
There are no contradictions between passages you cite. Nor is there any "shift" involved.
The entire 1873-1896 period was not a depression: there were several business cycles. Real GNP at the ned was highly than at the beginning. Nevertheless, the 1873-1879 period and 1893-1898 period saw rising unemployment, some years of recession, and as I have said, probably a debt deflationary drag on the economy. The 1880s, by contrast, seemed to be a period with falling unemployment and boom. Davis even finds a manufacturing recession lasting nearly 3 years from 1873-1875.
And whoever said that unemployment must track deflation exactly or closely?? What on earth makes you think Keynesians argue that deflation rates will cause unemployment at the same rate?
<i>"As far as I know, keynesians believe that deflation would drive up unemployment. Deflation depresses business. Where am I wrong ?"</I>
You're wrong, as I have said, if you think Keynesians argue deflation always causes recessions or can never accompany real output growth.
Delfation in certain circumstances will cause economic problems: but not all the time.
E.g., deflation caused by money supply collapse (even Roger Garrison agrees here). Deflation in an environment of high private debt causing debt deflationary depression .
There is a nuance to the argument proposed here that escapes you.
"And deflation hurts business only when nominal wages are sticky."
False. Debts are fixed in nominal terms and, when deflation causes wage and price falls, debtors face a greater burden in repaying debt. It is likely many private households and business will suffer severe debt servicing problem or bankrupcy.
Many debtors will go bankrupt taking creditors/financial institutions with them. As banks fail, more people lose savings and spending power. You have a debt deflationary depression as in America 1929-1933 or Australia 1892-1895.
You wrote : "Real GNP at the ned was highly than at the beginning"