Are Deflation and Depression Correlated?
In a 2004 study titled “Deflation and Depression: Is There and Empirical Link?,” Atkeson and Kehoe investigate the relationship between deflation and depression. Their conclusion after examining 17 countries over a period of 100 years is no, there is not a strong link.
In the Great Depression, they find a coefficient of .40 (with a standard error of .28) for a regression of the inflation rate on output growth. In other words, for a 1% decrease in inflation, there was an average .4% decrease in output. However, this result is not statistically significant.
Outside the Great Depression, they find a coefficient of .04(.03). This is neither statistically nor economically significant.
Overall, they find a coefficient of .08(.03). This is statistically significant but not economically significant.
Salerno argues here that it’s a good thing raw data was used in the study. He states:
From the Austrian standpoint, it is precisely the virtue of the Atkeson-Kehoe study that it uses raw data that have not been subjected to arbitrary statistical manipulations. For it is unaveraged, unsmoothed, unadjusted data that are the direct and immediate outcome of unique and non-repeatable human choices in the marketplace. As such, these data are the most meaningful in applied theoretical analysis and for the interpretation of economic history.
As Murray Rothbard often emphasized: “Austrians realize that empirical reality is unique, particularly raw statistical data. Let that data be massaged, averaged, seasonals taken out, etc. and then the data necessarily falsify reality.”
Rothbard objected even to the seemingly innocuous practice of seasonally adjusting the data: “In our view the further one gets from the raw data the further one goes from reality, and therefore the more erroneous any concentration upon that figure. Seasonal adjustments in data are not as harmless as they seem, for seasonal patterns, even for such products as fruits and vegetables, are not set in concrete. Seasonal patterns change, and they change in unpredictable ways, and hence seasonal adjustments are likely to add distortions to the data.”[
Of course, there is an argument to be made for using control variables, even from an Austrian point of view. That said, it’s hard to conclude anything from this study other than that a relationship between deflation and depression is not very clear and that we should be skeptical of (empirical) theories based on this type of connection without any further proof.
There are several other studies on this topic, so I plan on looking at them to find out what sort of results they’ve gotten if I have time.