Chronicles of a Deflation Unforetold

74 Pages Posted: 5 Dec 2006

Date Written: November 2006

Abstract

Suppose the nominal money supply could be cut literally overnight by, say, 20%. What would happen to prices, wages, output? The answer can be found in 1720s France, where just such an experiment was carried out, repeatedly. Prices adjusted instantaneously and fully on one market only, that for foreign exchange. Prices on other markets (such as commodities) as well as prices of manufactured goods and industrial wages fell slowly, over many months, and not by the full amount of the nominal reduction. Coincidentally or not, the industrial sector (as represented by manufacturing of woolen cloths) experienced a contraction of 30%. When the government changed course and increased the nominal money supply overnight by 20%, prices responded much more, and the woolen industry rebounded.

Keywords: monetary policy, price and wage rigidities, deflation, recession

JEL Classification: JEL E31, N13

Suggested Citation

Velde, Francois R., Chronicles of a Deflation Unforetold (November 2006). Federal Reserve Bank of Chicago Research Paper Series, Available at SSRN: https://ssrn.com/abstract=949177 or http://dx.doi.org/10.2139/ssrn.949177

Francois R. Velde (Contact Author)

Federal Reserve Bank of Chicago ( email )

230 South LaSalle Street
Economic Research
Chicago, IL 60604-1413
United States
(312) 322-2526 (Phone)
(312) 322-2357 (Fax)

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