Are Recessions Deflationary?

John Maudlin writes,

``My main concern, as readers know, is that we may have a weak economy in the latter half of the year and then introduce a large tax increase, which my reading of the economic studies on tax increases suggests will throw us into recession. Recessions are by definition deflationary." (bold emphasis added)

How true is the last statement?

If we measure inflation based on changes in consumer prices (annual change), then since 1970 when our monetary system shifted to a US dollar standard, out of the seven recessions, only the 2008 episode manifested a short bout of deflation.

In addition, his preferred measure of monetary aggregates, the MZM have practically shown little correlation in the annual rate of change in MZM and previous recessions. There had been two instances where recessions had been followed by higher MZMs and there had also been two instances where falling MZM succeeded recessions.

Besides it is misplaced to think that falling asset prices automatically equates to deflation, that's because money and wealth are two different things.

As Robert Murphy explains, (all bold highlights mine)

``In general, when investors reduce their demand for risky assets and flee to safe assets (such as cash), this will depress the market value of the risky assets. However, widespread selling of stocks by itself can't increase the total quantity of money.

``In the real world, things are complicated by the fact that our banking system uses fractional reserves. In this case, people really can influence the total quantity of money, based on their allocation of wealth. Specifically, if people withdraw their funds from banks in order to hold physical currency, then the banks must contract their outstanding loans because of legal-reserve requirements. If we are using a monetary aggregate such as M1, which counts checking account balances as part of the money stock, then an increased demand to hold physical currency can shrink "the money supply."

``Similarly, there are also complications if we take "money" to be one of the broader aggregates, such as M2 or M3, which include deposits in money-market accounts. In this case, if people transfer their wealth from a money-market account into a straight checking account or physical currency, this too can affect "the money supply."

``Notwithstanding these complications, the simple economy in this article is a good starting point to clarify our thinking. Money and wealth are distinct, and we should not assume that a fall in the stock indices necessarily means that "that money" has now been transferred someplace else."