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

Bryan Cutsinger is a monetary historian and an assistant professor of economics at Florida Atlantic University. Bryan returns to the show to discuss how we think about deflation, the history of growth driven deflation, the connection between the postbellum period and today, the potential of rapid productivity growth from AI, and much more. 

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This episode was recorded on September 29rd, 2025

Note: While transcripts are lightly edited, they are not rigorously proofed for accuracy. If you notice an error, please reach out to [email protected]. 

David Beckworth: Welcome to Macro Musings, where each week we pull back the curtain and take a closer look at the most important macroeconomic issues of the past, present, and future. I am your host, David Beckworth, a senior research fellow with the Mercatus Center at George Mason University, and I’m glad you decided to join us.

Our guest today is Bryan Cutsinger. Bryan is a monetary historian and an economist from Florida Atlantic University. He is also a returning guest to the show. Bryan joins us today to discuss his latest work on growth driven deflation in the late 19^th century and its implications for policy makers today, as we head into a potentially growth driven environment created by AI. Bryan welcome back to the program. 

Bryan Cutsinger: David, so good to be with you. 

Beckworth: It’s a real treat to get you back on the program. I really encourage listeners to go back and check out the previous twoprograms with Bryan. The first one, he joined me and talked about a paper where he looked at the public financing of the US Civil War. Specifically, the Confederacy. Ironically, they actually did not maximize the seigniorage flows they could have from their printing money, financing of the war effort. It’s an interesting question historians have looked at. Why didn’t they try to maximize it? What Bryan argued and showed is that there were different parts of the Confederacy that had different goals and interests, and so they didn’t get all the financing that they could have, and maybe we can thank them for that. 

The second time he came in more recently, he talked about the French Revolution and the hyperinflation. This was the first major hyperinflation in Western society. It was Bryan and his co-author, Louis Rouanet. Super fascinating conversation on an important period that really has shaped a lot of thought and questions. A lot of thinkers have looked back to this period. In fact, Bryan, while I was reading, preparing for the show, that even people in the Confederacy look back at the French Revolution and the hyperinflation surrounding it, they tried to draw lessons from it. Apparently, they did not learn their lessons because they didn’t maximize all the revenue as we talked about earlier. 

I just want to tie this into one other previous guest I had on. This was George Hall. Listeners will know, he’s been onseveraltimes, but he has a series of super fascinating papers with Tom Sargent. They look at how does one finance big expenditures, wartime expenditures. He compares France, the period that you cover, leading up to the French Revolution, with the UK. He shows how in the UK, they would run these big wartime expenditures, but then they would run primary surpluses. They would pay it off, kind of a Barro model of public finance. The French wouldn’t do that. What’s fascinating is what they point out in this paper is that we in the US are a lot more like the French now than the British Empire.

Yes, we run the big expenditures during World War I, World War II, but more recently, like COVID, if you consider that a war, a public health war, we have not been running primary surpluses. We’re not France, to be very clear. We’re not headed to hyperinflation, but we’re doing all the things that France did leading up to it. That should be a warning sign. Is that fair?

Cutsinger: Yes. I think that time period in particular is very interesting because England is able to tax-smooth, which is the basic idea here that if you have a large increase in demand for public spending, you don’t necessarily want to rely all on, certainly, printing money because the deadweight losses from massive amounts of inflation are quite large. Then, of course, raising taxes substantially in the middle of a war can reduce your economy’s productive capacity.

The basic idea here is, can you borrow to essentially tax-smooth rather than having to have very high tax rates? I think absolutely, if you look at that period, England obviously is committed to then running primary surpluses after the war is over and, as a result, is able to fund the war more effectively, whereas France did not have that option for a variety of reasons. One of them being, of course, that they are running quite a bit of inflation, which doesn’t necessarily make your bondholders particularly keen on loaning you money insofar as those bonds are denominated in the currency that’s being hyperinflated.

Beckworth: Yes, super interesting history. You tell us in the previous time you’re on, how this starts off, and what was going to be a currency that was backed by land turns into fiat, which leads to inflation, hyperinflation. If you take the story to its end, you get Napoleon and the emergence of the central bank of France. It’s a really interesting story. Again, I encourage listeners to go back and check it out.

Rethinking Deflation

The reason you’re here, Bryan, is not to retell all that, but to look at a new paper you have written, a super fascinating paper as well. This one is titled, “Rethinking Deflation and Its Effects: A Cross-Country Analysis of Supply-Driven Deflation.” Why don’t you maybe give us the executive summary of what you’re trying to do in this paper?

Cutsinger: Sure, so the basic idea here is that when you think about the question of how should central banks respond to supply shocks, the conventional wisdom, I think, is that at least in the case of a negative supply shock, we want central banks to look through them. Let the price level rise temporarily in response to a supply shock, and then it will come back down. It’s weird in that there’s an asymmetry here, which is that I don’t know a whole lot of people that, aside from, say, yourself and George Selgin and Scott Sumner and other market monetarists who say, “Yes, but do that symmetrically.”

If you have a positive supply shock, the central bank should look through the negative effect on the price level, that is, deflation. What we want to do is we want to say, “Look, there’s been a number of papers that have shown, both with some correlations and to some more sophisticated econometrics, that the link between deflation and poor economic performance historically is not very strong,” leaving aside, of course, the Great Depression, which is a very important episode.

We don’t look so much at the effect on output. Instead, what we pick up are two themes that, if you look at the literature on why deflation is bad, you will see, one, is there’s this concern about falling nominal interest rates? If nominal interest rates hit their effective lower bound, then it might be the case that monetary policy ends up being ineffective. We get the standard liquidity trap type of argument.

The other problem that you’ve seen in the literature with deflation is you get financial disintermediation. You have falling collateral values. People start defaulting on their loan. Bank capital starts falling, then the banks start failing. Then, other banks start calling in their loans. This leads to this spiral. What we wanted to look at is those two issues in particular. We wanted to say, “Okay, is there any evidence historically that when we had supply-driven deflation that we saw short-term nominal interest rates fall to their effective lower bounds or fall at all? Did we see a change or decrease, more specifically, in financial intermediation?”

That’s what we look at specifically in the paper is, and we can get into this, about how we try to identify supply versus demand-driven deflation. The question we’re really asking is, does supply-driven deflation appear to cause nominal interest rates to fall or financial intermediation to fall? These are two of the negative consequences that are often associated with the conventional view of deflation.

Beckworth: Yes. If you were to ask probably most macroeconomists, even any economist, what do they think of deflation, what’s the first thing they think of when you have deflation, they probably will invoke the 1930s. They probably will invoke periods of unemployment, of falling bank intermediation, financial system weakening. The point you’re making is, “Not so fast.” There could be another form of that.

You actually mentioned in your paper, and I’m glad you did this, a speech by Ben Bernanke. He was at the Board of Governors at the time. The speech was a 2002 speech titled, “Deflation: Making Sure ‘It’ Doesn’t Happen Here.” I think it’s great for two reasons, because I think it speaks both to how to interpret the tea leaves of deflation, but secondly, a point that he makes. For those who don’t remember, 2002, 2004, we had a productivity surge. It took off, and that created these disinflationary pressures.

If you go back and read the Fed minutes, the Fed statements from that period, transcripts, you’ll see they were really worried about deflation emerging. Now, understandably, the context they were thinking about was Japan, late 1990s. They had the bad type of deflation, weak demand. I would argue, we were actually seeing disinflationary pressures and, ultimately, deflation, should it emerge, coming from productivity gains during this period.

I think they were misreading the symptoms. Nonetheless, it’s an important period. Bernanke is like, “Hey, how do we guarantee that we don’t have,” in his mind, “a bad type of deflation, the demand-driven deflation?” His whole speech is about this, right? He completely overlooks this other possibility, except footnote one, which you cite in your paper. Let me just read footnote one and get your response to this. This is what he says in footnote one, 2002 speech titled, “Deflation: Making Sure ‘It’ Doesn’t Happen Here.” Here’s what he says:

Conceivably, deflation could also be caused by a sudden large expansion in aggregate supply arising, for example, from rapid gains in productivity and broadly declining cost. I don’t know of any unambiguous example of a supply-side deflation, although China in recent years is a possible case. Note that a supply-side deflation would be associated with an economic boom rather than a recession. 

What are your thoughts about that comment?

Cutsinger: Well, I think that exactly gets to the point that we’re trying to make in the paper and, specifically, if you think about interest rates and financial intermediation. Let’s start with interest rates. We’ve made these jokes, I think, on my past appearances before that I used to have this sign on my door that says, “Give a man a fish, he eats for a day. You teach the man the Fisher effect, and he’ll never confuse low interest rates with easy money,” or something along those lines.

The point is, when you think about something like supply-driven deflation, the key to keep in mind, is that the neutral rate is we tend to think of it as being somewhat pro-cyclical. If there’s a sudden rise in total factor productivity that would drive inflation expectations lower, or even potentially inflation expectations negative if you have deflation, you have a corresponding rise in the real rate. The actual effect on the nominal rate is ambiguous because, yes, inflation expectations could be falling, but the real rate could be rising.

If those things offset one-to-one, then, actually, there really should not be much of an effect on nominal interest rates from supply-driven deflation at all. In terms of financial intermediation, now, I should say in our paper, the way that we measure financial intermediation is by looking at the money multiplier. We do this primarily because we have consistent data across all countries from this period of broad money to outside money.

The insight, actually, if I can give you and your co-author, Josh Hendrickson, a compliment, came from a paper from you guys, I think, called “Great Spending Crashes.” The idea in your paper is that the money multiplier is more than just maybe an accounting relationship, but instead reflects the relative strength of demand for inside money, bank-issued money, and outside money, which, under a gold standard, would have been gold. It very well could be the case that when there’s a positive productivity shock that the demand for inside and outside money increase by roughly the same amount. In which case, we wouldn’t really expect to see much of an effect on financial intermediation, either in the case of a positive productivity shock. 

Later on in the paper, that’s the other thing we do, is we want to say, “Look, Bernanke makes this claim in the 2002 speech, where he’s basically saying, ‘Look, this is a theoretical possibility,’ but it’s not obvious how empirically meaningful is this theoretical curiosity.” One of the things that we find is that, actually, positive supply shocks account for a nontrivial amount of variation in both real output and the price level under the classical gold standard period, which is the sample time that we’re looking at.

Beckworth: Yes, so we need to be careful when thinking through periods of rapid productivity growth driven, maybe by AI in the future, but in this period is industrialization. We’re looking at a period, and you’ll get to this, but we’re looking at late 1800s, when there was rapid economic growth. We want to transition into this. I’ll just mention now before we get to it that we will come back and maybe look a little closer at the postbellum period of the US as a specific case of this, but you’ve got a cross-sample one. Maybe walk us through what is your data. What did you measure? How did you go about estimating these relationships?

Cutsinger: Sure. What we did here is we are looking at 12 countries on the gold standard. These would have been all core countries, not necessarily periphery countries. This is going to include Canada, United States, England, Germany, and several other European countries. The data is actually pretty straightforward. What we have is essentially real GDP for these countries, some measure of the price level, short-term interest rate data, and then a measure of financial intermediation, which, as I said, is not necessarily the standard measure of financial intermediation for people who are doing work on, let’s say, contemporary finance, but does work for us historically, or at least we try to make the case that it should work.

What we’re going to do is something very simple. We’re going to take the textbook undergraduate aggregate demand-aggregate supply model and say, “Look, this model has very clear predictions about what effect a demand shock or a supply shock should have on real output and the price level. Now, we’re going to use a sign-restricted VAR, but we’re not going to use long-run restrictions, which, with historical data, can sometimes get you some bizarre results.

Instead, what we do is we’re using a more recent approach that’s been applied to—actually, since you mentioned England earlier—was applied to England in a recent paper in Explorations in Economic History, and has also been applied to the modern US time period. What we’re going to do is we’re just going to impose impact restrictions. All we’re going to say here is that on impact, a positive supply shock cannot cause output to fall. That seems a pretty reasonable assumption. That’s the definition of a positive supply shock.

It cannot cause the price level to rise on impact. We don’t impose any long-run restrictions after that. Whatever happens in the long run, we are not restricting. It’s only on impact. Then in the case of a demand shock, all we’re saying is that in the case of a positive demand shock, the price level cannot fall, and output cannot fall on impact. Again, we don’t restrict what can happen in the long run. The other two variables that we include in that VAR are going to be short-term nominal interest rates and financial intermediation, which, again, we proxy using the money multiplier.

We pool all these countries together. There is a bit of an assumption here that these countries were similar enough that it’s justifiable to pool them together. Although in the appendix of the paper, we do this individually, and we see the same pattern. We’re going to pool all these countries together, and we’re going to say, “Look, we’ll leave the effect on short-term nominal interest rates and financial intermediation unrestricted, and we’re just going to look at how these two variables respond to what we call positive supply and positive demand shocks.”

Beckworth: Yes, and before we get to your results, I just want to look at a table that you provide, the summary statistics. This just, right off the bat, should be very suggestive. Those are just means and standard deviations, but it’s very telling, I think. Again, you’re looking at a period from 1880 to 1900. I’ll list the countries: Australia, Belgium, Canada, Switzerland, Germany, Denmark, UK, Italy, Netherlands, Norway, Sweden, United States.

The mean growth rate over that 20-year period is 2.5%. It was rapid growth. Some of them got as high as 4%, but the mean was 2.5%. The average growth of the price level was about -0-====.19% or -0.2%. It was a gradual, mild decline in the price level with some fairly robust growth. The average interest rate was 3.8%. On average, you had positive financial intermediation growth as well, close to 2%.

Just looking at the overall picture, the secular trends, the steady state of sorts, you see a world where there’s economic growth. There’s mild deflation. There’s financial intermediation. There’s no zero-lower-bound problem, so the world did not end. Now, there’s wars and other things happening that do cause problems. Not every country had deflation at the same rate at the same time, but this is the bigger point, I think.

I think that by itself is very telling. For those who don’t know, I know most of the listeners probably do know, but a VAR is a vector autoregression. It’s a way of looking at common patterns in the data, time-series patterns. What Bryan is doing is he’s looking at the typical shock in the data. What is a typical outcome? You have a typical supply shock, what happens? You have a typical demand shock, what happens? Maybe walk us through those results.

Cutsinger: On the note of the summary statistics, you actually bring up a really good point that I would like to highlight for those of you who would like to go look at the paper. Another thing that jumps out at me right off the bat is just looking at the scatter plots of real GDP, short-term nominal interest rates, financial intermediation, and whether or not you have inflation and deflation.

There’s an older paper from Atkeson and Kehoe in the American Economic Review in 2004 that they don’t look at nominal interest rates and financial intermediation. They’re just looking at output and deflation. Again, I was really struck by their paper. Then there was a few other papers, more recently by Claudio Borio, where they did scatter plots like this. Right off the bat, you look at these, and you’re like, “This is weird. There’s not an obvious connection in the data.”

Now, of course, that is not dispositive by any means. You would expect to see if this was something pretty negative, you would expect to see it in the data. You don’t immediately see it. To get to your question about, what do we see then in the vector autoregression? Essentially, what the vector autoregression allows us to do is to say, “How did these variables evolve over a 10-year period following a positive productivity shock or a negative demand shock, because we look at both?”

What do we see? Unsurprisingly, in the case of a positive productivity shock, we see real output growth rise. Now, again, we don’t impose that it has to rise in the long run. We only say that in order for it to be a supply shock, it has to rise, or, actually, more specifically, it cannot fall on impact. Unsurprisingly, we see positive productivity shocks increase real GDP growth over that entire 10-year time horizon. That seems pretty straightforward.

Now, on impact, we see the price level initially fall. Then, over time, it gradually goes back up to its long-run trend. Those of you who are familiar with how a gold standard works, this is not altogether surprising because the price level would revert back to its average because the gold supply essentially increases when there’s an increase in demand for monetary gold. A gold standard is going to stabilize the price level, at least on a longer time horizon.

On impact, we have some deflation, and then the price level returns back up to trend. Now, critically, though, what we’re curious about is short-term interest rates and financial intermediation. Here, what we see is that there’s some evidence of a really small—and when I say “small,” because you have to keep in mind, we’re already talking about interest rates, right? We’re talking about a 5% decrease of 5%, so very small decrease in short-term nominal interest rates, and then they immediately basically jump right back up to their long-term trend.

Nothing like a liquidity trap or effective lower bound or anything like that. Then, when it comes to financial intermediation, the confidence bands are pretty wide. If you just look at the median response, at least on impact, it’s basically zero. Over time, there’s a slight increase in financial intermediation. Again, the way to interpret that would be that there was an increase in demand for bank-issued money relative to gold, which is the opposite of what you would expect if there’s financial disintermediation.

If people lack confidence in the banking system, they’re not going to be willing to hold redeemable bank-issued money. They’re going to opt to try to get rid of that money and hold gold or silver instead. That’s the major headline result here is that despite the major claims to the contrary, we don’t see any obvious evidence of supply-driven deflation driving nominal interest rates and financial intermediation lower. If anything, it seems to basically be close to zero effect on short-term nominal interest rates and a slightly positive effect on financial intermediation.

Beckworth: That’s what you would expect from the interest rate response. Basically, zero response. In fact, your confidence intervals, they’re both above zero, below zero. Basically, there’s nothing significant in terms of the interest rate response. As you mentioned earlier, that’s what you might expect. You might have inflation going down, which you do. Your price level shock shows this. The flip side is, implicitly, you have that real rate going up, so it would be a wash. That’s why there’s nothing significant happening to this. That’s really amazing. Now, your demand shock gives you everything you would expect, right?

Cutsinger: That’s exactly right. The next thing we want to look at, and, actually, we got this idea from a paper that you wrote that your listeners should go read on the postbellum deflation in the United States, which is a critic of our view could say, “Well, Bryan, pretty interesting historical result you have here, but perhaps nominal rigidities were not as much of a problem at the end of the 19th century as they are today. It doesn’t matter the source of the shock. It could have been a demand shock. It could have been a supply shock. It doesn’t matter. Deflation wouldn’t have been a problem if prices were flexible enough that we don’t have a movement along that short-run aggregate supply curve.” 

That’s what we want to go look at next to say, “All right, is there any evidence of nominal rigidities?” Now, we don’t impose a source of that. We’re just saying, “Look, do demand shocks have real effects on the economy?” That’s exactly what we find. What we look at here are negative aggregate demand shocks. We find that a negative aggregate demand shock does, in fact, reduce output. The effect is pretty long-lasting, which we want to reiterate in the paper, we think that demand-driven deflation is very bad, right? It’s not as if we’re saying, “Oh, deflation all the time is great.” It’s like, “No, demand-driven deflation is bad. Central banks should pursue policies that prevent that from happening.”

We do see a decrease in output. Of course, we see a decrease in the price level. That’s what we would expect. Here, the effect on short-term nominal interest rates is actually negative, more negative, I should say, than in the case of the supply shock, and it lasts much longer. In other words, you don’t see that return back up to a long-run trend on short-term nominal interest rates following what we call an aggregate demand shock.

Again, with financial intermediation, we don’t see a gradual increase. The median response is actually negative on impact, and continues to be negative throughout a 10-year time horizon after the fact. Again, we agree that demand-driven deflation has the effects that the conventional view of deflation associates with it. In the case of supply-driven deflation, it’s not so obvious that the problems that people point to are actually problems.

Beckworth: Your demand shocks that you estimate, the data shows you exactly what the textbook description would suggest, what most people would suggest if you went and asked typical macroeconomists. It’s just surprising for many what happens on the supply shock. Again, this is over years. This isn’t just one month, two months. This is a significant time period. This is useful, right? It tells us that, one, you can have supply-driven deflation.

Again, it’s usually mild. We look at the summary statistics. We never had the type of deflation you had during the Great Depression, where the price level fell 30%. We’re talking maybe 1% at most or less than that. You can have this benign scenario. Deflation is accommodated by all these rapid gains. People are better off overall. It’s just so foreign to us, Bryan. That’s the problem. It’s so foreign to us. We may need to come to terms with it. We’ll come back to this point later as we talk about AI.

Now, you did one more thing in the paper before we leave your paper. You showed supply-driven deflation is possible, and it occurred. You showed that demand-driven deflation also occurs, and it was meaningful in the late 1800s. There were nominal rigidities that caused real losses. The question could be, well, how important? We can all do regressions with a low r-squared, right? Is it statistically significant? Is it economically significant? Was there a meaningful amount of supply-driven deflation during this period?

Cutsinger: That’s a great question. Again, what we do here is we say how much of supply shocks can account for the observed variation in output, and observed variation in the price level, observed variation in interest rates, and observed variation in financial intermediation. Here, what we find is that the supply shocks account for 20% of the observed fluctuation output over 10-year horizons. Demand shocks account for 17% or, basically, almost 18%.

Both of these are, of course, meaningful, which is exactly what you would expect, that economies are buffeted by both supply and demand shocks, and they can have real effects. Same thing on prices. That 15% of the variation in prices can be explained by positive supply shocks. About 16% of the fluctuations in short-term nominal interest rates can be accounted for by positive supply shocks. About 14% of fluctuations in financial intermediation can be accounted for by positive supply shocks.

Again, in that particular part of the paper, we go back to that 2002 speech by Ben Bernanke, where he makes this point about how, look, this is a theoretical curiosity. Not obvious that there’s any empirical counterpart to this. If we look at these countries under the gold standard, I would say that 20% of the output variation and 15% of the price level variation being explained by positive productivity shocks is far from trivial.

Beckworth: Yes, and I’m glad you went back to Ben Bernanke. I was at the US Department of Treasury when he made that speech, and I actually emailed him. He was just a governor back then before he became chair. He actually responded to my email. I was shocked. He was a rock star to us back then, and he was a governor. In fact, I recall one story where he came to Treasury for a meeting. I made a point to be the guy to meet him at the front door, walk him to his meeting. I emailed him. I said, “Look, couldn’t we be in the midst of supply-driven deflation?” Again, during this period, let me just recap, 2002, 2004, go look at productivity growth. It was rapid. It didn’t last long, only two years. Many attribute it to the delayed effect of all the fiber optic cables that were laid across during the stock market boom, the asset boom of the late ’90s. It was a bubble, but the fruition of it finally coming to bear in the data. 

He conceded to me in the email. In fact, I’ve saved this email. He conceded, “Yes, it could be, but I just don’t know. We don’t know.” It would be interesting at some point, Bryan. You and your co-author go back. Maybe look at some more recent data and see how much of, say, that period was due to the good type of deflationary pressures versus weakening demand.

Again, the way I read it, I see it as more benign. I want to just flesh this out because there’s still maybe people out there saying, “Oh, Bryan, you’re looking at averages across countries and stuff.” I would say, no, these are good results. Just to make this concrete, you mentioned a paper that I did. Now, I’m going to bring this up just to make this as concrete as possible before we go to policy implications.

The paper I wrote is a 2007 paper titled “The Postbellum Deflation and Its Lessons for Today.” I was motivated in part because of this very quote, where Bernanke says, “I don’t know of any real-world example.” Someone actually had asked him at a different time, “What about the late 1800s?” He goes, “That’s a mixed bag.” My purpose in this paper was twofold. One, I went out and I collected as much data as I could about this period. I go from 1866, really the end of the Civil War, all the way up to 1897. This was a 30-year period secular deflation.

I collected as much data. I went and looked at all the different measures of output. I got several financial intermediation measures, inflation measures. I collected the data, one, because Bernanke says it wasn’t clear. I wanted to say, “Let’s make this as clear as possible.” Secondly, as you mentioned and alluded to, I did a vector autoregression testing whether the demand shocks during this period were trivial, or did they actually matter?

Just a quick summary here for those who were listening. Between 1866 and 1897, so this 30-year period, we had deflation that averaged just a little over 2% a year. Just imagine it. Every year, we get deflation. It becomes normal. 30-year period of deflation. Over that same period, we had almost 4% growth. It’s 3.7% to be precise, but almost 4% growth, about 2% deflation.

Now, there was some variation early on, right after the Civil War, that the government was trying to get out of debt, all the debt issues. It ran deflation a little more rapidly. From 1866 to 1879, there was 4% deflation, but there was still 4% growth. Then from 1880 to 1897, it’s closer to the numbers that Bryan has, 0.8% deflation and 3.4% growth. Bottom line is this. There was rapid growth, and there was persistent deflation, and the world did not end.

I look at things in terms of financial intermediation, loan-to-GDP, and other measures like that, deposits-to-currency ratios. Overall trend is upward. Yes, there were some disruptions. The 1870s, there’s a crisis, early 1890s. There’s all this evidence that this was actually a robust period. Productivity growth was robust. You never had zero-lower-bound problems. Interest rates were 4% to 5% over this period.

Now, just a few comments. I know there’s skeptics out there. What about the agrarian unrest, Bryan? You know they’re going to say this. What about the famous “Cross of Gold” speech by William Jennings Bryan? That’s a fair comment. I’d like to hear maybe what your take. My take would be, we were in the midst of a structural change. Some of this protest was resulting from that fact that farmers were no longer the dominant economic sector. Higher inflation would not have changed their outcome. What are your thoughts about the agrarian protests in relation to monetary outcomes?

Cutsinger: We’ve gotten this comment before about this. I think it’s definitely point taken. Again, I think it’s very difficult sometimes when it’s difficult to look at what people say they’re angry about and try to tightly map that onto what’s going on with policy. It’s not obvious to me anyway that what voters are often angry about reflects a sophisticated understanding of what’s going on economically.

It could just be that William Jennings Bryan was able to identify a particular hobby horse that resonated with a group that was on the losing side of a structural change, as you mentioned, and that was the rallying cry. Again, not obvious to me that having positive inflation during that time period would have brought about better outcomes for anybody, farmers included. That’s my general take.

People, voters, whatever, they get angry about various things. It’s not at all obvious to me that that tells us that that period was, in fact, overall, very bad. Again, even if the deflation was bad for the farmers, it’s, again, not obvious that trying to offset that through whatever, you didn’t really have a central bank. The Treasury, of course, could have engaged in some sort of quasi open market operations, but you didn’t have a central bank in the US anyway that could have offset something like that.

It’s not at all obvious that trying to offset supply-driven deflation is a free lunch. The other criticism that we’ll sometimes hear is saying, “Okay, fine, interesting, but why not just price-level target?” Whenever there’s a positive supply shock, the central bank should lower its policy rate, boost aggregate demand to keep the price level if you wanted to do a price-level target as opposed to an inflation target.

Here, again, there’s research, you’ve published research on this, too, showing that that actually can create an unsustainable credit boom that then subsequently leads to financial distress later on. We cite some other papers in our paper here, too, which is that price-level stabilization is not a free lunch. Even if there were some groups like farmers during the postbellum period that were worse off because of sustained productivity-driven deflation, it’s not clear that even if you had a central bank that could have offset that that you would want to from a welfare standpoint.

Beckworth: From maybe a technical perspective, we can say the terms of trade for farmers were getting worse. Maybe it looked like higher prices would have helped them, but there’s a lot of other things that they consume that would also probably have been more expensive as well. Overall, I think the evidence is pretty clear from that period. Overall, Americans were better off because of the industrialization. The deflation at the time was a byproduct of that.

One other comment on this period, and I’ve had this said many times to me, folks will say, “Oh, but if you go look at the NBER business cycles, you’ll see the longest recession on record is from 1873 to 1879.” What’s interesting is there’s been a lot of research that says that is bunk. That is largely a relic of how the NBER originally dated that. There’s been more recent research. Christina Romer had better measures of GDP. Since her, a guy named, I think it was Joseph Davis. He had several NBER papers where he went back.

What they all show is that this recession from 1873 to 1875 was one to two years at most, so much smaller. Now, there was something there, and they all say something in the early 1890s was pretty serious. There was a depression. Again, the overall period was one of rapid growth, mild deflation, real wages going up, no zero-lower-bound problem. It just shows, this is a concrete case of where it did happen, and how we could look to it for some insights should we enter into a world like that again.

Now, I think we’ve made the case, Bryan. I think we’ll leave it there. Let listeners go check out the papers and stuff. We’ll provide links to your paper, as well as my postbellum paper. Here’s where I want to take this. We are possibly on the cusp of something similar. I hope we are. I hope we have rapid productivity growth. AI is truly transformative. There are some issues that come with that. There’s been a lot of press on this.

Rapid Productivity Growth from AI

There’s been concerns about structural change. We just talked about farmers. There could be white-collar folks who are losing out. A number of pieces. In fact, let me just go pull a few up here. There was a New York Times piece that was titled, “A ‘White-Collar Bloodbath’ Doesn’t Have to Be Our Fate.” It goes in, “Hey, we can make a choice, how we handle this, how it comes.”

Here’s an article from CBS titled, “As AI Threatens White-Collar Work, More Young Americans Choose Blue-Collar Careers.” At work, someone shared this with me. There’s an organization that’s talking about international AI benefit sharing. How do we make the gains from AI accessible to all people, not just those who are fortunate to be a part of the initial access and gains from it? There are these real problems. 

There’s been solutions thrown out, Bryan. You know this as well as I. Universal basic income, rapid productivity growth. Let’s take some of those gains, tax them. Maybe we set up a sovereign wealth fund for the US. I don’t mean the Bitcoin version. We set up something. We just take those, and we transfer it back to Americans. There’s been talk of baby bonds or baby equity packages. Everyone can participate in it, or maybe privatizing Social Security. People could participate in America, Inc. What would be an implication of your work here? What would be another solution for people to participate widely in these economic gains?

Cutsinger: My own view tends to be somewhat skeptical of a lot of these solutions to the problem. It’s not because I’m heartless. It’s because, oftentimes, I think once you start addressing some of the public choice issues that come into play when it comes to crafting policy that a lot of things that sound like a good idea on the blackboard or the whiteboard, as the case might be, once they hit the real world of politics, they end up not working so great.

My general view is that I think we should make it as easy as possible for people to reallocate themselves to various tasks. Anything that prevents people from easily changing careers, particularly anything surrounding occupational licensing or other types of labor market frictions that are driven primarily by government. I’m not saying all labor market frictions are driven by government policy, but those that are driven by government policy. I think policymakers should be thinking about ways to get those burdens out of the way so that people can go to where the jobs are very easily.

If we want to make that a little bit easier by offering perhaps more generous unemployment benefits or a UBI, we can kick those ideas around. Again, I’m always skeptical with some of these because it’s one thing to talk about, “Oh, this is how an ideal government response to problem X would be,” but we don’t live in an ideal world, and we don’t have an ideal government, and we never will.

Then the question is, what sort of solution are we likely to get with the actual policymakers that we have or that we think we will have in the immediate future? There, the case for a lot of these things becomes a little less clear. My general view is, let’s make it as easy as possible for people to change careers, to go to where those jobs are. To the extent that we have policies in place that prevent that, and those policies don’t really pass a cost-benefit analysis, let’s scrap those.

Now, I recognize that my own suggestion here is also subject to the same public choice critiques that I would have of these other solutions. My own just ideological disposition is typically, “Hey, let’s get these, what are often, in my view, arbitrary barriers that prevent people from switching careers. Let’s get those out of the way so that folks can go to where the jobs are.”

Beckworth: Two comments on that. I like what you’re saying there. One of the biggest barriers today, let alone in the future, of AI, is housing, right? It’s hard to afford housing where the jobs are. Someone loses their job in Michigan, they can move down to Texas. Maybe Texas isn’t the best example now because they do build a lot of housing down there. 

They want to move, say, to San Francisco. That’s a nice city to pick on. The housing supply is very inelastic. They can’t build. There’s regulations. One of the fundamental reasons, I know you know this, our listeners know this, that we have a housing shortage is because in America, housing is one of the primary assets people hold on to. It’s the way they save for retirements, their investments. It’s an investment vehicle. It’s also a consumption good. It’s both. There’s a tension there. You want your asset price to go up in value, but you want consumption to be affordable, and which of those tensions will win?

In the past few decades, it seems like the asset side view of housing has dominated. NIMBY is not in my backyard because I want my home prices to go up in value and all those other good things. If we had a world of rapid economic growth, again, I’m not suggesting this, but like baby bonds, or somehow we have Americans more vested in America, Inc. That might take some of this tension off houses as an asset that we have to preserve at all costs.

My second comment would be this. I think more fundamentally, all of these suggestions are about how to distribute the real gains broadly. Checks to people, equity in America, Inc. I think just let Americans participate through a lower price level. Let the real gains be translated broadly through things getting cheaper and cheaper over time. 

To be clear, I think both of us champion something like a nominal income target. You can preserve and keep stable nominal wages, but those nominal wages could go farther and farther if the price level is gently falling. People would feel better off. You know how everyone’s upset now because everything’s more expensive. Imagine a 30-year run like the postbellum period, where everything got cheaper over time. I think that’s, to me, a way to distribute the real gains. It doesn’t require a whole other level of bureaucracy or public choice issues. Let the market do its magic.

Cutsinger: I agree 100%, and I think that it also just makes things a little bit more intuitive to most people that when the economy is doing better, prices for things should be falling. In fact, I believe you’ve had CarolaBinder on the program before. She’s done work on consumer survey data. The interesting thing there is that it seems that despite all of the comments that you often hear that the public don’t understand nominal income targeting, but they understand inflation targeting, that’s not all obvious from how, let’s say, households think about inflation and poor economic performance. 

In other words, households associate high inflation with slow economic growth. That’s a negative productivity shock as opposed to, let’s say, high inflation and positive growth, which would be a positive demand shock. I think it makes sense, obviously. Let these things pass through to the price level.

I think another reason, and this is more in the case of a negative supply shock than a positive, but I guess it would go both ways. I have a short article at AIER that I wrote last year, and it’s basically a political economy case for nominal income targeting. The argument that I made goes something like this. The public often don’t understand, or it’s very difficult for noneconomists to look at the growth effects of various policies, whether that be tariffs or tax policy, regulatory policy, et cetera.

Instead, the inflation can be something that can be very salient for voters. When you have a central bank that’s inflation targeting and you have, let’s say, policymakers pursue either good, let’s say, pro-growth policy, or perhaps they pursue bad growth policy, if the central bank offsets those by targeting the inflation rate, they, in some sense, are short-circuiting this mechanism that would otherwise get the voters happy about pro-growth policies or angry about bad growth policies.

Beckworth: That’s a great point.

Cutsinger: Now, it seems like right now, the Fed has been saying they want to look through the effect of tariffs. I’ll have more to say on that in just a second. They said they want to look through the effect of tariffs, so they’re going to let those to pass through to the price level, which, of course, in my view, is what they should do.

My point is that if you think the tariffs are a bad idea and you want the voters to get frustrated about them and vote in a way that leads to policy changes, then targeting inflation to prevent that from passing through to the price level, in some sense, short-circuits this process, whereby a democracy can work, where the voters say, “Hey, I’m not happy about this. I’m not quite sure why I’m not happy about it, but prices are higher. I’m going to vote against the people that are responsible for that.”

The same thing would go for positive supply shock. If our policymakers, which I hope they do, adopt a good framework that allows a lot of innovation in AI, by allowing the price level to fall, the voters, again, they’re going to say, “Oh, this is great. I want to reward the people that I deem responsible for this.” I think a downside, actually, a political economy downside to inflation targeting, is that you short-circuit that process whereby the voters can register their approval or disapproval with policies by looking at what’s going on with inflation.

Beckworth: That is a great point. We’ll provide a link to your piece where you make that case. Let’s go back briefly to the point you made earlier about this. If, in fact, the Fed did try to offset rapid productivity gains, again, assuming a wonderful world of AI-driven growth, it actually could create some credit misallocation, some asset bubbles, for lack of a better word. 

This is not just something you and I are talking about, or Austrian. I know Austrians are well-known, or Austrian economists. Larry Christiano and some co-authors had a paper on this at Jackson Hole, I believe 2010. It was sometime in the early 2010s. His point is, if you have a Taylor rule and you expect rapid productivity growth, you’re going to have a pretty wide divergence between the actual overnight rate and the neutral rate. That’s going to create this misallocation in terms of credit.

You can create asset booms and bust cycles if you do try to offset these things. It’s more than just equity and getting the real gains out. It’s also about stabilizing the business cycle. Now, let me ask this question, Bryan. I think we all agree, you and I agree at least, maybe some of our listeners do as well, on how to approach such a world, which we all hope we get, of rapid productivity growth, rapid real gains from AI.

Tolerating Deflation

How could we transition to a framework that allows the Fed to comfortably land and come into a place where it tolerates a little disinflation, maybe even deflation? Right now, I think they would have an allergic reaction to that. What would be a first step, do you think, to getting us to a place where central bankers would be okay with what we’ve been talking about?

Cutsinger: I have two answers here. One, of course, is very self-serving, which is that this is partly why we wrote the paper.

Beckworth: Read the paper.

Cutsinger: Yes, sorry. It’s to try to change people’s perspectives. Now, again, criticism could be that, “Interesting, Bryan, but that’s the gold standard. It doesn’t apply today.” My response to that would be like, “I agree. That is totally true. The problem is that in order for us to tease this out, we have to go to a period where you didn’t have central banks that are actively trying to offset supply-driven inflation or supply-driven deflation.” That’s just not the world that we’ve lived in, basically, post-World War II-ish.

That’s the first thing is let’s just go look at the research here. Of course, our paper is one among many in this space that makes this point just from a slightly different angle. If they don’t want to buy the paper, that’s fine. Then my second view would be, say, okay, most policymakers think in terms of r-star. One of the things that I really learned from you and I learned from George Selgin and I learned from Scott Sumner when I was first getting into this, is that, despite my small government and pro-market proclivities, I often think that the best response is for the government to just get out of the way.

It’s not possible for central banks to do nothing. They can’t. They literally cannot do nothing. If you start thinking in terms of an r-star framework, then the question is, okay, an AI boom presumably drives r-star higher. How should the Fed respond to that? I think when we use these terms like, “Oh, the Fed should look through a supply shock,” that means the Fed is doing nothing. From a policy standpoint, the Fed is not doing nothing if it’s looking through a supply shock.

In the case of a negative supply shock, it should be cutting rates. In the case of a positive supply shock, it should be raising them. That’s the first thing. If you don’t buy the paper, it’s to say, “Okay, if you buy the r-star framework, then the Fed’s job is essentially to adjust its policy rate in response to movements in r-star,” which all the caveats there of it’s difficult to observe, and whatever.

We at least, I think, hopefully agree in principle that a positive total factor productivity shock should drive r-star higher. Thus, the appropriate response from the central bank should be to follow the neutral rate up. In fact, if the central bank does not follow the neutral rate up, then monetary policy is, in essence, too loose. Now, we can argue about, “Okay. Well, how do we actually identify this?”

You’ve written about this, Scott has written about this, of how you would go about implementing a nominal income target. I think if you’re a policymaker and you don’t buy my argument, that’s fine. You don’t buy the paper, that’s fine. Just, again, think in terms of this neutral rate versus policy rate framework. If the neutral rate’s going up, the Fed should be following it up. I think that’s what’s consistent with its mandate. I’m sure people disagree with me about that.

Beckworth: That’s a great point that you bring up. What would happen to interest rates in this world? I’ve had on the show, an individual named Zachary Mazlish, and he’s written a paper with Basil Halperin. They do some scenario playing out. What if you have rapid growth? I’ve asked previous guests this. Just imagine we go to, say, 5% real GDP trend growth, and maybe even higher than that. Let’s just say 5%. That would imply quite significantly higher real rates is what you’re getting to.

Of course, the point they bring up is a different point. What should the US Treasury be doing? If you’re AI bullish, you should probably lock in the rates we have today long-term because, in the future, they’re going to be higher. Of course, in the future, we’ll also have more income base to tax from. Your point’s well taken. R-star should be significantly higher in that world.

Here’s what I might do. I would adopt what you said there. I also think it’s why a nominal income framework would be useful. If we adopted one today, under normal circumstances, let’s say 4% nominal income growth, it builds in roughly 2% real growth. That’s where we think potential real GDP is, 2% inflation target. We get used to that. If we start putting our minds around a 4% nominal income, nominal GDP target, and then let’s say we get these structural shifts.

Now, let’s say real GDP is growing permanently at 4%. Now, if we’re going to stick with that 4% nominal GDP target, we’re going to have 0% inflation. If it goes even faster, we get our mild deflation. I think one thing we could do is to change the thinking from focusing on inflation to focusing on total spending or total incomes, and complement that with focusing on r-star.

Cutsinger: I completely agree. I think the Fed actually missed a good opportunity here with its recent framework review to do something a little bit more drastic. They basically went back to the 2016 framework, which I think is probably an improvement over the version of flexible average inflation targeting that we had. The point here being is that we just got done living through 40-year high inflation.

The point here being is that doing something that was a little bit different than what’s been done before, this is probably our best chance to have done it. Instead, we just went back to the pre-COVID status quo. I think that was a real missed opportunity, unfortunately, by the Fed to do something like a nominal income target, which would address many issues, like how should the Fed respond to AI? How should the Fed respond to tariffs? 

I think the point that Casey and I make in the paper, or an implication of the point we make in the paper, is that the Fed should look through something like tariffs, but it should also look through something like AI. It should take a symmetric approach to both of these things that would be consistent with promoting long-run macroeconomic stability in our view.

Beckworth: Well, Bryan, we are running near the end here, and I want to leave it with you, give you the final word. What are the big takeaways that listeners should take with them, and what should policymakers take with them?

Cutsinger: I want to go back to this US case that you brought up. When you look at the US, and you see that during the postbellum period after the Civil War, we’ve got robust growth and sustained deflation throughout the period, an important point to keep in mind here is that the US banking system was particularly crisis-prone, which is partially why those events that you mentioned occurred.

Nonetheless, the supply-driven deflation really did not seem to be that much of a problem. The point here being is that other countries like Canada, they had much better banking regulation and banking systems than the US. A lot of the issues that the US dealt with during this period really had very little to do with, let’s say, deflation and more to do with the peculiarities of US banking regulation.

In fact, my co-author, Casey Pender, he recently published a paper on this in the Journal of Macro, where he looked at the bank failures and deflation. What he found was that the bank failures occurred with aggregate demand-driven deflation, but not supply-driven deflation in the case of the postbellum United States. I think that’s a really important point here is that even despite the issues with the US banking system during the postbellum period, we still have robust economic growth and supply-driven deflation.

As far as policy goes going forward, again, I hope that folks at the Fed and other people that are in a position to influence monetary policy, certainly, more than the humble Florida Atlantic University professor is, will recognize that there are cases where a falling price level is not to be feared, and that we can get a better monetary policy framework by thinking in terms of either nominal income targeting, if that’s how you prefer to think about the world, or thinking about how productivity, whether it’s positive or negative, how that affects r-star, and thus how should the central bank respond to fluctuations in r-star. That would be my advice going forward.

Beckworth: Okay. Our guest today has been Bryan Cutsinger. His paper, co-authored along with Casey Pender, is titled “Rethinking Deflation and Its Effects: A Cross-Country Analysis of Supply-Driven Deflation.” Be sure to check it out. Bryan, thank you once again for coming back on the podcast.

Cutsinger: Great to be with you, David. Thanks for having me back.

Beckworth: Macro Musings is produced by the Mercatus Center at George Mason University. Dive deeper into our research at mercatus.org/monetarypolicy. You can subscribe to the show on Apple Podcasts, Spotify, or your favorite podcast app. If you like this podcast, please consider giving us a rating and leaving a review. This helps other thoughtful people like you find the show. Find me on Twitter @DavidBeckworth and follow the show @Macro_Musings.