I served seven years as the chair of the Princeton economics department where I had responsibility for major policy decisions, such as whether to serve bagels or doughnuts at the department coffee hour.
The more guidance a central bank can provide the public about how policy is likely to evolve the greater the chance that market participants will make appropriate inferences.
The basic prescription for preventing deflation is therefore straightforward, at least in principle: Use monetary and fiscal policy as needed to support aggregate spending.
The sources of deflation are not a mystery. Deflation is in almost all cases a side effect of a collapse of aggregate demand.. a drop in spending so severe that producers must cut prices on an ongoing basis in order to find buyers.
The crisis and recession have led to very low interest rates, it is true, but these events have also destroyed jobs, hamstrung economic growth and led to sharp declines in the values of many homes and businesses.
