What causes an economic credit bubble to end in deflation (US'30) vs. inflation (Recent Arg, Indo)?

Question

I've been reading conflicting viewpoints about credit bubbles and manias. I certainly don't believe the claim that "all credit bubbles end in deflation", as the recent cases of Argentina and Indonesia are clear evidence that credit bubbles can end in hyper-inflation.

However, I'm wondering what major factors are responsible for post-bubble deflation vs. inflation. Any thoughts or links would be much appreciated!

Answer 1

You're correct to look for a clear mechanism. If a mania precedes a bust, then there is clearly an increase in the nominal price of an asset without an attendant increase in the value of the asset. So there should be localized deflation within that sector, the necessary come-down after so much building.

Macroeconomically, this can bring on large-scale deflation or inflation. The deflation that characterized the Depression was due to a sudden loss of wealth, and basic market forces tell you that a loss in wealth means a decrease in demand, hence a lower equilibrium price. Meanwhile, the inflation that characterize Argentina and Indonesia stem more from a loss of faith in the currency. Indonesia's can be blamed on a combination of factors including nepotism, a slagging tourist industry, and rampant economic damage from natural disasters. Argentina has struggled to restore faith in the peso following the drastic economic collapse in 1998, and will continue to struggle for quite some time.

I suppose that if the U.S. economy in the 1930s was more open, or if the currency trading mechanisms were as advanced in that day as they are currently, we may have seen inflationary pressures win out.

Research in this vein (that bubble crunches and the ensuing depression is always different, rather than being a homogenous animal) is being carried out at the Philadelphia Fed.

Answer 2

The reason is very simple: policies of the national government and the central bank. In the 1930s U.S., the Federal Reserve was ordered to keep money tight while the federal budget was running a surplus; hence, deflation. In recent Argentina, the central bank expanded money supply to finance the national government's budget deficit; hence, inflation.

Answer 3

The major factors that determine inflation/deflation are strictly political. When the political powers determine that it is in their best interest to create factors that will lead to one or the other, they simply order their economic advisors to make it happen.