Whereas inflation erodes debt, which is fixed in nominal terms, deflation makes it more onerous in real terms.
But in a period of deflation, nominal changes matter much more: growing real GDP means little if the economy is contracting in money terms.
With 2.5% real GDP growth per year and 1% to 2% deflation, nominal GDP will advance 1% annually.
With 2% real GDP growth and 2% to 3% chronic deflation, nominal GDP may well be zero in future years.
Similarly, as inflationary concerns decrease (which includes deflation), nominal bonds become more attractive relative to TIPS, as future interest payments become more valuable on a real (or after inflation) basis.
It would oblige Argentina to continue trying to adjust its real exchange rate by deflation (cutting nominal wages and prices in nominal terms), a process which has already forced the collapse of many businesses.
In deflation the nominal value of debts remains fixed even as nominal wages, prices and profits fall.
The lack of good private investment opportunities has kept big banks and insurance companies buying government debt (which carries reasonable real rates of return despite low nominal rates thanks to deflation).
But by cutting nominal rates to prevent deflation, the Fed has reduced the real rate of interest too much.Evidence that this has been the case comes in two forms.
All these changes are designed to arrest the deflation, boost nominal GDP and hopefully real GDP, and at the same time, protect the renminbi's peg.
