Posted on 04/02/2014 3:55:29 PM PDT by BfloGuy
The fear of deflation serves as the theoretical justification of every inflationary action taken by the Federal Reserve and central banks around the world. It is why the Federal Reserve targets a price inflation rate of 2 percent, and not 0 percent. It is in large part why the Federal Reserve has more than quadrupled the money supply since August 2008. And it is, remarkably, a great myth, for there is nothing inherently dangerous or damaging about deflation.
Deflation is feared not only by the followers of Milton Friedman (those from the so-called Monetarist or Chicago School of economics), but by Keynesian economists as well. Leading Keynesian Paul Krugman, in a 2010 New York Times article titled “Why Deflation is Bad,” cited deflation as the cause of falling aggregate demand since “when people expect falling prices, they become less willing to spend, and in particular less willing to borrow.”[1]
Presumably, he believes this delay in spending lasts in perpetuity. But we know from experience that, even in the face of falling prices, individuals and businesses will still, at some point, purchase the good or service in question. Consumption cannot be forever forgone. We see this every day in the computer/electronics industry: the value of using an iPhone over the next six months is worth more than the savings in delaying its purchase.
Another common argument in the defamation of deflation concerns profits. With falling prices, how can businesses earn any as profit margins are squeezed? But profit margins by definition result from both sale prices and costs. If costs — which are after all prices themselves — also fall by the same magnitude (and there is no reason why they would not), profits are unaffected.
If deflation impacts neither aggregate demand nor profits, how does it cause recessions? It does not. Examining any recessionary period subsequent to the Great Depression would lead one to this conclusion.
In addition, the American economic experience during the nineteenth century is even more telling.
Twice, while experiencing sustained and significant economic growth, the American economy “endured” deflationary periods of 50 percent.[2] But what of the “statistical proof” offered in Friedman’s A Monetary History of the United States? A more robust study has been completed by several Federal Reserve economists who found:
... the only episode in which we find evidence of a link between deflation and depression is the Great Depression (1929-34). We find virtually no evidence of such a link in any other period. ... What is striking is that nearly 90% of the episodes with deflation did not have depression. In a broad historical context, beyond the Great Depression, the notion that deflation and depression are linked virtually disappears.[3]
If deflation does not cause recessions (or depressions as they were known prior to World War II), what does? And why was it so prominently featured during the Great Depression? According to economists of the Austrian School of economics, recessions share the same source: artificial inflation of the money supply. The ensuing “malinvestment” caused by synthetically lowered interest rates is revealed when interest rates resort to their natural level as determined by the supply and demand of savings.
In the resultant recession, if fractional-reserve-based loans are defaulted or repaid, if a central bank contracts the money supply, and/or if the demand for money rises significantly, deflation may occur. More frequently, however, as central bankers frantically expand the money supply at the onset of a recession, inflation (or at least no deflation) will be experienced. So deflation, a sometime symptom, has been unjustly maligned as a recessionary source.
But today’s central bankers do not share this belief. In 2002, Ben Bernanke opined that “sustained deflation can be highly destructive to a modern economy and should be strongly resisted.”[4] The current Federal Reserve chair, Janet Yellen, shares his concerns:
... it is conceivable that this very low inflation could turn into outright deflation. Worse still, if deflation were to intensify, we could find ourselves in a devastating spiral in which prices fall at an ever-faster pace and economic activity sinks more and more.[5]
Now unmoored from any gold standard constraints and burdened with massive government debt, in any possible scenario pitting the spectre of deflation against the ravages of inflation, the biases and phobias of central bankers will choose the latter. This choice is as inevitable as it will be devastating.
I disagree. The velocity of money is an interesting but, ultimately, meaningless metric.
If we're talking transacted prices then velocity is everything because if the money isn't moving (like maybe it's sitting in some bank somewhere) then it's simply not involved with defining some price. That's why velocity can track inflation even while money supply growth stays unchanged:
Aw hell, I know all this mussin' 'n fussin' with all this here fancy dancy book learnin' gets a might high-fallutin', but ya know business is like they say, business...
Of course that's not true at all. What if the previous supply was just right, and then doesn't keep up with growth. That would result in deflation as well.
A free market in money would adapt to changes in its supply
Right. By dropping prices, reducing employment and reducing production. Increased defaults, reduced borrowing and less new business creation.
No! What you say is "not true at all".
The only "just right" supply of money is that which the free market determines is "just right". The government cannot determine it for us.
If you believe it can, then you must examine your premises. They seem to land heavily on the planned-economy side.
If the free market supplies the "just right" amount now and in the future supplies less, deflation can result.
Why does that make deflation a good thing?
Why does that make deflation a good thing?
Because deflation is an increase in the purchasing power of the currency. It isn't any more complex than that. Why do you continue to reject that a dollar growing in value is a bad thing?
I suspect it's because the only deflation you've witnessed in your lifetime is the wrenching kind caused by government price-fixing of the interest rate. A free market wouldn't see that.
And?
Why do you continue to reject that a dollar growing in value is a bad thing?
I don't reject the idea that deflation is a bad thing. Because it hurts investment, reduces employment, increases loan defaults, reduces borrowing and shrinks business creation.
I don't know why I continue to waste the pixels.
The only deflation that does what you state is the deflation created by the Federal Reserve Bank when it raises interest rates above the artificially-low rate it had imposed previously.
Are you truly unable to see the difference between that and the price reductions caused by improvements in productivity? If so, why?
I guess you missed the Panics, Depressions and Crashes that occurred when we had no Central Bank and which caused the deflation that you claim is impossible?
Are you truly unable to see the difference between that and the price reductions caused by improvements in productivity? If so, why?
Are you truly unable to remember post #5? If so, why?
Interesting discussion; I just wish I had enough book learnin’ to really follow it.
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