In a recent blog post at the Wall Street Journal, linked to by Paul Krugman and discussed almost endlessly in social media, we are presented with five reasons to worry about deflation. According to Krugman, the blog post is “a very nice explainer.” Krugman notes that there is only one important piece missing from the blog post: that “zero is not a magic red line,” and the lesson that “too-low inflation has all the adverse effects of outright deflation, just to a lesser degree.”
And further, “This means that Europe is already in a lowflationary trap, qualitatively the same as a deflationary trap.”
Yet no matter how one reads the blog post, which lists five supposedly worrisome consequences of deflation, it falls short of any real argument. Unless one has already adopted the normative position that an economy must engineered to minimize unemployment, these points are nowhere near to being worrisome.
To David Wessel, the author of the blog post and a director in the Brookings Institution, the five listed reasons, lauded by Krugman, we should be worried are as follows.
1. Deflation is a generalized decline in prices and, sometimes, wages.
2. It can be hard (though, as we’ve seen, not impossible) for employers to cut nominal wages when conditions warrant.
3. As economic textbooks teach, the prospect that things will cost less tomorrow than they do today encourages people to put off buying.
4. Deflation is terrible for debtors.
5. Cutting interest rates below zero is very hard.
I suppose if you are a wage earner facing a reduced salary you might not like #1; if you’re a manager of a business firm in a shrinking or unproductive industry, you might find #2 troublesome; if you’re a debtor you probably don’t like #4; and if you are a central banker you don’t fancy #5, or at least find it problematic when trying to ease the effect of politicians’ fiscal deficits. These points, which make up a full 4 out of the 5, find only specific groups or certain situations in which deflation isn’t supportive.
Surely we can find groups or situations which don’t look good also under inflation? So what is the point Wessel is trying to make, unless he has friends only in these categories and no friends in categories affected by inflation?
The deflation hysteria is really not an argument at all, but an emotionally based political preference. Not only do we need to assume (incorrectly) that the economy is about employment, but we need also think of the status quo inflationist regime as some sort of natural starting point that is as close to Pareto optimal as it gets. Otherwise we will find ourselves in a position where we need to compare and contrast the current situation’s biases with the potential biases of deflation, and then ask ourselves if it is (1) possible and (2) valuable to do something about it. The position of deflation phobia then falls apart, so let’s not think rationally about this is the message from inflationists.
Let’s look more closely at point #3, which should appear as ridiculous or plain stupid to most consumers. Apparently we are to believe that consumption will come to a halt unless we inflate prices overall. Because if we know that food will be cheaper tomorrow than it is today, and even cheaper the day after tomorrow, then we will put off buying more food simply because we will save lots of money starving to death. That’s the logic.
OK, maybe it is unfair. Or at least, that’s what inflationists will tell us, since food is a necessity for survival we might have to face the music and at least buy enough to survive. But the logic applies to non-necessary goods and services produced by companies that employ millions of people. Without inflation, people will put off buying such things and therefore force these people into unemployment, and the whole economy will come crashing down.
That’s a valid argument. We all know of all those people who already in the early 1980s realized the truthfulness of Moore’s Law and therefore wouldn’t buy a personal computer. They understood, and accurately so, that computers will only get better and cost less, so they put off buying one. And they still don’t have a computer, some three decades later, because it will be even cheaper years down the road. Yes, information technology (especially hardware) has been strictly deflationary for decades. This is why it has made no impact whatsoever on our way of life, and this is why nobody has chosen to buy technology.
But wait a minute, that’s not what has happened. Instead, the highly deflationary industry of information technology has seen fantastic growth, immense investments, and employs more people than ever before, and it has made the whole world much better off. This single case should be enough to sink the ghost ship of deflation phobia, since it conflicts with pretty much every single point raised in defense of artificial inflation. But somehow it doesn’t.
One reason is that the argument against deflation is an argument for a failing economy, an economic and social catastrophe. Think the Great Depression. (This is somehow a supposed trump card that Krugman and others play when they feel like it, whether or not it fits the narrative.)
This is really core to the hysteria, and it is as baseless as most other claims made by inflationists. The Great Depression saw deflation (shrinking prices), which is a natural consequence of an economy going through a correction after having suffered a great credit-infused boom. And since correlation implies causation, deflation must lead to depression and so we’re all screwed if prices go down. The only way of surviving is if the government inflates prices and thereby spurs artificial booms. (Anybody hear the ghost of Keynes here?)
Of course, except for the logical fallacy and the fact that this interpretation of what “caused” the Great Depression is based on a theory of glorious government that doesn’t include a theory of what causes recessions (except for invoking “animal spirits”), one has to accept the assertion that the whole point and purpose of the economy is to provide every willing man and woman with a well-paying job.
It is really not that difficult to provide all with jobs, but to combine unchanging professions with unchanging consumer preferences (that is, a never-shrinking demand for a good or service) and economic development and growth is pretty much impossible. If it weren’t for the latter, which translates to the welfare and prosperity of society overall, we could just prohibit excavators and have people dig with shovels. Even better, prohibit shovels as well and have people dig with their hands – that would create more jobs than there are unemployed.
Yet this is not what inflationists want – they are shooting for the “free lunch” that Keynes promised. By inflating and letting one artificial boom follow the other, maybe we can have government produce eternal growth and glory. It is just that this thing we generally refer to as “reality” comes back to haunt us over and over again when we pretend we don’t have to take it into account. The real capital (the machines, natural resources, know-how, etc.) doesn’t grow only because we produce bigger numbers in bank accounts or in the Fed’s accounting. Sustainable growth needs capital investment and improved productivity, which is very much tied to the real, physical world.
So what about deflation, isn’t it dangerous still? No one claims moving from a many decades-long inflationist regime to a non-inflationary state of affairs won’t be costly. We are so used to inflation that basically everything we do is based on anticipating continued inflation. Most of us have never seen anything but inflation (sometimes “high,” sometimes “low,” but inflation nevertheless), so it is safe to say most of us are no equipped to deal with deflation.
Wessel’s point #4 is a case in point: “deflation is terrible for debtors.” Yes, but inflation is terrible for creditors. This is a problem only because Wessel assumes, as does Krugman, that we need ever more credit to feed those artificial booms so that we don’t ever need to face reality. But there is no basis for this belief, except for invoking spirits, cherry-picked data points, and certain Keynesian narratives – there is no proof. And the story still only works if we think an economy is about creating employment (as if we are all better off because we work harder, not because we’re more prosperous) rather than creating wealth through increasing productivity.
Under inflation the government creates an implicit subsidy for debtors by punishing creditors. For any loan offered today, the principal will be worth less a year from now. And since with inflation salaries increase more easily, it is easier for the employed to pay off loans even if one’s real wage (as opposed to one’s nominal wage) doesn’t increase.
By inflating, real wages are made more flexible and can go down even though nominal wages increase. So it is really a scheme to trick the working class into accept lower wages while tricking business owners to think consumers have more funds available to purchase their goods. But more money is not more wealth on a macro level. It is wealth only if the money is earned by someone as a result of a productive innovation that makes people (consumers) better off. This, in itself, causes prices to go down (deflation) since we’re made better off and the purchasing power of money therefore goes up.
The only real loser of deflation is government, since politicians cannot produce constant fiscal deficits and kick the can down the road by making the debts worth less (while spending the newly-“printed” money). Perhaps this is the real reason why inflationists fear deflation – that it is a strict limit to the growth and glory of government?
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