The news stories about deflation have been mushrooming again much as they did back in the early 2000s. Back then, Ben Bernanke was a member of the Fed but Greenspan was still chairman. Bernanke convinced Greenspan that deflation was imminent and that it had to be stopped. Oh my God! We can’t let prices fall! The Fed cut rates aggressively, held them low for too long and the housing bubble was the result. Good thing we avoided that nasty deflation. There are good reasons to avoid rapid deflation but as Robert Higgs points out in this article at Mises, the rate of economic growth and the rate of price level changes are not correlated.
“Notably, rapid economic growth occurred both before and after 1897; neither a falling nor a rising general price level was uniquely associated with economic growth.” To elaborate just a bit, the rate of economic growth from 1866 to 1897, a period of secular deflation, was perhaps the greatest ever experienced by the US economy during a period of comparable length. Real GDP grew by more than 4 percent per year, on average, notwithstanding the persistent deflation.
So, even if you’ve not mastered the works of Ludwig von Mises and Murray Rothbard, even if you are a confirmed positivist in your methodological bent (as I was in 1971), you can see clearly that the rate of economic growth and the rate of price-level change have been independent, at least within the ranges of these variables in US economic history. (Hyperinflation or hyperdeflation would be another matter: either would be devastating by making economic calculation and long-term contracting virtually impossible.)
I believe that the Fed’s recent actions will ultimately prove inflationary, maybe even disastrously so. Higgs explores the possibilities:
Which brings us to the second question: for better or worse, does deflation actually loom at present? If it does, its occurrence will surprise me greatly, because the Fed has been creating base money as if there were no tomorrow, and if the bailouts continue, as seems likely, more of the same is virtually certain. So far, the huge spurt in base money has simply been absorbed and held by the banks in the form of (legally) excess reserves, but the likelihood that the banks will sit on $268 billion of excess reserves forever is nil. Once they feel more secure, their loans and investments will go forth in search of a higher yield than the Fed pays them (since a recent change in policy) on their reserves, and at that point the banking system’s money multiplier will kick in with terrific force.
In short, given the monetary conditions now prevailing, the greater threat by far is inflation, not deflation. And contrary to what the investment “experts,” the politicians, and the mainstream economists believe, inflation is not a benign element in the economy’s operation. It is, as it has always been, the most dangerous and destructive form of taxation.
I think it is safe to say that sustained deflation with Ben Bernanke as Fed Chairman is very unlikely. Just last week, he announced to anyone who bothered to listen that he is going to be printing money to buy securities in the open market. As long as the Fed has control of the printing press, we don’t have to worry about prices falling for any length of time.
The Great Depression is the source of our fears of deflation. The Fed back then allowed the money supply to fall by roughly 25% over a short period of time. That rapid deflation was a primary cause of the depression because wages were not allowed to adjust to the new price level. But that one instance of a rapid deflation and its consequences does not mean that deflation should be avoided at all costs. In a capitalist system with a fixed monetary base (or nearly fixed as on a gold standard), prices should fall as productivity increases. In fact, that should be the goal of any capitalist system – to increase the purchasing power of its citizens. Isn’t that what we want? Isn’t that how we create wealth?
Inflation is favored by those who receive a newly created dollar first because they can benefit from that new dollar before it loses value. Who receives a newly created dollar first? Since the government has the sole power to create money, it is politicians who benefit most from inflation. Second in line are the wealthy and that is why inflation is the source of the increased inequality we see in our society. Inflation is the most regressive of taxes, hurting the poor most of all. If we want to benefit all citizens equally, we need to eliminate inflation. If we want to create wealth, we need to eliminate inflation. Inflation is the enemy, not deflation.