Alan Reynolds Embraces Deflation
Conservative economist and Cato Institute senior fellow Alan Reynolds takes to the pages of The New York Post to argue that the economic situation’s not so bad:
A wise adviser to President John Kennedy, Arthur Okun of Yale, devised the “misery index” to gauge the pain of economic crisis – a measure that simply adds together the unemployment rate and the inflation rate. It hit 22 percent in June 1980, during an inflationary recession that preceded the Fed’s disinflationary squeeze of 1981-82. The misery index was nearly as bad in January 1975, at 19.9 percent.
Assuming inflation was close to zero this January, the misery index would have been roughly the same as the unemployment rate, or 7.6 percent. By this standard, we have a very long way to go before the economy feels nearly as miserable as it did in 1975 or 1980.
John Judis observes that this is a strange argument to make against a fiscal stimulus measure whose purpose is to avoid a deflationary spiral.
To go stronger, one question a non-crackpot asks himself before proclaiming the economic situation not so bad is “does my method carry the implication that the Great Depression was only a mild downturn?” And, indeed, Reynolds’ method does have this implication. During the Depression, the unemployment rate was extremely high but the inflation rate was strongly negative leading to “misery index” measures that are a lot lower than the “stagflation” of the late-1970s:
In other words, according to Reynolds not only are today’s problems no Great Depression, but the Depression itself paled in comparison to the horrors of the Ford years. But surely nobody—not even Reynolds—is dumb enough to think that economic conditions were worse in 1975 and 1980 than they were in 1932. Right?
61 Responses to “Alan Reynolds Embraces Deflation”
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February 9th, 2009 at 11:56 am
In the Post now – but stupidity like that is gonna prove irresistible to Fred Hiatt, or perhaps I should say, Donald Graham, Fred bein’ the WAPO’s sockpuppet for D.G. So on to the Outlook tomorrow!
February 9th, 2009 at 12:03 pm
When you already know that the answer is always “smaller government”, the real challenge is in posing the problem.
February 9th, 2009 at 12:08 pm
For the classical economist, such as Reynolds, deflation isn’t bad, especially when compared to inflation. Deflation is a market “correction.” Inflation, on the other hand, occurs when government prints money (usually to achieve political ends) faster than the economy can produce goods. Reynolds no more believes Keynes’ theory (i.e., that deflation is not self-correcting) than he believes in spaghetti monsters.
February 9th, 2009 at 12:11 pm
I’ve been trying to figure out for a long time why conservatives seem to irrationally hate inflation. Sure, high inflation is bad for an economy, but probably less so than deflation; and a low positive inflation rate is probably best. So why the monomaniacal focus on the evils of inflation?
Are conservatives net lenders (so that inflation erodes their wealth)? Do they think inflation will raise unit labor costs? I just don’t get it.
February 9th, 2009 at 12:30 pm
Yeah, I guess that’s it. Also, higher inflation allows more government spending, and since conservatives seem to have gotten it into their heads that “govt. spending = wealth redistribution,” they may want low inflation to act as a check on Congress.
Or maybe the fact that inflation was high during the Carter years turned inflation-fighting into an article of faith among conservatives. After all, if Carter was the Devil and Reagan was Jesus, then inflation would have to assume the role of Original Sin, right?
February 9th, 2009 at 12:32 pm
Inflation robs an economy of a future; why invest a dollar today if its value will be much lower tomorrow. Reynolds is right to worry about inflation. After all, when was the last time the US suffered anything close to hyper-inflation: the last time the government paid for a war (the Viet Nam War) with borrowed money. Sound familiar? While I can understand why Reynolds is inclined to base his prescription on persoanl experience (he lived through the 1970s inflation but not the Great Depression), has he not noticed that our largest banks and companies are failing on a scale not seen since the Great Depression?
February 9th, 2009 at 12:58 pm
the last time the US suffered anything close to hyper-inflation: the last time the government paid for a war (the Viet Nam War) with borrowed money.
There was nothing remotely approaching hyperinflation during the Vietnam war period in the US. Between 1965 and 1974, deficit spending reached its highest percentage of of GDP in 1968, at 2.9%. The inflation rate for 1968 was 4.27%. It rose over 5% in ‘69 and ‘70, but then fell to only 3.27% by 1972. Hyperinflation? In 1980, long after the US involvement in Indochina had ended, inflation was 13.58%, and the deficit was at 2.7% of GDP. Thirteen percent is still nothing like hyperinflation, and it wasn’t because of Vietnam.
February 9th, 2009 at 1:04 pm
DTM, if annual inflation is 20%, what rate of return would be necessary for me to invest $1 for ten years? Herschel, every respected economist, left, center, and right, believes the high inflation of the late 1970s was directly attributable to the “guns and butter” policies of the Johnson years.
February 9th, 2009 at 1:50 pm
Rayl:
Your argument is even worse than dtm says.
During deflation, you DON’T want to invest, because the safest investment of all is simply hoarding your cash and letting its purchasing power increase.
And of course hoarded money isn’t being productively invested, which is why deflation is deadly for growth and jobs.
The way to keep people investing is to make sure that hoarders lose purchasing power. Moderate inflation does that.
Of course, severe inflation is also bad. But there is no threat of that now.
February 9th, 2009 at 2:06 pm
Remeber who the republicans ultimate constinuency is. Deflation is great for those living off wealth. The tension between inflation and deflation goes way back, read the debates during William Jennings Bryan’s various political races. The core issue was basically that the wealthy living off their inheritance want deflation while the workers need some moderate inflation.
Rayl, yeah hyperinflation is bad, but deflation is a catastrophe. Anyone who is in debt (like say the vast majority of homeownsers who have mortgages!) is absolutely destroyed by deflation.
February 9th, 2009 at 2:42 pm
Deflationary spiral? Are you kidding me? A single category of assets – namely housing – has been declining in price. But that’s not a “deflationary spiral”. We are facing enormous inflationary pressures that are going to really destroy the value of the dollar in the next three years.
February 9th, 2009 at 3:03 pm
every respected economist, left, center, and right, believes the high inflation of the late 1970s was directly attributable to the “guns and butter” policies of the Johnson years.
It would seem that Brad DeLong disagrees with you. I believe, actually, when you refer to economists you’re actually confusing them with editorial and op-ed writers. Your scenario is particularly unconvincing in light of the fact that the inflation of the 1970s was a global phenomenon, although it peaked at different times in different places.
February 9th, 2009 at 3:07 pm
Deflationary spiral? Are you kidding me? A single category of assets – namely housing – has been declining in price. But that’s not a “deflationary spiral”. We are facing enormous inflationary pressures that are going to really destroy the value of the dollar in the next three years.
The dollar will be valuable 3 years from now. Less valuable than it is now, but still valuable nonetheless. Just like it was somewhat more valuable 3 years ago than it is now, and somewhat more valuable still 3 years before that.
I make no claim about whether we are really headed into a deflationary spiral. I am not an economist. But I do understand that the last thing you need to worry about when plunging into a recession is inflation. Rather, you want to force money into the economy, both through fiscal and monetary policy and by maintaining a significant inflationary penalty against hoarders.
Seriously, people talk about the value of a dollar as if that is more important than whether people are out of work, factories are closing, government receipts are plunging, and all sorts of other economic ills. It just isn’t that big a deal that your dollars buy less now than they did in the past (the exception being those on fixed incomes, which is why COLA adjustments to social security are so important), and I don’t think there are too many working people in America who, if given a choice between having a job that pays them in somewhat less valuable currency 3 years from now and being out of work but knowing that those lucky enough to still have jobs have not seen the value of the dollar go down, would choose the latter scenario.
Again, though, if there is a serious risk of Brazil-style hyperinflation, you will see me change my tune, as that scenario is bad too. But there’s no evidence of that and all signs point that we need a pretty big inflationary jolt right now.
February 9th, 2009 at 3:12 pm
And then there’s the case that it had to do with oil shocks that came about when Nixon and Kissinger decided to dump American interest wholesale and equip Israel with weapons in the war with Egypt at an unprecedented rate, and OPEC got on its hind legs and finally used the oil weapon.
Oh, but we can’t remember certain things, can we? Cause we were defending, uh, something. As Patrick Tyler describes it in his book, that something was pretty much the hysteria and think tank moral panic that has become a regular feature of the D.C. set.
February 9th, 2009 at 4:13 pm
To add to DTM’s point, the New Republic has an article up about deflation, the drop in the CPI in December was the largest in 60 years.
February 9th, 2009 at 6:19 pm
There are several kinds of ways to define deflation. Some are rather benign, even salutary, and others are not. Nevertheless, a consistent, low level of price deflation makes for a much healthier economy than a consistent level of inflation. That makes no comment on other sorts of deflation in any way.
February 9th, 2009 at 6:29 pm
Nevertheless, a consistent, low level of price deflation makes for a much healthier economy than a consistent level of inflation.
Absolutely not. Anything that makes your money more valuable (or just as valuable) tomorrow than it is today is a terrible thing, because it encourages you not to invest or consume it. (And that also means that moderate sustained deflation is not possible, because ANY deflation will tend to spiral.)
Making your money less valuable over time is the cost of a growing economy. People need to grow up and accept it.
February 9th, 2009 at 6:47 pm
Dilan,
Exactly, it is amazing to see conservative now seemingly championing deflation, it is like they really have become the party of the landed gentry, entrenched aristocracy or something, they seem to have taken this party of the South thing seriously.
Who supposedly believes in Capitalism again?
February 9th, 2009 at 7:23 pm
“Rather than a problem to be dreaded and combated, falling prices through increased production is a wonderful long-run tendency of untrammeled capitalism.” – Rothbard
And so it’s been for most of human history. Indeed, no one complains at the continual increase in the amount of computer power that can be bought for the same amount of money. Neither do they complain when productivity reduces the price of windmills, solar panels, electric cars that they crave so deep as to tickle their colons.
But when it comes to monetary policy, psychology trumps all that was taught in econ 101. The expectation that prices will decrease overwhelms all other factors. Consumers panic, even as their ever expanding level of wealth materializes around them, they refuse to buy. An economy spirals out of control until the wealth of the world can be bought up for tree-fiddy to a lone “Loch-ness” monster, smart enough to extort a black man for his lunch money.
No, it is the Liberals jobs to make sure they fight for that minimum wage, then secretly tax it away in inflation. It is the liberals job to seed the idea of death through deflation, because after all it is the printer of money that gains the most from it, not us the silly lay person who give the printer his power. And so goes another tail from the tomes of Scientology.
February 9th, 2009 at 7:26 pm
Lol, “tail”
February 9th, 2009 at 7:26 pm
Absolutely not. Anything that makes your money more valuable (or just as valuable) tomorrow than it is today is a terrible thing, because it encourages you not to invest or consume it. (And that also means that moderate sustained deflation is not possible, because ANY deflation will tend to spiral.)
Making your money less valuable over time is the cost of a growing economy. People need to grow up and accept it.
Sorry, but this just isn’t so. Assuming a constant supply of money, any increase in the amount of goods for sale will decrease their cost, and therefore raise the value of money. This is really simple stuff. I am surprised it is so difficult to fathom. Economic growth does not, in any way, shape or form, depend on a depreciating dollar.
Now, empirically, the time period in which we had the strongest real growth was 1880-1900 which was approximately 4.0% per year, while CPI decreased at approximately 1% per year, which pretty much puts the lie to the fantasy you are attempting to sell. Sorry.
Money becoming more valuable over time does not lead to less investment. Interest rates are still positive, even if CPI is falling, because of time preference. In other words, if CPI is -.5%, interest rates will be closer to 2% and investments will be discounted at an extremely low rate. Where you get into trouble is with monetary deflation, or deflationary shock. In other words, if prices fall quickly due to a decrease in the overall money supply, there is no reason to invest, but if they fall slowly and steadily, there is every reason to do so.
Before you reply, think about the secular deflation in technology which has come with increased productivity, and think whether that has, in any way, led to a situation in which technology companies cannot find capital.
February 9th, 2009 at 8:23 pm
Is there a critical mass of people holding off on purchases because they’re speculating that the prices will keep going down, or is there a critical mass of people who fear hunger and homelessness?
I suspect that most of us are just trying to get by and to avoid severity. I don’t see rent or grocery prices falling.
February 9th, 2009 at 10:15 pm
“Rather than a problem to be dreaded and combated, falling prices through increased production is a wonderful long-run tendency of untrammeled capitalism.” – Rothbard
And that is why the mainstream of the economics profession views Murray Rothbard as, at best, a kook, and more likely a charlatan.
And so it’s been for most of human history. Indeed, no one complains at the continual increase in the amount of computer power that can be bought for the same amount of money.
Inflation is not measured by the price of one item but by the mix of items purchased by typical consumers and businesses. So long as such averages are going up at a moderate rates, it doesn’t really matter that particular items are going down in price (because of, for instance, technological improvements). So long as your money’s worth less in general tomorrow than it is today, you have the incentive not to hoard it.
No, it is the Liberals jobs to make sure they fight for that minimum wage, then secretly tax it away in inflation. It is the liberals job to seed the idea of death through deflation, because after all it is the printer of money that gains the most from it, not us the silly lay person who give the printer his power. And so goes another tail from the tomes of Scientology.
Inflation isn’t a plot to secretly “tax away” money. The theory I laid out above has also been proven in practice– deflationary spirals have caused long depressions and recessions on multiple occasions. Inflation MIGHT be thought as a tax on hoarding your money. But guess what– YOU HAVE NO FRICKING RIGHT TO HOARD YOUR MONEY. Hoarding your money prevents other people from making use of it to grow the economy. It is a selfish betrayal of your obligations to society. And finally, bankers don’t get rich on inflation. They get rich on the spread of interest rates (as well as transaction fees). Indeed, if they don’t find people to loan your money out to at interest, they lose money.
February 9th, 2009 at 10:25 pm
Sorry, but this just isn’t so. Assuming a constant supply of money, any increase in the amount of goods for sale will decrease their cost, and therefore raise the value of money. This is really simple stuff. I am surprised it is so difficult to fathom.
Of course, economics isn’t simple. Indeed, the whole problem with sound money types is they never got past supply and demand and into a course on money and banking.
In the real world, prices are sticky. Businesses don’t like to cut them, and workers don’t like wage cuts.
Further, even if prices weren’t sticky, deflation would STILL create an incentive to hoard money. And we don’t want you hoarding money. It’s bad for society if you do it.
In addition, though, your theory leaves out a couple of big variables:
1. Under no circumstances would you EVER want a stable money supply. That means you would have no power to do countercyclical monetary policy to arrest inflation and recessions and stabilize the business cycle. So your “assumption” is a total nonstarter that, if it were enacted, would lead to massive periodic bread lines and soup kitchens.
2. You must be assuming a balance of payments with other nations. After all, the US could keep its own money supply stable, but if there were an imbalance of payments, the actual money supply would still be changing due to foreign investment.
Now, empirically, the time period in which we had the strongest real growth was 1880-1900 which was approximately 4.0% per year, while CPI decreased at approximately 1% per year, which pretty much puts the lie to the fantasy you are attempting to sell. Sorry.
During that same period there were 6 or 7 panics of at least 4 to 5 years each, with abject poverty comparable to the great depression in each one, plus the 20 year + “long depression”. Why? Because there was no effective means to do countercyclical monetary policy.
You can go back to the 19th Century if you want. I prefer the 21st.
Money becoming more valuable over time does not lead to less investment. Interest rates are still positive, even if CPI is falling, because of time preference.
You are ignoring RISK. You don’t want ONE DOLLAR to remain in a mattress, but with deflation, putting the money in the mattress is RISK FREE in a way no other investment is. Yes, there will still be higher risk, higher reward investments. But as long as at least some risk-averse people choose to hoard, money will be pulled out of the economy and we will be thrown into periodic panics and depressions.
Before you reply, think about the secular deflation in technology which has come with increased productivity, and think whether that has, in any way, led to a situation in which technology companies cannot find capital.
Again, deflation of specific goods isn’t the issue. That happens all the time. But if money GENERALLY becomes more valuable over time, people won’t invest it, they’ll hoard it.
Inflation stops that activity in its tracks and forces that money into the economy.
February 9th, 2009 at 10:39 pm
Dilan-
With all due respect, you actually have no clue what you are talking about. Everything you say flies in the face of both theory, and empirical reality, and verges on pop-economics and bizarre theology. Also, it is impossible to have five 6-7 year downturns and one twenty year panic in a span of only twenty years. Just FYI.
February 9th, 2009 at 11:10 pm
I come late to this feud but DTM is right. The value of money was fixed because money was gold, and there was only so much of it. The only way to get more was to dilute the gold, which (before banks) had the effect of ruining people’s savings if they trusted the money (essentially hyperinflation) or ruining people’s willingness to accept the money in exchange for goods and services if they didn’t (essentially hyperdeflation) so the money had to be good.
This kind of thinking has slopped over into the modern world, which is why goldbugs sound so kooky. They really are. We now know and understand what they are really afraid of better than they do.
But back to normal inflation and deflation … basically, inflation helps creditors (you repay your loans with money which buys less than the money you borrowed) and deflation helps lenders (people who borrowed money from you pay you back with money that’s worth more than what you lent them.)
From this simple hypothesis you can see the hysteria. Inflation (within reason) helps the poor, especially in our debt-laden society; deflation (within reason) helps the rich, unless the rich are grotesquely over-leveraged (i.e. borrowed a huge amount themselves, leveraging their own bank or hedge fund 100 to one) or otherwise gambled on ever-rising asset prices…. you see how this plays out, I think….
anyhow, I support the stimulus.
And I’m a net debtor (student loans plus mortgage).
February 10th, 2009 at 1:06 am
Matt,
all due respect, but you are the one who is out in the weeds here, DIana, DTM and Dilan have pretty much laid out mainstream economics. Gold standard loons and Ron Paul supporters aren’t credible economists.
And stuff like computers and electronics going down in price isn’t deflation. Yeah it is great you can buy a laptop for $500 that used to cost $1,500 but if your rent has gone from $500 a month to $900 or a house now costs $300,000 that used to cost $150,000 you have inflation.
February 10th, 2009 at 1:12 am
Inflation is not measured by the price of one item but by the mix of items purchased by typical consumers and businesses. So long as such averages are going up at a moderate rates, it doesn’t really matter that particular items are going down in price (because of, for instance, technological improvements). So long as your money’s worth less in general tomorrow than it is today, you have the incentive not to hoard it.
And when we choose to use the CPI which ignores energy, homes, education, and medical expenses, all of which dominate the spending of the average person, what use is the measure?
Inflation clearly helps those who have the money first. If I have an extra trillion dollars, I can spend it into an economy that is not aware of that trillion dollars. Once I have spent it, the quicker the better, the economy then realizes there is an excess of money and inflates the value of each individual unit of money.
Deflation is the natural course of an economy. The only reason we see deflation in select products is because goods deflate and inflate at variable values, and some manage to beat the government induced level on inflation. By carefully choosing whatever basket of goods at whatever ratios we like we can produce a number that has no meaning beyond the hope that it supports the party currently in power.
Inflation isn’t a plot to secretly “tax away” money. The theory I laid out above has also been proven in practice– deflationary spirals have caused long depressions and recessions on multiple occasions.
The Federal Reserve was designed and written by 8 of the richest 10 men in America. To say it was not an effort to improve their own fortunes is asking too much of a set of men who have carefully used political influence and control to commandeer the most important resources of their time.
But guess what– YOU HAVE NO FRICKING RIGHT TO HOARD YOUR MONEY. Hoarding your money prevents other people from making use of it to grow the economy. It is a selfish betrayal of your obligations to society. And finally, bankers don’t get rich on inflation. They get rich on the spread of interest rates (as well as transaction fees). Indeed, if they don’t find people to loan your money out to at interest, they lose money.
It is interesting that economies ever grew without money, the end all of economic advancement if one were to listen to someone as blind as you. No, money is a means to properly allocate resources… it is neither necessary or particularly effective in it’s current incarnation. If a banker has trouble making money at 2% interest he can simply petition to government to lower the requisite reserve ratio so that on savings of 10 dollars he makes 100 dollars in loans for a 20% return. And so on, but don’t listen to me. We only called the crisis time after time, and told you what to do to fix it. That fact that you’ve yet to listen only brings more admiration for the capitalistic system that grows despite your best efforts.
February 10th, 2009 at 1:52 am
Eric-
FWIW, I am neither a Ron Paul supporter nor a gold standard loon. My point, and it is a valid one, was in response to the lunacy propounded on here that mild inflation is necessary for economic growth. Not only is it not, empirically, but it is not theoretically either. That doesn’t mean it isn’t part of the system in which we work, but it is hardly necessary for growth.
The mainstream economic view does not look kindly on inflation, and certainly does not look at it as part of the recipe for growth. Nor does it look on inflation as a way that the man keeps poor people down, or is that not what you meant by them putting forth the mainstream economic view. Of course, one of them put forth the theory that we had 35 years of recession in a 20 year period, but I suppose that is the mainstream mathematical view of time. Right?
Anyway, what they are saying is wrong from many points of view. Stable prices, or slightly down trending prices do not lead to less investment, only deflationary shocks do. We may be having one right now, as we did in the 30s, but the difference between that and moderate deflation is no different than the difference between moderate inflation and 70s type inflation.
Again, what I was responding to was this:
Making your money less valuable over time is the cost of a growing economy. People need to grow up and accept it.
I simply pointed out that there is loads of data showing it is not true. Literally hundreds of years.
Also this:
You are ignoring RISK. You don’t want ONE DOLLAR to remain in a mattress, but with deflation, putting the money in the mattress is RISK FREE in a way no other investment is.
Which is a complete misstatement of the concept of risk, and shows an almost total lack of knowledge of the determination of interest rates using any available model. As long as nominal risk free rates are positive, investment should not be curtailed by mild deflation. They simply make the real return on investment higher than the nominal return.
I do agree with you that Ron Paul types are as nutty as they come, but none of that excuses a complete lack of knowledge of economic history, interest rates, math and risk, at least in my opinion.
February 10th, 2009 at 2:08 am
To continue, it is worth noting that Hal Varian, chief economist at Google and formerly of Cal, whose Intermediate Micro book is still widely used, and whose Micro Analytics is quite popular for those of us who have actually gone past econ 101 says just about the same thing in this NYT Editorial. Deflation driven by supply is fine, but by demand, or by monetary shock, is terrible. Anyway, I am not arguing, as the linked article did, that deflation is good today. My first comment was this:
There are several kinds of ways to define deflation. Some are rather benign, even salutary, and others are not.
Varian says this:
Yes, cheap is good. Deflation itself isn’t necessarily bad; what matters is what causes the deflation.
Deflation is a symptom, not a disease. Just as a rosy complexion can be a sign of health or of a fever, deflation can be a sign of underlying economic strength or weakness.
Falling prices can arise from too much supply or too little demand. Having too much supply can often be a good thing, while having too little demand is almost always bad.
Maybe you ought to think about what is accepted in mainstream economics for awhile…
The entire article:
February 10th, 2009 at 2:08 am
Sorry, here is the link.
http://people.ischool.berkeley.edu/~hal/people/hal/NYTimes/2003-06-04.html
February 10th, 2009 at 2:15 am
Matt:
You are projecting. My side is supported iby every orthodox economist, the fed ,most politicians, and much of the private sector. Your side is supported by the kooks and is rejected by the modern science of economics as the modern equivalent of phlogiston and humours.
February 10th, 2009 at 2:37 am
Dilan:
What exactly is “my side?” That deflation can be good or bad depending on the causes, and that a long term trend of lower prices coming from increased production due to increased capital and productivity is the sign of a healthy economy? Do you consider Varian, who says the exact same thing, to be a heterodox economist? If so, why are his textbooks so widely used in both undergraduate and graduate programs across the country?
You are simply misunderstanding my point, and perhaps because you are used to dealing with Ron Paul Kooks. Stable money does not equal a totally rigid money supply, just a policy of disinflation, and, as I said originally, and as Varian said in his article, deflation can be a sign of health or of sickness, so it is not as monolithic as you make it out to be. Notably, he also referenced the same data I did in the article I linked, and gave the same explanation as to salutary and problematic deflation.
February 10th, 2009 at 2:51 am
Maybe I can interest you in some studies by those wacko kook economists at the NBER, Harvard and Rutgers who recently studied good and bad deflation and the differences between the two:
http://papers.ssrn.com/sol3/papers.cfm?abstract_id=509860
More on good and bad deflation:
http://deepblue.lib.umich.edu/handle/2027.42/47954
Anyway, the point was to add a bit of nuance to a discussion lacking any. I thought you guys were big on nuance over here
February 10th, 2009 at 11:27 am
Any of you econ 101ers going to modify your views here, and realize that there is, in fact, in the view orthodox economists beneficial and harmful deflation, and realize that inflation is not a priori necessary for any sort of economic growth, and that it needs to be seen as harmful or hurtful based on its causes and not its existence? Any of you going to go back on the view that:
Absolutely not. Anything that makes your money more valuable (or just as valuable) tomorrow than it is today is a terrible thing, because it encourages you not to invest or consume it. (And that also means that moderate sustained deflation is not possible, because ANY deflation will tend to spiral.)
and acknowledge the more reasonable view that:
There are several kinds of ways to define deflation. Some are rather benign, even salutary, and others are not. ?
February 10th, 2009 at 1:41 pm
Matt:
Is there an emperical example of this supposedly “good” deflation happening and being sustainable without leading to a reduction in investment and periodic panics? So far you’ve mentioned the late 19th Century, but that was bookended by two terrible deflationary spirals, so that doesn’t qualify. (Indeed, that’s exactly what the orthodox model predicts will happen.)
Meanwhile, 75 years of monetary theory and empirical data shows that moderate inflation is key to stabilizing the economy, and that you need the Central Bank to be able to jack up the money supply to fight recessions and crank it down to control severe inflation.
Finally, when you say that inflation is awful, what do you mean? Brazil-style inflation is surely awful, and every monetary theorist I know of thinks that it is worth controlling. But US-style inflation is not awful at all. So your dollars are worth less 10 years from now than they are now. Who the hell cares other than those on fixed incomes, and we can correct for that by including COLA’s in entitlements?
There is no reason other than a personal perversion and fetish why someone would want their money to be just as valuable in the future as it is now. Really, some people get erections looking at porn; other people get erections knowing that their money isn’t going down in value. But the rest of us don’t care and shouldn’t care.
So why not just have moderate inflation and avoid causing a latter day Panic of 1907 as the policies that you advocate would cause?
February 10th, 2009 at 2:09 pm
Well, that is a wholly different question. I do not believe that there are long periods on record of moderate deflation without eventual problems, though, on the other hand, there are no long periods on record of moderate inflation without subsequent problems, either asset bubbles, or high inflation, happening either. The assumption was, for awhile at least, that moderate inflation was a proper tool, and that the Phillips curve would always hold. That was clearly a mistake belief. There was, after that, a belief that very moderate inflation was sustainable, but two large investment bubbles later, we now question that precept. There is, I guess, no history of prolonged prosperity which comes without any negative side effects. I can’t think this should be incredibly surprising to anybody.
As for the evils of inflation, there are many. I am not sure I agree with you about wanting an asset to maintain value being a personal fetish. I try to shy away from normative views on such things. The pernicious effects of inflation tend to be more visible in business decisions and financial markets. Businesses tend to unwittingly consume capital, and markets tend to mistake inflationary profits for economic ones until they rediscover the fact that we are in a higher cost of capital environment. Neither of these are necessarily disastrous, but they are not helpful to society either.
The best of all possible worlds would include a Taylor rule or something similar to guide monetary policy, so that we would have better knowledge with which to plan and make decisions. Really, even better would be for a monetary system which mimicked a commodity standard in normal times, and came as close as possible to a pure interest rate environment unless we were in crisis. Unfortunately, economics is political, and there is often a political need for cheaper money. That isn’t something I feel I can analyze very well, as most of the concerns dealing with the political economy focus first on political philosophy and only then on the economic means necessary to achieve those goals.
February 10th, 2009 at 2:10 pm
Finally, you mistake what I said for advocating some policy. I am not. I was simply pointing out that deflation can happen for several reasons, demand, supply and monetary, and that these are not all signs of doom. They can be a sign of health. I don’t think we should promote deflation as policy, nor do I think we should promote inflation.
February 10th, 2009 at 11:45 pm
Really, even better would be for a monetary system which mimicked a commodity standard in normal times, and came as close as possible to a pure interest rate environment unless we were in crisis. Unfortunately, economics is political, and there is often a political need for cheaper money.
The need to arrest recessions (and, for that matter, to control severe inflation) is not “political”. People not working isn’t “political”. Businesses closing isn’t “political”.
Mimicking a commodity standard means we can’t manipulate the money supply to arrest the business cycle. And that’s just terrible because it means longer more severe recessions.
Indeed, the 75 years I was talking about were 75 years where we used our independent central bank to AVOID a depression. In contrast, when we had the equivalent of commodity backed money, we had great depressions all the frickin time.
Obviously, nothing smooths out the business cycle completely. But having an independent central bank smooths it out a lot. And since I prefer occasional short recessions to occasional long depressions, I oppose a stable currency with every fibre of my being.
February 11th, 2009 at 1:37 am
You are misreading what I wrote, but I have no idea if it is deliberate or not.
Mimicking commodity money unless in crisis means exactly what you suggest, and that is to have the flexibility to use monetary policy to avert recession or combat inflation, but not to use it for political means. By political means, I mean the two most common uses of inflation as policy. One is to fund war without having to raise taxes, and the other is to attempt to have a high wage rate policy which needs to allow for inflationary profits to keep businesses in business.
The first is as old as central banking, and can be seen clearly from at least the time of WWI in Austria Hungary to the current war. The second is a big part of the cause of stagflation in the 70s, as a policy of full employment with heavy unionization is nearly impossible to achieve without ending in runaway inflation. Long run Phillips curves and all of that.
As far as central banking and avoiding depression, it is a mixed record. Certainly the early years were not too promising, and a lot of the reason that we have had no further depressions is that we have simply renamed them as recessions, which was not a term used before the Great Depression. Nevertheless, monetary policy has been effective in many cases, and that is why it needs to be a clear option.
Personally, I do not share your preference for stability over growth, but again, that is a normative issue.
February 11th, 2009 at 2:41 am
One other thought…
You seem to mistake the concept of stable money. Perhaps that comes from learning economics outside of a university, or from arguing with too many Paultards online. Stable money =/= a rigid money supply. It means a stable price level, which could, in all reality, be somewhere between down half a percent and up a percent or two. It is really the underpinning of a market economy, and there have been as many articles written about it as perhaps any other topic. Friedman wrote some great stuff, his collaborator Anna Schwartz also edited a fantastic book on the subject. It isn’t really controversial stuff offline.
February 11th, 2009 at 4:07 pm
Mimicking commodity money unless in crisis means exactly what you suggest, and that is to have the flexibility to use monetary policy to avert recession or combat inflation, but not to use it for political means. By political means, I mean the two most common uses of inflation as policy. One is to fund war without having to raise taxes, and the other is to attempt to have a high wage rate policy which needs to allow for inflationary profits to keep businesses in business.
This is a solution to a non-problem, though. We have an independent Federal Reserve which means the politicians can’t touch the money supply. It’s a good argument for keeping it that way, but it isn’t a good argument for changing things.
Further, what you propose would just lead to arguments as to what constitutes an “emergency” that would justify countercyclical monetary policy, and would also prohibit the Fed from doing needed tinkering that might prevent the emergency in the first place.
It means a stable price level, which could, in all reality, be somewhere between down half a percent and up a percent or two. It is really the underpinning of a market economy, and there have been as many articles written about it as perhaps any other topic. Friedman wrote some great stuff, his collaborator Anna Schwartz also edited a fantastic book on the subject. It isn’t really controversial stuff offline.
As I noted above, deflation can never be sustained. It will always spiral. And moderate inflation keeps money moving through the economy. So there’s no reason to want stable prices, except to not have to tell your grandchildren how much less a bottle of milk cost in the good old days. So moderate inflation is better than the other two alternatives you propose.
Remember that while Friedman and Schwartz were accomplished scholars, they were also ideologues who believed that rich people should get to keep whatever they make. That had a lot to do with their opposition to inflation.
February 11th, 2009 at 7:44 pm
The graphs shows a misery index near 20% in 1933, compared with less than 8% today. That seems as strange answer to my piece, which had a wide variety of data such as real GDP, industrial production, peak unemployment rates, and mortgage interest rates.
The graph ends in 1933 for a reason — inflation was quite rapid in 1934-36 (arguably helpful because it reduced the real burden of Smoot-Hawley tariffs as well as debts and the dole). I’ll show what happened after 1933 in a cato.org blog soon. I never said or even implied the misery index was the sole measure of economic distress. What I said was that to prove this recession is worse that 1974-75 or 1981-82 we need more data and less hysteria. If you don’t like my data, where is yours?
February 13th, 2009 at 1:31 pm
So there’s no reason to want stable prices, except to not have to tell your grandchildren how much less a bottle of milk cost in the good old days. So moderate inflation is better than the other two alternatives you propose.
If you accept sentence one, then you make a convincing argument. Unfortunately for your argument, no orthodox economist accepts that the only problem with moderate inflation is a loss of purchasing power, and many would argue that this particular side effect is not one of the major costs, as real interest rates stay stable, so not much real purchasing power is lost. The problems of inflation are misallocation, inefficient taxation, and difficulties in estimating real profits.
You should take a lesson from a good left wing economist like Alan Blinder, and accept that there are real problems from moderate inflation, and then suggest that the problems from zero inflation are worse, even though real problems exist with both. Then you might be making a reasonable argument. As is, you simply assert something that isn’t so and build your argument on it.
February 14th, 2009 at 2:51 pm
The misery index was 14-25 percent from 1932 to 1942. That’s not low. So Judis is wrong to claim “the U.S. in the 1930s” shows “why a low misery index may indicate the onset of a depression.”
I put together a table showing 1926-42 inflation or deflation rates and unemployment, and their sum (the misery index).
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