EKIP– Expert Club for Economics and Politics A Different Opinion
In early January, Eurostat data were published, showing the first annual deflationary episode in the Eurozone since 2009 – the overall price level between December 2013 and the same month in 2014 fell by 0.2%. This sent the European Central Bank and a large group of Keynesian economists into a panic. The ECB decided to respond to what was happening with a plan to get out of the “dire situation”, which essentially consists of pouring more than a trillion newly printed euros into the continent’s economy, while Paul Krugman feverishly predicts an apocalypse from the pages of the New York Times.
What is the real source of the great deflationary fear? From a theoretical perspective, for some macroeconomists, the presence of falling price levels creates an incentive for consumers to postpone their consumption in anticipation of even lower prices. This is seen as particularly dangerous during economic crises, because it can further reduce aggregate demand - and as we know, falling aggregate demand is a major cause of crises according to Keynesian business cycle theory.
The above thesis is based on the idea that consumption can be postponed indefinitely in anticipation of lower prices/greater purchasing power, which, however, we know from experience to be impossible. Although there is consumption that can be postponed in time to take advantage of lower price levels, this only happens for a certain small range of goods and services. In fact, if this Keynesian understanding were correct, no one would ever buy computer equipment and new mobile phones - there prices are constantly falling, if we follow the logic the consumer should just sit and wait. Let's not open the topic of goods whose consumption by definition cannot be postponed - food, for example.
The episode of the Great Depression in the United States, where data show recession and deflation in one, also creates fear among certain economists. Because of this, and because of certain developments in the field, the two phenomena are perceived as related – i.e. deflation is seen as a cause (or at least as an aggravating factor) of recessions. However, historical data indicate different things, a large part of the economic growth of the United States in the 19th century was accompanied by deflation. As a study by the Federal Reserve itself shows, almost 90% of all episodes of deflation in the monetary history of the United States were not accompanied by recession. [1] Joseph Salerno also proves the same in one of his monographs from 2003 – economic growth and a negative consumer price index (which measures inflation / deflation) have existed together in many periods of economic history. [2]
Ultimately, the problem of deflation also touches on the broader question of the origin of the business cycle, or what actually causes economic crises and how they should be solved. While Keynesian economists see the problem in a lack of aggregate demand, which can be cured with active monetary policy and pouring trillions into the economy through central banks, the admirers of the Austrian school see credit expansion and the work of the same central banks as the source of bubbles and their inevitable bursting.
When, due to the wrong signals given to entrepreneurs by artificially low (by central banks) interest rates, resources are invested in bad investments (malinvestments) and this leads to boom, bust and the realization that many projects are not actually profitable, the deflation that occurs as a result is curative. It is part of the process of redirecting resources from bad investments to actually working projects. Is the decline in property prices after 2008 something illogical and should be stopped? No, it was clear to everyone that it was a huge sector bubble.
The truth is that deflation, like inflation, would be perfectly normal processes in a monetary system that does not include a central bank monopoly. And in fact, today deflation is dangerous especially for economies totally dependent on and mired in debt, as well as for those who drive and maintain this status quo.
[1] Atkeson, Andrew and Kehoe, Patrick. Federal Reserve Bank of Minneapolis. Deflation and Depression: Is There an Empirical Link?January 2004.
[2] http://mises.org/library/deflation-and-economic-growth
