February 25, 2015


The Price Paradox (Robert Skidelsky, 2/15/15, Project Syndicate)

 In 1923, John Maynard Keynes addressed a fundamental economic question that remains valid today. "[I]nflation is unjust and deflation is inexpedient," he wrote. "Of the two perhaps deflation is...the worse; because it is worse...to provoke unemployment than to disappoint the rentier. But it is not necessary that we should weigh one evil against the other."

The logic of the argument seems irrefutable. [...]

As British economist Roger Bootle pointed out in his 1996 book The Death of Inflation, the price-cutting effects of globalization have been a much more important influence on the price level than the anti-inflation policies of central banks. Indeed, the post-crisis experience of quantitative easing has highlighted monetary policy's relative powerlessness to offset the global deflationary trend. From 2009 to 2011, the BoE pumped £375 billion ($578 billion) into the British economy "to bring inflation back to target." The Fed injected $3 trillion over a slightly longer period. The most that can be claimed for this vast monetary expansion is that it produced a temporary "spike" in inflation.

The old adage applies: "You can lead a horse to water, but you can't make it drink." People cannot be forced to spend money if they have good reasons for not doing so. If business prospects are weak, companies are unlikely to invest; if households are drowning in debt, they are unlikely to go on a spending spree. The ECB is about to discover the truth of this as it starts on its own €1 trillion program of monetary expansion in an effort to stimulate the stagnant eurozone economy.

So what happens to the recovery if we fall into what is euphemistically called "negative inflation"? Until now, the consensus view has been that this would be bad for output and employment. Keynes gave the reason in 1923: "the fact of falling prices," he wrote, "injures entrepreneurs; consequently the fear of falling prices causes them to protect themselves by curtailing their operations."

But many commentators have been cheered by the prospect of falling prices. They distinguish between "benign disinflation" and "bad deflation." Benign disinflation means rising real incomes for lenders, pensioners, and workers, and falling energy prices for industry. All sectors of the economy will spend more, pushing up output and employment (and sustaining the price level, too).

The answer to Keynes's question becomes rather easy once you look at not having to have a job as a good instead of an evil.

Posted by at February 25, 2015 1:30 PM

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