Deflation Isn't Always Dangerous (article by my professor)

Economics Economics Questions
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My professor wrote this article a few years ago. It seems he was a Treasury Dept economist during the Bush Administration. We will be discussing this topic and his article tomorrow. Please take a look at it and offer your critique of it, particularly the last half of the first column where he mentions the dangers of deflation. I have my own thoughts on his article, but I have too much homework to do at the moment to type them out. I would appreciate it! http://uweb.txstate.edu/~db52/deflation.pdf

Mind you I don’t plan on going into the room as Mr. Knowitall and proselytize my view. I learned not to do that long ago, but I would like to raise questions and concerns that perhaps even he has never thought of.

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the article as a whole has much more good content than I expected.

his 3 points:

  1. deflation will get workers fired if they insist on high wages. this also reduces production, Note that later in the article he replies to this by saying deflation will reduce costs of production, so nobody gets fired and production continues.

The question is, there are two alternatives; One do nothing, let them get fired, and watch them come crawling back at a lower nominal, but possibly greater real wage, when they are broke. Why is this bad?

Other alternative: Inflate . Why will this help things? Unions insist on higher wages when inflation strikes. So that real profits are down, as are real costs, so the workers will get fired and production stop. Not only that, inflation notoriously and inevitably creates bubbles, leading us to messes like the one we are in we are in now, with unemployment and reduced production in spades. So that the cure of inflation will just exacerbate the diease.

  1. Deflation makes debt more onerous, which leads to an increase in delinquencies and defaults, and the poor long suffering banks lose money. Which will also make them stop lending, the silly dears.

Ahem. That’s the problem? Deflation will be bad for the banks? Because they are squeezing the debtors so hard the debtors will default? Nopers. Nobody is holding a gun to the bankers’ heads, forcing them to insist on the debtors being bled white. They are big boys, the banks, and will soon enough figure out what I already have. Mainly, if you are taking too much money in times of deflation, so much that it’s bad for your bottom line, then guess what? TAKE LESS. It’s that simple.

Of course I’m not suggesting that God forbid the banks give up a single penny of real profit. All they need do is ease up on nominal profits.

  1. With deflation, the central banks will have to charge zero interest. When they want to lower rates further, they won’t be able to. And then they won’t be able to help us all with new economic stimulus.

Now there is an argument that is charming in being wrong from every possible point of view.

What mainstream economists consider “economic stimulus” comes not from the low interest rate per se, but from the mountains of new printed money, whether on paper or electronically, that comes on its heels. Having lots of money to spend is what makes people spend. It’s not about the low interest rate.

Also, why should the govt/Fed meddle in the economy in the first place? The US constitution does not say they are allowed to. Plus, it’s not like they have done us any good. The purchasing power of the dollar has dropped by about 95% since the inception of the Fed.

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Thanks Dave