A “consensus” opinion among economists is that deflation is an evil greater than inflation. Unfortunately, this conventional wisdom has had a pernicious effect on economic policy in much the same way that the global warming “consensus” has distorted climate policy.
But it is no coincidence that in both instances, the main beneficiaries of the outcomes from the selected policies are the operatives of governments. In the case of climate change, governments support research that encourages them to expand their regulatory powers & their sources of tax revenues.
When it comes to inflation, gains to governments come from the fact that they tend to be the largest net debtor in any community. Inflation is advantageous to spendthrift politicians & bureaucrats in reducing the real value of debt repayments. & all the rest of us that save or lend to governments will have lower living standards.
Recently, governments have been aggressively “reflating” their respective economies with “stimulus” spending financed with public-sector deficits & rising debts. & most central banks pursued expansionary monetary policy or pushed interest rates down to historically-low levels. (In the US & Japan, these are at hysterically-low levels, close to zero!)
Economic froth & illusory growth from artificially-cheap credit & massive government spending makes politicians & central bankers leery of being blamed for ending the party. As such, it is tough for them to implement exit strategies that dampen spirits even though it is unlikely that such plans were ever concocted before they embarked on that path.
And so, it is very likely that public-sector spending orgies & artificially-cheap credit tend to lead to rising price levels. Well, there is one other option: sovereign default as Argentina has done several times & as Greece may be forced to undergo. With so much new public-sector debt to fund bail-outs & pay for deficit-financed spending amidst shrinking tax revenues, public-sector defaults seem inevitable in the future.
With falling price levels working against the interests of governments, public-sector officials have strong incentives to halt this process. Given the incentives that public officials face, it is no surprise that inflation occurs much more frequently, lasts longer & has destroyed more wealth than has deflation. With rising price levels working in favor of governments, public-sector officials have weaker incentives to halt this process that constitutes an invidious & destructive tax.
For its part, deflation has reared its ugly head in a few spectacular moments while also being blamed for problems not of its making. For example, the Great Depression is often cited as the worst-case scenario of a deflationary spiral. More recently, claiming that Japan’s economy is in the grips of deflation, the Bank of Japan has pursued a “zero-interest rate” policy along with inflating the money supply.
But considering deflation to be declining price levels, it may be the messenger rather than the cause of economic problems. & it may be the bearer of glad tidings when secular price declines occur due to rising productivity so that overall living standards rise.
It is instructive to note that prior to the Great Depression & the collapse of Japan’s economy in the late 1980s that asset prices overshot their long-term trend. As such, it would be natural for there to be widespread decrease in prices so that they could be realigned with economic fundamentals.
Unfortunately, policy makers in these two instances tried to prop up prices rather than allow the liquidation of ill-fated investments. In turn, it took longer for markets to shake off the impacts of “bubbles” so that economic pain was unnecessarily extended. As such, it is distressing that a similar set of policy choices were made in response to the recession that began in 2008.
It turns out that Japan’s government & central bank have spent almost 20 years tilting against the windmill of so-called deflation when they should probably have embraced it. As it is, demographics are trending in a way that should make deflation the preferred option for Japan’s citizens. With average age rising, an increasing number of retirees on fixed incomes are being supported by a smaller number of workers. As such, deflation will be increasingly advantageous for an increasing proportion of Japanese society.
Policy responses to the current economic conditions provide us with another opportunity to discover the impact of expanding the role of governments in the economy. In most instances, policies that allow deflation to run its course will lead to lower price levels & a lighter tax burden with less regulation. & policies that promote inflation will lead to rising price levels & a heavier tax burden with more regulation
This is all very disheartening. Government officials can be expected to follow a path that makes their lives easier while shifting enormous burdens to citizens & taxpayers. Meanwhile, Mainstream economists will queue up to support more government spending, higher taxes & increased regulations.