Monday, November 17, 2008

Solving The "Problem" Of Deflation

Doug French has an article on LRC about deflation today, where he quotes the worries of people like James K. Galbraith, Arthur Laffer and Ambrose Evans-Pritchard about deflation.

Evans-Pritchard argues that deflation has the effect of causing people to withhold shopping because they wait for prices to go down and that it increases the burden of debt. It is true that all other things being equal price deflation will increase people's willingness to postpone purchases, but that is no different from the effects of higher nominal interest rates, and to the extent nominal interest rates fall with inflation it will have no effect. And seeing how people buy for example computers and mobile phones even though they have fallen in price for decades (especially in quality adjusted terms), there is no reason to believe the effect will be that large. And a limited degree of postponement of purchases really isn't that bad as it increases the pool of savings and the real money supply, and as people will eventually buy those things (as Keynes put it, in the long run we're all dead so eventually they're gonna have to buy them).

As for increasing the burden of debt, that is not really a problem relating to lower price but to lower income. In fact, given a certain level of nominal income, lower prices will increase the ability to pay back debts as they can use the money saved on lower prices.

It should finally be noted that if the government truly believed that deflation was a big problem, it is in fact easily solved. And by that I am not referring to the various schemes that the Fed has put in place. Nor even to Bernanke's infamous helicopter scheme. There is actually no reason to bother sending out a bunch of helicopters to distribute the money when there's an easier and far more effective way of solving this problem: legalize counterfeiting!

Pass a law saying that as long as the government considers deflation to be a problem, anyone who makes new notes/bills that are fairly well made will get away with it and these bills will then be considered legal tender and allowed to be part of the money supply. This should first of all create a lot of jobs in the printing press manufacturing industry and is a full-proof way of fighting deflation as people would soon have loads of money, something which would definitely cause prices to go up, which in turn would make people less willing to postpone purchases and dramatically reduce people's debt burden. Deflation problem solved!

But, wouldn't this create big redistributive effects as some will not be able to afford to buy printing presses and other necessary input* and perhaps make the people who print the most so rich that they might not bother do honest work anymore? Yes, indeed, it would. But the point here is that this scheme really differs nothing from the regular process of inflation, except in the sense that we here have regular counterfeiters that benefits instead of the government and fractional reserve commercial banks, and that different people can earn their living through the redistributive effects of inflation instead of productive works. So in other words, no argument (except perhaps the opinion that they like better the people who now benefits from inflation) can be made against this scheme that is not also an argument against inflation in general.

*=Another more egalitarian and even more radical version of this scheme would be to allow people who can't afford to buy printing presses and other necessary input to buy it on credit and pay back using the money they later print. But since that would clearly create hyperinflation, it is not as similar to the existing money creation process.

UPDATE: See also Bloomberg columnist Michael Lewis' patriotic offer to take $5 billion from the TARP in return for a pledge to quickly spend all that in cooperation with his wife and family and relatives, thereby quickly putting the money in circulation and thus boosting the economy!


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