Saturday, December 27, 2008

Deflation Boosts U.S. Economy

Because it was released on Christmas Eve, when most people including me were focused on other things, the November personal income- and spending report for the U.S. didn't attract much attention. Yet it contained some interesting news.

Despite the fact that the savings rate rose significantly, real consumer spending rose as much as 0.6% in November, following 5 straight months of declines. This means that the economy probably didn't contract as much as most people have believed, though it will still definitely contract.

But how could real consumer spending increase even as the savings rate rise? Simply because real household income rose sharply, by 1.1%, which is a lot for a single month (at an annual rate it's roughly 14%). And why did it rise so much? Because of deflation, as the price index fell by 1.2%. The deflation during that month thus provided a significant boost to the purchasing power of U.S. consumers and so to the entire economy.

This is not meant to suggest that deflation can't in other circumstances have a contractionary effect. But it clearly illustrates that this is not always the case and that deflation thus can have a positive effect, something which is usually neglected by non-Austrians.


Blogger Aragon said...

Even mainstream historians occasionally admit that real consumption can increase during massive deflation and during liquidiation of unsound businesses.
Here is how Murray N. Rothbard described the great deflation of 1839-1843 in his book "History of Money and Banking in the United States" (p. 103), using data collected by Peter Temin:

"But didn’t the massive deflation [of 1839-1843]have catastrophic effects—on production, trade, and employment, as we have been led to believe? In a fascinating analysis and comparison with the deflation of 1929–1933 a century later, Professor Temin shows that the percentage of deflation over the comparable four years (1839–1843 and 1929–1933) was almost the same. Yet the effects on real production of the two deflations were very different. Whereas in 1929–1933, real gross investment fell catastrophically by 91 percent, real consumption by 19 percent, and real GNP by 30 percent; in 1839–1843, investment fell by 23 percent, but real consumption increased by 21 percent and real GNP by 16 percent... Temin properly suggests that the reason can be found in the downward flexibility of prices in the nineteenth century, so that massive monetary contraction would lower prices but not particularly cripple the world of real production or standards of living."

8:44 AM  

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