The 'Deflation Danger' Should Abate …

What is it with this perennial fear the chief money printers have of falling prices? Not that we are likely to see it happen, but if it does, what of it? Bloomberg reports on the recent ECB decision with the following headline: Draghi Says Deflation Danger Should Abate as Economy Revives

The headline alone is a hodge-podge of arrant nonsense. First of all, 'deflation' (this is to say, falling prices), is not a 'danger'. Speaking for ourselves and billions of earth's consumers: we love it when prices fall! It means our incomes go further and our savings will buy more as well. What's not to love?

The problem is of course that when prices decline, the 'wrong' sectors of society actually benefit, while those whose bread is buttered by the inflation tax would no longer benefit at the expense of everybody else. But they never say that, do they? Has Draghi ever explained why he believes deflation to be a danger? No, we are just supposed to know/accept that it is.

Secondly, the 'as economy revives' part makes no sense whatsoever. Why and how should a genuinely reviving economy produce inflation? Economic growth occurs when more goods and services are produced. Their prices should, ceteris paribus, fall (of course, we are not supposed to inquire too deeply into which ceteris likely won't remain paribus if Draghi gets his wish).

 

From Bloomberg:

 

“ European Central Bank President Mario Draghi signaled that deflation risks in the euro region are easing for now after new forecasts showed that inflation will approach their target by the end of 2016.

The news that has come out since the last monetary policy meeting are by and large on the positive side,” he told reporters in Frankfurt today after the central bank kept itsmain interest rate at 0.25 percent. He also indicated that money markets are under control at the moment, lessening the need for emergency liquidity measures.

Draghi is facing down the threat of deflation in an economy still recovering from a debt crisis that threatened to rip it apart less than two years ago. New ECB forecasts today underscore his view that the 18-nation bloc will escape a Japan-style period of falling prices as momentum in the economy improves.”

 

(emphasis added)

We have highlighted the sentence above because we keep reading about the 'Japan-style deflation trap' for many, many years now. You would think that Japan was a third world country by now the way this keeps being portrayed as a kind of monetary evil incarnate that destroys the economy. Of course, nothing could be further from the truth.

 

Inflation is Not Equivalent to Economic Growth

'Inflation' is not the same as 'economic growth' – on the contrary, it both causes and frequently masks economic retrogression. How much inflation has there been in the euro area over time? Let's have a look.

 


 

Euro Area TMS-a

The euro area's true money supply since 1980. One can only shudder at this depiction of 'deflation danger' in action – click to enlarge.

 


 

What about prices though? Let's have a look-see:

 


 

HCPI-LT-wow chartSince 1960, there was exactly one year during which prices according to the 'CPI' measure actually fell, namely in 2009, by a grand total of 0.5% – click to enlarge.

 


 

As Austrian economists have long explained, it is simply untrue that prices must rise for the economy to grow. Consumers obviously benefit from falling prices (only Keynesian like Paul Krugman don't realize that, as their thought processes are evidently unsullied by logic and/or common sense). All of us can easily ascertain how beneficial the decline in computer prices, cell- and smart phone prices, prices for TV screens, etc. is. Naturally, it would be even better if all prices fell, not only those on a select group of consumer goods.

What about producers? Won't they suffer? By simply looking at the share prices and earnings of the companies that make all the technological gadgets the prices of which have been continually declining for decades, everybody should realize immediately that the answer must be a resounding NO. This is by the way not only true of the firms that are in the final stages of the production process, i.e. the stages closest to the consumer. It is obviously also true for the firms in the higher stages of the capital structure. But why? It is quite simple actually: prices are imputed all along the chain of production. What is important for these companies to thrive are not the nominal prices of the products they sell, but the price spreads between their input and output.

In fact, the computer/electronics sector is the one that comes closest to showing us how things would likely look in a free, unhampered market economy.

Of course, in said free, unhampered market economy, Mr. Draghi and a host of other central planners would have to look for a new job.

 

Charts by: ECB


 

 
 

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6 Responses to “No, Deflation is Not a ‘Danger’”

  • Vess:

    Pater, I am not saying that you are wrong, but it’s a bit more complicated than you make it sound.

    In a genuinely growing economy, the total amount of credit grows (not just the amount of produced goods) – because businesses are taking loans to develop further, as they think that the “good times” will persist for at least a while longer. Under a fiat money system and fractional reserve banking, credit and money are essentially interchangeable. So, a healthy growing economy tends to experience a healthy level of “inflation”.

    This is a fact. The problem is that Keynesians tend to draw all the wrong conclusions from this objective fact.

    For instance, they tend to think that economic growth and a certain level of inflation are interchangeable and even that inflation is a precondition (or at least an indication) for economic growth. So, they try to “spur up” a stagnant economy by creating inflation.

    They are completely oblivious to the following problems:

    1) They tend to put the cart before the horse. Economic growth causes some inflation under the stated circumstances – but increasing inflation artificially won’t lead to growth.

    2) Nobody can tell what the “healthy level of inflation” really is. Too much inflation will obviously kill the economic growth.

    3) Economic growth and inflation tend to occur simultaneously only under fiat money and fractional reserve banking. Remove those and you can have economic growth without any inflation.

    There are some other problems with your reasoning.

    For instance, as you have argued yourself elsewhere, Japan is a straw-man argument because it isn’t really deflating. The true money supply there has been growing steadily during all these two decades of “deflation”, albeit at a relatively slow pace.

    Also, it can be argued that the high-tech industries are prospering because of the increased productivity and innovation – i.e., that they are doing this DESPITE the negative effect of falling prices, not because of them.

    • worldend666:

      >>Also, it can be argued that the high-tech industries are prospering because of the increased productivity and innovation – i.e., that they are doing this DESPITE the negative effect of falling prices, not because of them.

      I don’t think anybody would disagree with that statement. However the falling price level in high tech industries demonstrates something very important empirically about deflation, and that is that consumers are happy to purchase goods even when they expect lower prices in the future. The chief argument by the deflation fear mongers is that constantly falling prices will lead to some kind of trap where consumers will hoard rather than spend, leading to further price drops. Such a downward spiral did not develop in the high tech sector.

  • Kreditanstalt:

    “Why and how should a genuinely reviving economy produce inflation?”

    If a natural resource necessary to the production process is being depleted (with demand increasing, not falling or falling more slowly), one could expect (price) inflation. Possibly, too, if technological improvements (which tend to increase productivity & reduce cost) fail to materialize in a product one could expect the price of that product to at least remain stable.

    Just guessing. But these may also occur in any economy, not merely “genuinely reviving” ones…

    • worldend666:

      >> if technological improvements (which tend to increase productivity & reduce cost) fail to materialize in a product one could expect the price of that product to at least remain stable.

      In this case there would not be economic growth

      >>If a natural resource necessary to the production process is being depleted (with demand increasing, not falling or falling more slowly), one could expect (price) inflation.

      This is overheating surely? It describes the process where economic growth has reached it’s limit.

      • Kreditanstalt:

        Well, an example is OIL…not perhaps yet “depleting” but certainly becoming more costly to extract. At over US$100/bbl. that alone will cause price inflation down the line.

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