The question should be, is inflation ever good? Deflation increases household income as prices go down. When the price of gas, food, or clothing decreases, ceteris paribus household income increases because expenditures are less monthly. The result is more disposable income and more savings. More savings equals more investment and long-term planning for productive endeavors.
I am getting a Ph.D. in monetary economics focusing on Knut Wicksell. He is the modern father of the economics of aggregate price stability; yet, in 1925, he conceded that deflation in times of increasing productivity is an equilibrium state. Some could argue this is debatable, but that is how Karl Uhr and David Davidson also read it. This is my view. However, if the historical figure who modern economist reference and connect their theoretical lineage to questioned the validity of price stabilization, there might be some credence to deflation as the goal. Letting prices deflate brings prosperity.
In economics, there are two schools of thought about the aggregate price level.
- The stabilizers
- Neutral money
What are the Price Stabilizers’ ideas?
Stabilizers are the consensus. They believe that a stable aggregate price level is good because it will result in a more optimal long-term economic growth path. On the surface, this seems to make sense. But think about it. Does it matter if one stabilizes the gas price at the pump daily? Prices should respond to supply and demand, not aggregate indices. What is the federal reserve decided to stabilize the rent price in your town? There would be a loss of consumer or producer surplus because of price controls. Aggregate price stabilization seems reasonable, but with a history from Wicksell to Lars Jonung (a remarkable economist from Sweden) or Michael Woodford (Real rate inserted in the DSGE model) and Holston, Laubach, and Williams (using a Kalman filter to estimate a price stabilizing neutral interest rate). They all revert to a NAIRU model that targets inflation and uses a Taylor rule. The net result is a loss of efficiency in an economy with growing productivity.
Neutral money, proposed by Mises and Hayek and perhaps Wicksell, argues that prices, particularly relative prices, should be allowed to adjust as they contain essential price mechanisms to convey information about consumers and investor intertemporal preferences.
What about the Great Depression? Exactly. Prices were not allowed to fall enough. Bubbles need to deflate for an economy to return to money macro equilibrium. Prices are information points that bring individual markets to equilibrium and the economy into a Warlsian General Equilibrium.
Which economists were against aggregate price level stability?
Besides Milton Friedman, several other prominent economists have been against the stabilization of the price level and have advocated for a monetary policy focused on controlling the money supply. Some of these include:
- Friedrich Hayek: Austrian economist and recipient of the 1974 Nobel Prize in Economics.
- Murray Rothbard: American economist and historian who was a leading figure in the Austrian School of economics.
- Jacques Rueff: French economist who was a prominent monetarist and advocate of the gold standard.
- Anna J. Schwartz was an American economist who co-wrote “A Monetary History of the United States” with Milton Friedman.
- Leland B. Yeager: American economist known for his contributions to monetary theory and international economics.
To not support the central bank’s idea about price level stabilization is an argument for deflation. As technology makes us all more efficient (yeah, right), we get better at producing more for less. The quantity supplied (of output) increases, and prices go down.
These economists, like Friedman, believed that monetary policy should be focused on controlling the money supply and that price stability would emerge as a result. They argued that attempts to stabilize prices through monetary policy could lead to unintended consequences and undermine the economy’s stability.
Deflation is a sustained decrease in the general price level of goods and services in an economy over a period of time. There are several arguments in favor of deflation:
It’s important to note that deflation can also have negative consequences. For example, falling prices can decrease demand for goods and services, as people may delay purchases in anticipation of even lower prices in the future. This can result in a vicious cycle of falling prices and decreased economic activity.
There are some economists who believe that deflation can be good for an economy under certain conditions. Some of these economists include:
Friedrich Hayek: Austrian economist and recipient of the 1974 Nobel Prize in Economics. Hayek believed that deflation could result from a reduction in the money supply, which can increase the purchasing power of money and promote economic growth.
Murray Rothbard: American economist and historian who was a leading figure in the Austrian School of economics. Rothbard believed that deflation could signify a healthy economy, as it indicates that the supply of money is increasing more slowly than the supply of goods and services. Rothbard as a person, was controversial in some of his views. However, is books on a monetary theory I can recommend. E.g., The Monetary History of the United States and the Great Depression.
Leland B. Yeager: American economist known for his contributions to monetary theory and international economics. Yeager was a monetarist who believed that monetary policy should be focused on controlling the money supply, and he believed that deflation could be a natural result of a stable money supply.
These economists argue that deflation can benefit an economy, leading to cost savings, encouraging saving and investment, and reducing the burden of debt. However, it’s important to note that deflation can also have negative consequences, such as decreasing demand for goods and services and leading to economic contraction. The view on the impact of deflation on the economy is a matter of ongoing debate among economists.
Thoughts on why deflation is good
Freedom: Less control. Let the markets decide prices, not a bureaucracy.
Cost savings: Deflation can lead to lower prices for goods and services, resulting in cost savings for consumers and businesses. This can increase purchasing power, allowing people to buy more goods and services for the same amount.
Encouragement of saving: Deflation can encourage saving, as people expect prices to be lower in the future. This can lead to higher savings, which can provide a source of funding for investment and economic growth.
The incentive for investment: Deflation can make investments more attractive, as the return on investment will be worth more when prices are lower. This can encourage businesses to invest in new projects and create jobs.
Debt reduction: Deflation can help reduce the burden of debt, as debt becomes easier to repay as prices decrease. This can benefit individuals and governments who have taken on significant amounts of debt.
It would be hard to have a thesis that argued for anything but deflation in times of growth and increased productivity.