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Is There Really A Risk Of Deflation ?

by Doug Mataconis @ 2:01 pm on December 2, 2008.

Robert Higgs takes a look at the hysteria that seems to be building in the popular media over the risk that we’re entering a deflationary recession:

We are now hearing ominous warnings about imminent deflation. Checking the welcome page at AOL this morning, I see that the lead item in the financial news section heralds “The Looming Threat of Deflation.” This headline encapsulates two highly problematic ideas. The first is that deflation would necessarily be a bad thing. The second is that deflation is likely to occur in the near term

First, as Higgs notes, the idea that deflation always means economic downturns simply isn’t true:

“Notably, rapid economic growth occurred both before and after 1897; neither a falling nor a rising general price level was uniquely associated with economic growth.” To elaborate just a bit, the rate of economic growth from 1866 to 1897, a period of secular deflation, was perhaps the greatest ever experienced by the US economy during a period of comparable length. Real GDP grew by more than 4 percent per year, on average, notwithstanding the persistent deflation. So, even if you’ve not mastered the works of Ludwig von Mises and Murray Rothbard, even if you are a confirmed positivist in your methodological bent (as I was in 1971), you can see clearly that the rate of economic growth and the rate of price-level change have been independent, at least within the ranges of these variables in US economic history.

Second, as Higgs notes, there simply isn’t any evidence out there that real deflation is occurring:

If it does, its occurrence will surprise me greatly, because the Fed has been creating base money as if there were no tomorrow, and if the bailouts continue, as seems likely, more of the same is virtually certain. So far, the huge spurt in base money has simply been absorbed and held by the banks in the form of (legally) excess reserves, but the likelihood that the banks will sit on $268 billion of excess reserves forever is nil. Once they feel more secure, their loans and investments will go forth in search of a higher yield than the Fed pays them (since a recent change in policy) on their reserves, and at that point the banking system’s money multiplier will kick in with terrific force.

In short, given the monetary conditions now prevailing, the greater threat by far is inflation, not deflation. And contrary to what the investment “experts,” the politicians, and the mainstream economists believe, inflation is not a benign element in the economy’s operation. It is, as it has always been, the most dangerous and destructive form of taxation.

Given the amount of new money we’re plowing into the system, I’d be more worried about hyperinflation than deflation at this point.

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One Response to “Is There Really A Risk Of Deflation ?”

  1. Jaycee Says:
    February 19th, 2009 at 2:42 am

    i think we r right now experiencing the so called global crisis. as u can see . there r lots of work retrenchment and closing og big companies…..but then again if wqe try another method of eraning as u say. then why not i go with ur ideas sir.

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