Wednesday, January 14, 2009

Falling Prices Are the Antidote to Deflation (George Reisman)

Professor George Reisman gives an excellent primer on the relationship between falling prices and deflation:

Down to One CentA disastrous economic confusion, one that is shared almost universally, both by laymen and by professional economists alike, is the belief that falling prices constitute deflation and thus must be feared and, if possible, prevented.

The front-page, lead article of The New York Times of last November 1 provides a typical example of this confusion. It declares:

As dozens of countries slip deeper into financial distress, a new threat may be gathering force within the American economy — the prospect that goods will pile up waiting for buyers and prices will fall, suffocating fresh investment and worsening joblessness for months or even years.

The word for this is deflation, or declining prices, a term that gives economists chills.

Deflation accompanied the Depression of the 1930s. Persistently falling prices also were at the heart of Japan's so-called lost decade after the catastrophic collapse of its real estate bubble at the end of the 1980s — a period in which some experts now find parallels to the American predicament.

Contrary to The Times and so many others, deflation is not falling prices but a decrease in the quantity of money and/or volume of spending in the economic system. To say the same thing in different words, deflation is a general fall in demand. Falling prices are a consequence of deflation, not the phenomenon itself.

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1 comment:

Anonymous said...

The real goal in this crisis should not be inflation or deflation. The real goal of the Government in this crisis should be to prevent or, at least, retard the further downward slide in the standard of living of the majority of the people. The question is: Is Bernarke too much the intellectual to be able to see what his real goal should be?