1. Skip to navigation
  2. Skip to content
  3. Skip to sidebar
Source link: http://archive.mises.org/10489/bernankes-apoplithorismosphobia/

Bernanke’s Apoplithorismosphobia

August 19, 2009 by

Fed Chairman Ben Bernanke, like most mainstream economists, has an irrational fear of deflation — whether it is understood as falling prices or a contracting money supply. I have coined the term “apoplithorismosphobia” for this psychological malady. In contrast, average Americans love deflation whether it’s at Wal-Mart, in the Cash for Clunkers program, or from the tax credit for first time home buyers. Austrian economists love most forms of deflation too, and we think it is the ultimate cure for economic crises.FULL ARTICLE

{ 47 comments }

Bruce Koerber August 19, 2009 at 8:39 am

Economic Numbskulls
Tuesday, August 18, 2009

Deflation Is Not The Big Bad Boogeyman!

Like with most economic issues there is very little true understanding. It may seem odd but almost all trained economists just regurgitate what they were taught. They do not delve into theory to try to find coherence. One reason is because they have been taught the empirical methodology so almost instantly they would be submerged in mathematical gibberish that has no coherence.

And so what remains is a covey of academic, economic imbeciles who regurgitate Keynesian doctrine. ‘Prices are sticky downwards’ is some supreme law in Keynesianism and anything that would disrupt that ‘great law’ would cause great havoc!

To ask questions about why deflation is a bad thing causes these economic charlatans to leap into a fog of pseudo-political discussion to cover their economic ignorance and as a diversionary tactic.

Deflation is as natural as your exhale.

Don’t hold your breath waiting on economic wisdom from the empirically trained ego-driven interpreters or the ego-driven interventionists!

Christopher August 19, 2009 at 8:54 am

The Austrian way of thinking will only come into fashion if the world rejects US debt. Our gov’t will do almost anything to insure that there is no alternative to US Treasuries.

My apologies for being the pessimist.

Jonathan August 19, 2009 at 9:04 am

If Bernanke ‘went Austrian’ there would be social chaos. I am Austrian but do not think we can flick the switch and have beneficient deflation without catastrophic consequences. People have lived for generations now under a fiat system and have reasonably responded by accumulating debt. To change the rules on them overnight when the majority are now in debt would lead to asset price collapse, mass debt defaults etc etc which is not the same as deflation from productivity gains, eg. cheaper laptops.
I think the most pragmatic way of getting from ‘here to there’ so to speak would be a gradual removal over a long period of time of the Fed, unbacked dollar, state etc. as in a country where the majority are indebted, no one will support a reversion to hard money overnight.

jgo August 19, 2009 at 9:18 am

Mark Thornton wrote: “The key thing is that the price of producer goods has to fall faster and farther than consumer goods for the correction process to proceed.”

Why do you say this?

I see nothing in the article to support the assertion.

2nd Amendment August 19, 2009 at 9:30 am

It’s terrible what deflation did to the computer industry.

Back in the good old days of 1950, a computer costed an average $20 Million dollars in that times money and was only about as powerful as a simple pocket calculator and did not even have a monitor, results were printed on pieces of paper. Plus you had to hire operators to flick the different switches because there was no programming languages yet.

You had to use heavy air conditioning and cooling system because the system ran hot and you had to keep a few technicians in the room all the time because every few minutes a tube burnt and had to be replaced.

Today, for about $400 in today’s deprecated valueless money, I can buy a Dell mini notebook with Linux pre-installed and roam the internet with my high-speed wi-fi, download music, upload my homework to my university’s servers, I can follow my investments at the dow-jones, check the weather, chat with colleagues, find customers for my services, book hotel reservations, order a pizza, play super realistic videogames in 3D.

It’s incredible all the horrors and the misery that deflation in the computer sector did to me.

Yup, those mainstream economists are absolutely right, deflation is the enemy and must be stopped.

Mark Thornton August 19, 2009 at 9:55 am

Its a technical point concerning producer goods vs. consumer goods. The price of capital goods will fall faster during a crisis than consumer goods because the demand for capital goods falls faster than for consumer goods. Notice that this creates profit opportunities for entrepreneurs because the cost of the “means” is falling relative to the “ends.”

Russell August 19, 2009 at 12:32 pm

I can understand Bernanke’s fear of deflation from the political standpoint (and Congress holds the sword of Damocles over the head of the Fed). The economy has been built on leverage at all levels from Wall Street to Main Street. Yes it is unhealthy but is is the source of pressure on the Fed and the government to do something fast to ameliorate the pain. That is why the Fed is trying to bring the correction in with a soft landing by using stimulus.

Of course, if one believes, as I do, that there are underlying economic laws as described by the Austrian School that one cannot defy without big costs, then you do not believe that this will lead to a healthy readjustment.

If you believe that government intervention can save the day, or your problems are being addressed by the government, then are in favor of it.

Bruce Koerber August 19, 2009 at 2:08 pm

Does the fiat spider suck the life-blood of its victims?

bobobberson August 19, 2009 at 3:08 pm

Here is my conversation with an economist about deflation. my questions are first and the economist answers are in ‘brackets’ >>>>>
————————————————-

Why is deflation bad? Certainly severe price swings either way are bad, because it impairs people’s ability to predict what will happen in the future and plan appropriately, but why is a slight deflation a problem and so feared by people in the media?

>>>> At the core is that we are a consumption based economy. In general, lower prices are good but when you have a general decline in all prices across virtually all markets people begin to wait to make purchases. If you actually look at computer sales data you will see that people actually did hold off buying machines b/c they knew the new product cycle would deliver a newer (higher quality) machine at the same, if not lower price. But there is the catch – we knew when the product cycle was going to change or when new cars were going to come out. Even though it may have been delayed somewhat people entered the market place. Now we are in the situation were consumers have no clue on prices will hit bottom. Add in the general uncertainty of what is going on in the economy and consumers are on the sidelines – bad for GDP since it is so dependent on consumption. There is a significant behavioral aspect to this self-feeding, downward spiral. I agree, it isn’t rational but it is human psychology. >>>>

—————-
I have heard that deflation is bad because people will then save their money, and will not purchase items, which will cause people to lose their jobs, and cause them to save more and its a “trap” (a problem with positive feedback i.e. makes itself worse) and a downward spiral. I do not see this fear holding up logically, personally, or historically.

A) Logically: Price reductions in are often inducements to purchase. Consumers will respond with lower prices by purchasing. Increased purchases allow businesses to enjoy economies or scale combined with reduced material costs. Increase business allows more people to become employed, more people employed leads to a tighter job market with lower costs, which could produce higher real-wages, which would produce inflation. The competition for cheap resources would then again increase the price of those resources preventing a spiral of inflation. So it is at least possible that deflation will fix itself without massive spending.

>>>>>> Agreed, but not when people perceive that prices will continue to fall. The fall in consumption and the resulting drop off in business will cause layoffs, as you are seeing take place now with a slowing economy (even though deflation really isn’t the issue at the moment). Everyone, including business, face lower material costs but they aren’t producing b/c few are buying. At the end of the day the lower input prices won’t do much. They are low because demand has decreased. >>>>>>

———————–
B) Personal Finance: On a personal level if the iPhone was lowered to $50 dollars I would immediately go out and buy one today. The housing decline induced me to buy a house on sale, if cars get cheaper I will probably buy a new one.

>>> Deflation tends to help people on fixed incomes and hurt those carrying debt (which is most Americans). We are seeing tremendous deflation in housing prices – great if you are a buyer but bad if you are an owner with little equity. While your example is correct that they might be able to pay down debt faster that will not, in the case of housing, prevent people that are underwater from just walking away.>>>>>

——————————————–

C) Historically: Henry Ford and the entire history of nearly any consumer good. Henry Ford consistently lowered his price and that increased demand for the Model T, which in turn allowed him to obtain better efficiencies, lower costs, AND pay his workers more. The long decline in computer prices has mirrored the model T. It was lower prices that lead to increased demand for computers and greater efficiencies in manufacture which lead to even lower costs. Lower cost computer and cars both allowed for increased efficiencies in other areas of the economy, how did the long deflation in prices of commodities, computers, or cars destroy America? Where has a country experienced long bouts of deflation (although governments can interrupt the markets and prolong recessions) and what was the damage? I have seen several cases of hyper-inflation destroying a country and its people, but the periods of slight deflation in a country do not appear to be as destructive.

>>>> A little bit of inflation is better than deflation and certainly hyper-inflation. These goods prices didn’t fall because of the general decline in prices in the economy. These prices, for these goods, fell because of production efficiencies, new technologies, etc etc. You are confusing moving down the long run average cost curve with a decline in the overall price index for an economy. One is good, the other is really bad. Commodities are a different animal than the products in that they are a traded commodity and fluctuate with supply and demand (and speculation). Certainly, price inflation in commodities hurts consumers – look at the run up in oil and gas. Lower commodity prices certainly help. In these cases, it is usually where discretionary income gets spent. More for gas, less for other things. Less for gas, more for other things. Again, this is one singular market in the overall economy. In general, you are focusing on micro-examples in order to justify macro moves.>>>>
———————–

Specifically how would you respond to the examples posed in this article:
http://mises.org/article.aspx?Id=1241

>>>> Ahh, Mises…good old Austrian Economists…article isn’t incorrect, lower prices are good. Where I think they fudge over is the behavioral aspect of deflation. Experimental economists and behavioral economists have shown that folks just won’t spend…at the end of the day it is all about expectations. Your logic and thinking is not incorrect. It really is just a fundamental break-down of the “rational economic being” that economists like to use.>>>>>

Thanks, Please let me know where I error in thinking deflation is fine. I like your class and these economic issues interest me.

Micah August 19, 2009 at 3:19 pm

Yes, Bruce, it does, but not before paralyzing said victim and putting off eating it until later, letting it digest in the mean-time.

Robbie Clark August 19, 2009 at 3:51 pm

I don’t think you made any errors bobberson. The economist’s errors were numerous though. I’d ask him how he thinks the steady inflation and price increase has been a good thing for our economy and that perhaps he should look at the problems we are currently experiencing. He seems like a level-headed guy, but also a bit caught up in his own and his field’s wisdom and omniscience.

“>>>> A little bit of inflation is better than deflation and certainly hyper-inflation. These goods prices didn’t fall because of the general decline in prices in the economy. These prices, for these goods, fell because of production efficiencies, new technologies, etc etc. You are confusing moving down the long run average cost curve with a decline in the overall price index for an economy. One is good, the other is really bad. Commodities are a different animal than the products in that they are a traded commodity and fluctuate with supply and demand (and speculation). Certainly, price inflation in commodities hurts consumers – look at the run up in oil and gas. Lower commodity prices certainly help. In these cases, it is usually where discretionary income gets spent. More for gas, less for other things. Less for gas, more for other things. Again, this is one singular market in the overall economy. In general, you are focusing on micro-examples in order to justify macro moves.>>>>”

Gobbledy-gook. He states a few things in this paragraph, but logic is completely absent in the defense of his claims. I’d ask him how anything in that paragraph specially relates to commodities but not things like houses or food.

“>>>> Ahh, Mises…good old Austrian Economists…article isn’t incorrect, lower prices are good. Where I think they fudge over is the behavioral aspect of deflation. Experimental economists and behavioral economists have shown that folks just won’t spend…at the end of the day it is all about expectations. Your logic and thinking is not incorrect. It really is just a fundamental break-down of the “rational economic being” that economists like to use.>>>>>”

Elitist economist garbage. Concerned with what he thinks the numbers should be only. The implications of that statement are that the economy will be completely destroyed and never recover if we allow deflation to happen. You should ask him again your question about deflation destroying countries. He did not answer it, but that doesn’t matter to economists because it’s not what their models predict. As if human written computer models are the true forecasters of reality.

greg August 19, 2009 at 3:56 pm

Do not confuse deflation with increases in productivity or technology. For example, the decrease in the cost of your computer or flat screen TV is not the result of deflation, it is the result of constant advances in technology and productivity.

Do not confuse deflation with the huge price spikes in commodities due to over speculation in the futures markets and then the huge price fall due to over shorting of the same markets. Oil rising to $150 a barrel and then falling to $35 effects the prices of most goods and services. And it is that price decline that gave the government a free ticket to increase the money supply to fight this “deflation” which was in fact a return to normal.

Like inflation, deflation is a general adjustment to the prices of goods. Notice I did not say wages. And there lies the problem with deflation, you don’t see a general decrease in wages. If the government and unions would allow wages to adjust down to reflect the decrease in the CPI, there would be no problem. But I live in the real world and I can tell you that general wages will not fall.

Deflation without an adjustment in general wages does have a negative impact on productivity advances as capital investment falls off with the rate of deflation. And it is that impact on real growth keeps an economy from advancing.

Finally, cash for clunkers and the first time home buyer credit in nothing more than a tax cut. And in my book, a tax cut is a good thing. The house credit actually brings more taxes into the economy than the government gives up. Average out all new construction and existing homes, you will find about 30% of the sales price goes to direct taxable wages. On a $100,000 house, that is $30,000 and $10,000 in federal, state and FICA taxes. That does not include any indirect wages.

Ghost August 19, 2009 at 4:10 pm

I’ve always wondered why these so called economists decrying the evils of deflation not make the logical leap (according to their theory) and say inflation will lead to mass shortages. After all, why wouldn’t businesses, in an inflationary environment, wait to sell their inventory until prices have risen? What nonsense!

Robbie Clark August 19, 2009 at 4:17 pm

Actually, inflation and deflation are the rising and lowering of the value of money, respectively. This is caused by the increase or decrease in the supply of money, respectively. You could ask the economist about that as well bobobberson.

If he disagrees with that definition ask him how it’s possible that the value of money changes without changing its supply. I’d like to hear that answer.

waywardwayfarer August 19, 2009 at 4:41 pm

bobbobberson:

Your economist friend is talking a lot of nonsense. What does he mean by “a decline in the overall price index of an economy” vs. prices declining because of increasing efficiency of production? If the production of most or all goods is steadily and simultaneously becoming more efficient, then a general decline in prices must result. The “good” deflation, occurring throughout all sectors of production, can cause the “bad” deflation? That’s nuts.
I’m tempted to make some assumptions that the “bad” deflation is that caused by a contraction of the money supply, which would at least clearly distinguish it from price deflation caused by increased efficiency of production. Even so, the labeling of it as “bad” is based upon a fallacious conflation of correlation and causation: Deflation accompanies recession or depression, and is present alongside the economic hardship, therefore, deflation caused the hardship. Of course anyone familiar with Austrian econ knows that deflation during a recession/depression is not a cause, but itself a symptom of previous inflation, not to mention a necessary correction of it.

He says the economy is “consumption based” – essentially stating that we consume in order to produce. Of course this is bass-ackward. We produce in order to consume. It might seem an innocuous-enough statement, but all sorts of mischief springs from that fallacy.

In his assumptions about purchasing decisions, he’s completely overlooking time preference. A good now is more valuable, all else being equal, than a good in the future. People know full well that in six months they can buy a computer twice as powerful as the one currently available for half as much money. Does this mean that people will forever put off buying a computer? Of course not! They will buy when they consider the utility they would gain from it in the present to exceed the savings they would reap by waiting.

Presumably, there are some instances in which people might defer purchasing an item for reasons of declining prices. The decline must be both expected and exceptional relative to the normal rate of change. Even then, a high enough time preference can render it a moot point. I know that the price of fresh strawberries drops precipitously in June, but if I want some in November, the odds are good that I’ll pay the higher price to have them then rather than wait for that expected drop.

Mike Sandifer August 19, 2009 at 4:44 pm

There is a big difference between the temporary discounts offered under the cash for clunkers program, the credits for homebuyers, and deflation. There also a big difference between deflation caused by increases in productive efficiency, as seen in consumer electronics, and economy wide deflation due to a simultaneous collapse in aggregate demand and investment.

The discounts in the cash for clunkers program are temporary, hence do not create expectations of continued deflation in new car prices. Hence, this isn’t even price deflation. These are just discounts. Otherwise, with expectations of continued falling prices, consumers would start to delay purchases of cars, waiting for further price declines, which would leave larger inventories and further price declines…This is a self-feeding process.

Likewise, the housing credits offer discounts on houses, without expectations of further price deflation for the foreseeable future.

Deflation due to increased efficiency in meeting consumer demand, such as with consumer electronics sometimes causes purchase delays, but new features often more than offset this otherwise spiral down in prices and demand.

Economy wide deflation, in which both consumption and investment contract in a feedback loop leads to depressions. Prices continue to fall as consumers delay purchases and increase savings, causing cuts in investment and production and leading to layoffs throughout the economy, which just further hurts aggregate demand and leads to yet more deflation. This can lead to unemployment figures and drops in consumption out of all proportion to the malinvestment during the boom.

This is seen by most modern economists as a situation in which there is a shortage of money in the economy. Consumers, producers, and often banks want to hoard, meaning increasing the money supply can get the economy moving again. As opposed to self-feeding increasing unemployment, inflation reduces real wages and the value of real debt, allowing people to work harder for less money and those who issued too uch credit to take a haircut in the purchasing power of their interest and principle payments.

To make this work, the Fed always has to have a nominal GDP target, such that monetary expansion replaces diminished ouput growth to maintain employment and adjust debt repayments. When output growth picks up again, the money supply is proportionally contracted.

Interest rates don’t rise much during times like this, because the money isn’t making into the general economy due to the liquidity trap. This is, again, in essense a relative shortage of money with respect to demand, so more quantitative easing is justified.

Examine Australia’s monetary policy over the last 15+ years and see how well they’ve fared with a similar approach.

Mike Sandifer August 19, 2009 at 4:50 pm

I should add that the decrease in real wages for workers and in the real debt owed is how the credit overextension during the booms is worked off. How does it make sense to try to work this off with high unemployment? The Austrian approach just does not make sense, and worse, it doesn’t fit the data.

waywardwayfarer August 19, 2009 at 5:14 pm

Mike Sandifer:

I’m afraid you’re also guilty of failing to consider time preference in your argument. People are not going to defer a purchase indefinitely simply because prices are declining. A car now is useful; one in the indefinite future is less so, regardless of how much less it costs in monetary terms. At some point, people will value the present use of the car more valuable to them than the savings realized by waiting.

You said, “Deflation due to increased efficiency in meeting consumer demand, such as with consumer electronics sometimes causes purchase delays, but new features often more than offset this otherwise spiral down in prices and demand.”

How do new features offset this? Since new features represent added value for the price, they would therefore constitute a further price deflation. By your reasoning, they should exacerbate the situation, not mitigate it.

You said, “This can lead to unemployment figures and drops in consumption out of all proportion to the malinvestment during the boom.”

How do you know? By what method are you identifying and measuring the malinvestment in order to compare it to the unemployment figures and drop in consumption?

waywardwayfarer August 19, 2009 at 5:34 pm

Also@Mike Sandifer:

“I should add that the decrease in real wages for workers and in the real debt owed is how the credit overextension during the booms is worked off.”

When wealth is consumed faster than it is created, how do you propose avoiding a decline in real wages? Pumping more fiat currency into the economy doesn’t create any more real wealth.

“How does it make sense to try to work this off with high unemployment?”

There need not be protracted unemployment, if wage rates are allowed to fall to their market-clearing level. The persistent unemployment of recessions is largely a result of governments and labor unions forcing wages to be maintained at the artificially high levels of the boom period.

Mike Sandifer August 19, 2009 at 6:02 pm

waywardwayfarer,

“I’m afraid you’re also guilty of failing to consider time preference in your argument. People are not going to defer a purchase indefinitely simply because prices are declining. A car now is useful; one in the indefinite future is less so, regardless of how much less it costs in monetary terms. At some point, people will value the present use of the car more valuable to them than the savings realized by waiting.”

The problem is the numbers. The deflation of the asset bubble, at about 2 trillion dollars for housing shouldn’t be enough to account for asset devaluation in the tens of trillions and a doubling of the unemployment rate. Thsi is a 14+ trillion dollar economy, and the simple temporal shifting of investment toward longer term investment due to the previous levels of monetary expansion cannot come close to accounting for the disaster we currently face.

And when it comes to general, economy-wide deflation, you have to remember that unemployment continues to increase, further weighing on demand.

“How do new features offset this? Since new features represent added value for the price, they would therefore constitute a further price deflation. By your reasoning, they should exacerbate the situation, not mitigate it.”

The added value changes the temporal discounting of utility in that case.

“When wealth is consumed faster than it is created, how do you propose avoiding a decline in real wages? Pumping more fiat currency into the economy doesn’t create any more real wealth.”

Deflation represents an increase, not a decrease in real income. That’s one of the reasons unemployment increases. The value of real debt increases due to deflation as well, which is a double whammy for an ailing economy.

“There need not be protracted unemployment, if wage rates are allowed to fall to their market-clearing level. The persistent unemployment of recessions is largely a result of governments and labor unions forcing wages to be maintained at the artificially high levels of the boom period.”

Protracted unemployment is exactly what results from these sorts of downturns. That is, when banks are insolvent, hence traditional monetary policy loses traction. Hence, lending collapses, hurting consumption, leading to unemployment, further hurting consumption, leading to deflation which then feeds a spiraling down out of all proportion to the antecedent causes of the economic contraction. When 70% of lending disappears (the bailout banks’ share), savings pile up, consunption collapses, unemployment explodes,… How do you get out of that? Fiscal policy is too slow and clumsy and adds to the national debt. But, more aggressive unconventional monetary expansion toward a set target drives increased consumption, investment, and employment, by lowering real wages and real debt such that society pays for its previous over-consumption.

Robbie Clark August 19, 2009 at 7:24 pm

Mike Sandifer: “The deflation of the asset bubble, at about 2 trillion dollars for housing shouldn’t be enough to account for asset devaluation in the tens of trillions and a doubling of the unemployment rate. Thsi is a 14+ trillion dollar economy, and the simple temporal shifting of investment toward longer term investment due to the previous levels of monetary expansion cannot come close to accounting for the disaster we currently face.”

It doesn’t account for it because it’s not the only cause or the only problem we’re experiencing. The entire economy and the financial industry in particular are built on sand. Otherwise known as fiat money and inflation.

Mike Sandifer August 19, 2009 at 8:37 pm

Robbie Clark,

“It doesn’t account for it because it’s not the only cause or the only problem we’re experiencing. The entire economy and the financial industry in particular are built on sand. Otherwise known as fiat money and inflation.”

Well, what was the monetary base versus supply expansion rate over the period 2002-2006, versus productivity gains? Do you look at numbers? it sill isn’t enough.

Also, long before the current Fed and fiat money, there were far more severe crashes and downturns than this one. Have you ever heard of the Long Depression? Or, before that, how about the Wildcat banking era, in which there were competing private currencies and banking collapses were the norm?

RTRebel August 19, 2009 at 8:48 pm

In the mainstream spirit, I propose a “Fatty’s for flat screens” program. Just trade in your old cathode ray tv’s for a flat LCD or HDTV and get $3000 in credit!

Just think of it. The nations eyes will be less strained, meaning we can stick it to those greedy eyeglass and contact lens capitalists! More of the nation’s family members could gather around the LCD in their home, and thus increase desperately needed family time. The major networks can switch to digital TV without fear of losing viewers (but shhhh don’t tell anyone they lobbied for this program) And how great will it be for the environment that these mass LCD’s will take up so much less energy and radiation!

I mean, what’s not to like!? Economic law is for suckers!

2nd Amendment August 19, 2009 at 9:25 pm

Deflation is bad because we live in a consumption economy and if prices of food go down, people will wait before they buy food and will stop eating until prices of food bottom.

Deflation is bad because we live in a consumption economy and if gas prices go down, people will stop buying gas and go to work walking until prices of gas go down.

Does the above make sense ? I didn’t think so.

Deflation will not stop people from consuming the necessary or even buying what they want now. But at least they won’t have to worry that their life savings will evaporate because of hyper inflation.

Mike Sandifer August 19, 2009 at 9:42 pm

2nd amendment,

There is a lack of nuance in your comments. It’s not that people “stop” consuming food, it’s that the consumption of certain foods will slow. That’s a big difference.

And deflation will slow gas consumption under many circumstances. During the rapid deflation after September of last year, I started putting less gas in my car everytime I went to the station, because the prices were falling so rapidly. Of course it saves money. Apparently, you don’t think consumers like to save money.

Not only that, but you have to consider that consumers are highly indebted and deflation increases the real value of debt.

Robbie Clark August 19, 2009 at 9:44 pm

Mike Sandifer: “Also, long before the current Fed and fiat money, there were far more severe crashes and downturns than this one.”

Please tell how you know how long this crash will last. Business collapse is the norm. Why are banks special? That reminds me of something from Rothbard I read on this website. Paraphrasing: “If banks aren’t failing at similar rates to other businesses that’s a sign you’ve got a problem.”

I actually have seen monetary base numbers from 2002-2006 (this website is so useful), but what’s your point? I agree that 4 years of excessively loose monetary policy isn’t enough. My point isn’t that the bad economy is built on 4 years of sand. It’s built on 96 years of sand. Or to be kinder, 38 years of sand. And it may all be catching up to us. Which does explain the depth of the crash.

Mike Sandifer August 19, 2009 at 10:45 pm

“I actually have seen monetary base numbers from 2002-2006 (this website is so useful), but what’s your point? I agree that 4 years of excessively loose monetary policy isn’t enough. My point isn’t that the bad economy is built on 4 years of sand. It’s built on 96 years of sand. Or to be kinder, 38 years of sand. And it may all be catching up to us. Which does explain the depth of the crash.”

96 years of sand? Surely you’re not referring to the purchasing power of a dollar 96 years ago compared to today. Inflation is only important when it’s unexpected, or when expectations for continuous, untargeted inflation develop.

When economic actors know the Fed has a target inflation rate of 3% in a given year and are reasonably sure that rate will be realized, they will factor it into their economic decisions in the first place and very little actual purchasing power will be lost.

Do you know what the average inflation rate has been over the last 96 years, even given a 97% dollar depreciation? Around 3 and a half percent.

BioTube August 19, 2009 at 11:05 pm

96 years of sand? Surely you’re not referring to the purchasing power of a dollar 96 years ago compared to today. Inflation is only important when it’s unexpected, or when expectations for continuous, untargeted inflation develop.
When economic actors know the Fed has a target inflation rate of 3% in a given year and are reasonably sure that rate will be realized, they will factor it into their economic decisions in the first place and very little actual purchasing power will be lost.

That mistake was excusable when Adam Smith made it(economics was new), but it’s been long proven that inflation is always lopsided – that is, some gain access to the newly printed money first and benefit from the higher quantity before value has a chance to drop(this is seigniorage); this comes as the cost of the last to get access to it. The lopsided nature of inflation is why bubbles always have affect one sector more strongly than the rest(were inflation even, it might not be so bad).

Mike Sandifer August 19, 2009 at 11:23 pm

BioTube,

If the expectations for inflation are already factored in, seigniorage isn’t a problem, other than being a tax.

Chuck August 20, 2009 at 2:22 am

Keynesians believe we are cursed by abundance. The only thing people have in abundance is stupidity.

Gil August 20, 2009 at 7:08 am

“It’s terrible what deflation did to the computer industry.” – 2A.

Oh yes, take one particular industry where the technological pace was at its fastest. Newflash -computers aren’t getting particularly faster or cheaper that much any more.

And, of course, Biotube ‘no one’ suffers from deflation. Not those whose loan is getting harder and harder to pay off, not those who are contracted to pay a fixed amount of money per year to someone, not those who get pay cuts in line with deflation, etc.

Quite frankly if you argue deflation is good because you’re thinking of the price of goods & services coming down whilst the money remains the same then the only bad inflation that matters is a pool of shrinking good & services where people are trying to outbid each other with the same amount of money they had before. Or, alternatively, deflation caused by a shrinking money supply doesn’t really matter the same way that an increasing money supply doesn’t really matter as long as people have some time to adjust.

Professor Blitzkrieg August 20, 2009 at 7:31 am

@ Mike Sandifer,

A quick search on mises.org and wikipedia reveals that the “long depression” was not in fact a depression. There were soaring levels of economic growth, employment rates and standard of living.

The reason this period lives in infamy is because a few select groups, such as farmers, seemed to suffer while bigger players and international markets put them out of business.

Wildcat banking or the era of free banking was only free from federal regulation. States still wrote policies for reserve requirements and set interest rates.

The theory of non-fiat currency doesn’t really need a historic precedent anyway. We still keep our wealth in commodities like gold, oil, stocks, etc. Everyone knows these assets are preferable to dollars.

Everyone on mises wants to abolish the fiat currencies, which is a sound idea. Really all you need to happen is for the federal government to allow us to trade gold like we trade dollars, so that competition with better currencies can drive fiat money out of the market.

2nd Amendment August 20, 2009 at 7:42 am

Professor Blitzkrieg,

You can trade Gold like you trade dollars. You can buy a car, groceries, pay your handyman with gold coins and if the price is right they will accept it.

Some will refuse because of the accounting hassles. But any place you pay in cash you could theoretically pay in gold.

2nd Amendment August 20, 2009 at 7:44 am

“Newflash -computers aren’t getting particularly faster or cheaper that much any more.”

I agree, Microsoft’s Vista is ruining everything.

But my point is that technological advancement and productivity increases leads to deflation and yet this creates wealth for all.

So deflation is not the enemy.

2nd Amendment August 20, 2009 at 7:50 am

Mike Sandifer,

It’s funny that you didn’t get my sarcasm about food and gasoline.

Keynesians argue that deflation causes people to stop consuming. Yeah, right, like they will stop eating or filling up.

That was my point. Deflation doesn’t stop people from consuming necessities, on the contrary and it does not stop them from buying what they want to buy right now.

Those who wait to make a purchase probably would still have waited in an inflationary environment.

That’s my point.

It’s easy for a Keynesian to say that people will stop to buy big Plasma TV’s in a deflationary environment because people want to wait for a better price of a better TV.

But what about food and gas, people need it now and will not wait.

Gil August 20, 2009 at 10:49 am

Who said anything about Windows Vista, 2A? Computer hardware prices aren’t necessarily in the magically fast and homogenous pace that it did in the ’90s. CPU prices have barely budged and RAM price have been relatively stable for the past two years. On the other hand, flash memory has certainly is moving upwards in capacity. Computers are no longer ‘out of date in six months’ anymore.

Yet which ‘-flation’ are you talking about, 2A? The change in the volume of money or the change in volume in goods & services? You, like most others, want inflation to refer ‘upwards change in money supply’ whilst deflation to mean ‘more good & services in a static money supply’ thus talk about two different things.

Beside people carry on with their purchases in mildly inflationary and deflationary environment? Wow. After all, if inflation and deflation are relatively low and everyone’s constantly transacting then there’s little damage either way.

Mike Sandifer August 20, 2009 at 5:26 pm

Professor Blitzkrieg,

“The theory of non-fiat currency doesn’t really need a historic precedent anyway. We still keep our wealth in commodities like gold, oil, stocks, etc. Everyone knows these assets are preferable to dollars.

Everyone on mises wants to abolish the fiat currencies, which is a sound idea. Really all you need to happen is for the federal government to allow us to trade gold like we trade dollars, so that competition with better currencies can drive fiat money out of the market.”

Apparently, you’ve never heard of Gresham’s law. You have it exactly reversed. Currency with less intrinsic value tends to drive out the more valuable. People prefer to hold the better currency and offer the inferior one in trade.

Mike Sandifer August 20, 2009 at 5:30 pm

You guys can favor gold coins and/or a gold standard all you like, but even if it were a good idea, it wouldn’t matter, because politicians always debase currencies when they see fit.

There is nothing wrong with fiat currencies when there is discipline. There is nothing right about gold standards when there isn’t.

Mike Sandifer August 20, 2009 at 5:37 pm

Chuck,

“Keynesians believe we are cursed by abundance. The only thing people have in abundance is stupidity.”

Many of you Austrian amateur economists seem to think that the only two approaches to economics are the Austrian and Keynesian. Apparently, you’ve never heard of monetarists. Most economists today recognize some monetarist/Keynesian consensus, but have different emphases on montary versus fiscal policy, especially stimulus.

Mike Sandifer August 20, 2009 at 5:47 pm

2nd Amendment,

“That was my point. Deflation doesn’t stop people from consuming necessities, on the contrary and it does not stop them from buying what they want to buy right now.

Those who wait to make a purchase probably would still have waited in an inflationary environment.

That’s my point.

It’s easy for a Keynesian to say that people will stop to buy big Plasma TV’s in a deflationary environment because people want to wait for a better price of a better TV.

But what about food and gas, people need it now and will not wait.”

You completely missed my point. People don’t stop buying food and gas, the rate of purchases slows. People wait on the more expensive food items and put less gas in their cars-per-trip to the gas station to save money.

Would you fill your tank up this week if gas prices would be ten percent less next week and you don’t expect to use a whole tank of gas? Maybe, but what about a 20% expected drop in prices?

And wages are sticky in deflationary environments, except when the money supply is increased.

Ron August 20, 2009 at 7:47 pm

I believe the government is afraid of deflation because it would require them to reduce their spending. They after all are trying to artificially maintain tax flow by inducing people to spend and buy, by printing money, with the expectation that this is a bump in a near perfect scheme.

They still haven’t recognized it is the scheme that is flawed (Keynesian)

What they don’t seem to be grasping, is the scheme has run its course, by falsifying values to the point that a correction is due and they have no idea how deep it will correct or where or for how long.

So to protect the status quo and try to protect the tax flow they are falsifying worth and value to a heightened state by printing money in hopes it is a temporary glitch they can use to find another income stream…….HEALTHCARE seems to be that target; that stream.

The government isn’t fixing the problems it created but trying to find another lucrative cash flow to sustain its falsification of worth delivered by political merit and not market worth to maintain there political position.

They are in fact in hot pursuit of whatever income stream is left, to corrupt the system of worth by merit or market value and replace it with government selected value based on political favor and whim.

Socialisms claws of deception. Market worth is nearly fully corrupted and will soon be under house arrest when they pass of this boondoggle of a bill to insure the last vestiges of financial wealth creation are under the government perversion of value.

Robbie Clark August 20, 2009 at 8:12 pm

To Mr. Sandifer this is from Wikipedia: “Gresham’s law is commonly stated: ‘Bad money drives out good.’

This law applies specifically when there are two forms of commodity money in circulation which are required by legal-tender laws to be accepted as having similar face values for economic transactions.”

In the system Austrians want to go to there wouldn’t be legal tender laws so Gresham’s law doesn’t apply according to that definition.

But regardless, wouldn’t people stop accepting the crappy currency eventually? Businesses would just stop wanting to take it, which is what would happen if banks could issue their own currencies. The stuff not worth anything would just stop being traded at some point because the bank went under or it was deemed to be worth less than dirt. But again, that’s a moot point without legal tender laws.

Mike Sandifer: “There is nothing wrong with fiat currencies when there is discipline. There is nothing right about gold standards when there isn’t.”

I don’t think I even understand the second statement. Please explain.

To the first sentence, I’d prefer a system not as easily subject to to whims of politicians. Call me crazy.

Mike Sandifer: “People don’t stop buying food and gas, the rate of purchases slows. People wait on the more expensive food items and put less gas in their cars-per-trip to the gas station to save money.”

No, people make more frequent smaller purchases. Isn’t that an increase in the rate of purchases?

But what’s your point? How is this damaging? People make less frequent purchases and save their money. This includes businessmen and corporations as well (you can see this happening today). Bad companies go away, resources are freed up, people are now sitting on real capital. The people saving their money see an opening and use their savings to fund new ideas/innovations/investments/whatever.

Mike Sandifer August 20, 2009 at 11:52 pm

Robbie Clark,

“To Mr. Sandifer this is from Wikipedia: “Gresham’s law is commonly stated: ‘Bad money drives out good.’

This law applies specifically when there are two forms of commodity money in circulation which are required by legal-tender laws to be accepted as having similar face values for economic transactions.’”

Wiki is supposed to substitute for an evidence-based argument? Think for a minute. Both commodities and paper money fluctuate in value… That alone pokes a hole in any idea of continuous commodity currency dominance. And what if the commodity the private money consists of experiences a bubble? Wouldn’t the private issuer have an incentive to issue more currency over reserves without raising interest rates for depositors? Speculation sometimes takes hold until the whole thing ends up in a bank run when the commodity bubble collapses.

“Mike Sandifer: “There is nothing wrong with fiat currencies when there is discipline. There is nothing right about gold standards when there isn’t.”

I don’t think I even understand the second statement. Please explain.”

Politicians have always watered down or abandoned gold standards or competing currencies whenever it suited them. That’s why there are virtual no non-fiat currencies around today. So, even if you think a gold standard or competing currency is a good idea, it’s very, very unrealistic.

“No, people make more frequent smaller purchases. Isn’t that an increase in the rate of purchases?

But what’s your point? How is this damaging? People make less frequent purchases and save their money. This includes businessmen and corporations as well (you can see this happening today). Bad companies go away, resources are freed up, people are now sitting on real capital. The people saving their money see an opening and use their savings to fund new ideas/innovations/investments/whatever.”

You’re forgetting that decreasing consumption leads to decreasing investment and increasing job losses that are mutually reinforcing on the downside. Deflation of this sort is a trap that is hard to get out of.

Robbie Clark August 21, 2009 at 10:17 am

Wikipedia was just for the definition of the law, which specifically applies to legal tender.

EIS August 22, 2009 at 1:09 am

“Wiki is supposed to substitute for an evidence-based argument? Think for a minute. Both commodities and paper money fluctuate in value…”

Yes, but one fluctuates more rapidly than the other, thus the desire to use the more stable currency. Only when the government, by decree, sets an arbitrary fixed exchange ratio amongst two different types of currency does Gresham’s law hold (the “better currency” will be saved for international transactions).

“You’re forgetting that decreasing consumption leads to decreasing investment”

You’re forgetting that that’s complete nonsense; it didn’t make sense when Keynes said it, and it doesn’t make sense today. Only in inflationary scenarios can this possibly hold true (since the rate of interest will rise even if there’s an increase in savings, due to a prolonged artificial reduction in interest rates). During a noninflationary environment, a fall in consumption must mean increased investment activity; it’s self-evident.

“And wages are sticky in deflationary environments, except when the money supply is increased.”

And this so-called “stickiness” is the cause of unemployment. Say’s law holds; real money balances would be restored.

“When economic actors know the Fed has a target inflation rate of 3% in a given year and are reasonably sure that rate will be realized, they will factor it into their economic decisions in the first place and very little actual purchasing power will be lost.”

Utter nonsense; this failed a long time ago buddy, the FED can’t target the money supply. Try to stay within this decade.

“Inflation is only important when it’s unexpected, or when expectations for continuous, untargeted inflation develop.”

Expecting the actual rate of inflation is impossible, as interpreting individual’s demand for money requires omniscience. This is why the FED cannot target the money supply; it is uncontrollable. There exists a multi-tier debt structure, all of which create fiduciary media. This is why, during hyper-inflationary scenarios, P rises faster than M (to use simple terms you’re familiar with).

“Also, long before the current Fed and fiat money, there were far more severe crashes and downturns than this one.”

Yes, the FED has been able to push back this great depression for quite some time through perpetual (and often rapid) expansion of the money supply. Unfortunately, this little scheme must eventually destroy itself. By the way, the FED began open market operations in 1922 under your idol Fisher, causing an inflationary environment, and an inevitable bust, just like Hayek and Mises predicted (Hayek predicted the great depression 3 months in advance). Milton Friedman was a Fisherite chosen by the Statists to represent “capitalism.” His theories were obliterated in the 20s-30s, and he has caused much harm with his “floating exchange rate” scheme. We’ve had steady price levels (as we did in the 20s), and now we’re pumping massive “monetary stimulus” into the economy; let’s see how it works out. Fisher gets to be discredited once again!

“The Austrian approach just does not make sense, and worse, it doesn’t fit the data.”

Try understanding it before you criticize it.

EIS August 22, 2009 at 1:19 am

The comment above is a response to Mike Sandifer, in case anyone was wondering….

Mike Sandifer August 24, 2009 at 9:01 pm

“Yes, but one fluctuates more rapidly than the other, thus the desire to use the more stable currency. Only when the government, by decree, sets an arbitrary fixed exchange ratio amongst two different types of currency does Gresham’s law hold (the “better currency” will be saved for international transactions).”

So, how much more does the dollar fluctuate versus gold and over what period?

“During a noninflationary environment, a fall in consumption must mean increased investment activity; it’s self-evident.”

And yet, that hasn’t happened at all. In fact, the increased monetary base is resulting in very little extra money in the actual economy. Banks aren’t lending much and consumers continue to save. So, where’s the increased investment, and against what baseline?

“And this so-called “stickiness” is the cause of unemployment. Say’s law holds; real money balances would be restored.”

Say’s law is an accounting identity, not an empirical concept. Show me evidence that there is such a thing, or that it’s even relevant when investment has dropped considerably and is flat.

“Utter nonsense; this failed a long time ago buddy, the FED can’t target the money supply. Try to stay within this decade.”

The Fed just hasn’t done it right. Set a nominal GDP target and stick to it through thick and thin and the markets will respond much more positively. Most of this mess was avoidable.

And the Fed doesn’t have to anticipate inflation. They can respond to price levels. Some Austrians are very wrong to claim that increases in the monetary base are the same thing as inflation. As the current situation demonstrates, when there’s a bottle neck concerning bank lending, this is far from the case.


“Yes, the FED has been able to push back this great depression for quite some time through perpetual (and often rapid) expansion of the money supply. Unfortunately, this little scheme must eventually destroy itself. By the way, the FED began open market operations in 1922 under your idol Fisher, causing an inflationary environment, and an inevitable bust, just like Hayek and Mises predicted (Hayek predicted the great depression 3 months in advance). Milton Friedman was a Fisherite chosen by the Statists to represent “capitalism.” His theories were obliterated in the 20s-30s, and he has caused much harm with his “floating exchange rate” scheme. We’ve had steady price levels (as we did in the 20s), and now we’re pumping massive “monetary stimulus” into the economy; let’s see how it works out. Fisher gets to be discredited Once again!”

How much malinvestment was there in the 20s? In what proportion was it to the downturn beginning in ’29? Where are your numbers? It’s easy to demonstrate mathematically that if Roosevelt hadn’t chickened out on his pro-dollar debasement policy, the depression may have ended years before it did. The market needed a clear signal regarding monetary supply meeting the extreme demand to bring employment and price levels closer to full employment levels.

“”The Austrian approach just does not make sense, and worse, it doesn’t fit the data.”

Try understanding it before you criticize it.”

Are you aware that Hayek was not a liquidationist during the Great Depression? He changed his mind. Apparently, you don’t even know the history of what has long been a purely historical, as opposed to theoretically vibrant, economics.

See this link, for example:

http://economics.sbs.ohio-state.edu/jmcb/jmcb/07056/07056.pdf

Comments on this entry are closed.

Previous post:

Next post: