1. Skip to navigation
  2. Skip to content
  3. Skip to sidebar
Source link: http://archive.mises.org/12330/radio-deflation/

Radio Deflation

March 29, 2010 by

Michael McKay, Patrick Barron and I talked about deflation on Radio Free Market last Saturday.

{ 1 comment }

Dick Fox March 30, 2010 at 3:55 pm

Being enchanted with deflation is the worst of modern Austrian thinking. I sometimes feel that the Austrians of today have remorse that the recession on 1920-21 was so short. Thinking that deflation is penance for inflation in a sense prolonged the Great Depression.

Enchantment with deflation is the flip side of monetarist theory. The monetarists preach that a modest inflation is good for the economy. The modern Austrians preach that a modest deflation is good for the economy. Hayek states it well when he says “(W)hat I had done had often seemed to me more to point out barriers to further advance on the path chosen by others than to supply new ideas which opened the path to further development.” This line of thinking is a barrier to the further advance in economics.

In the past I have written of the fallacy in this thinking by discussing how deflation is destructive to corporate profits, explaining that purchases early in the production cycle are transformed into greater costs as the currency appreciates. A 5% annual deflation can wipe out 5% profits. But let me talk of something different.

An asset has a value and can function as collateral for loans for expansions and investment. When the government passes laws that impair the assets, their value declines. Such a decline in value will choke off lending and borrowing, and the economy will slide into decline. The modern Austrian enchanted with deflation will cheer, but in fact the government has impaired assets and the economy is in actual recession. Note that this recession is not caused by a previous inflation, but by the actions of the government impairing the assets. The impairment could be restricted land use for “environmental” reasons, placing oil reserves off limits for exploitation, excessive progressive taxes, and a host of others.

Understand, both Hayek and Mises understood this problem with deflation so the enchantment with deflation is not universal in Austrian thought. It has grown out of the errors of Rothbard and has been exacerbated by the increase of modern Austrian praise heaped on deflation.

I encourage all Austrians to rethink their love affair with deflation and return to the development of a real monetary theory, including inflation and deflation, which was so desired by Hayek. As John Cochran and Fred Glahe point out in their book on the Hayek-Keynes debate, Keynes (and I would add monetarism) turned toward the financial sector while Hayek and Mises turned to Wicksell’s natural versus money rate of interest. This means that the Keynesians and monetarists are trapped in their theory and can’t find the answer. The Austrians have the way paved by Hayek and can show the way out. Don’t be seduced by the evil mistress of deflation.

Comments on this entry are closed.

Previous post:

Next post: