It is great to see mainstream economists lending “empirical support” to aspects of the theoretical deflation argument that certain Austrian School economists have been making. Maybe the mainstream and even some Austrian economists also will realize that attemting to stabilize money’s purchasing power (the “price level”) contradicts Mises’s demonstration that money is inherently non-neutral. Furthermore, attempting to stabilize money’s purchasing power by injecting loanable funds not the result of previous savings into the banking system sets in motion the business cycle. As Austrian business cycle theory demonstrates, the additional bank credit not backed by previous savings lowers the rate of interest below its free market rate and enables investments to be made that absent the artificial increase in loanable funds would not have been possible. The eventual liquidation of these malinvestments is the bust phase of the business cycle.

Mild deflation and positive economic growth can and have occured at the same time in the past. That’s not to say that the two are entirely unrelated, just that there are lots of other factors that come into play as well.

I still maintain that dramatic rates of inflation OR deflation are detrimental to economic growth. Often times Austrians imply that deflation is good, and the more the better. I don’t THINK that is what they actually mean. I can’t imagine a good outcome from say a 10%-20% deflation rate that persisted for years. In such a case burying money in the backyard would be a top notch investment strategy. I don’t care how much you try to instruct the average person, a shrinking paycheck doesn’t induce people to spend, even if the price of everything they buy is getting cheaper at a faster rate than their paycheck is shrinking. Such an environment would hardly be conducive to economic growth.

Please correct me if I’m wrong.

I don’t think that there has been a significant, sharp inflation in U.S. economic history that was not preceded by a substantial increase in the money supply and/or credit expansion. Yes, a notable deflation did occur in the 1930s, but this period followed the 1920s, a decade that as Rothbard and Anderson (among others) have shown was one in which the Fed artificially expanded the money supply and considerably manipulated interest rates. The sharp deflation of the 1930s was a response to the substantial monetary intervention of the 1920s. The 1930s deflation occurred despite, as Professor Salerno described in an article for The Freeman (I think it appeared in the late 1990s), the Fed’s significant attempts to maintain stable prices through additional inflationary policies.

Historically and etymologically inflation and deflation were defined, respectively, as an increase or decrease in the supply of money. Modern “progressive” useage has insidiously altered the meanings to focus on the effect, i.e. the respective increase or decrease in prices, and not on the cause of the price changes. The shift in definition is akin to the changed meaning (at least in the U.S.) of the term “liberal”. Since Professor Salerno’s article is discussing a study by mainstream economists, I assumed that for the sake of his commentary he adopted the updated, “progressive” definition.