Sunday, January 04, 2015

Deflation, the Good and the Bad

Many people dislike inflation or rising prices of goods and services, understandable. So deflation or declining prices of commodities is good for them? Who benefit, who lose, if deflation happens?

In Europe, high prices of commodities and services, partly due to high taxes, discourage people from high spending. Cheap oil should encourage them to travel more, spend more, but it seems it did not do the trick, now the threat of deflation in the Euro area is getting higher. 


And here is the recent inflation data for Europe.


More news of deflation  fears.

From The Irish Times.

From Bloomberg.

This is standard Keynesian approach, monetary tinkering of issuing/selling and buying bonds, releasing and then getting back money.

Below, a good illustration of "benign" and "malign" deflation.
LAS - long-term Aggregate Supply, SAS is short-term AS, AD is Aggregate Demand.

Chart on the left says a "negative demand shock" makes people cut their spending, the demand curve moves to the left (AD1 to AD2), output declines (Y1 to Y2), price declines, deflation.

Chart on the right says a "positive supply shock" due to rise in productivity expands the supply (SAS1 to SAS2) of commodities -- mobile phones, flat tv, standard bread, etc. -- output expands    (Y1 to Y2) and price declines, deflation.

Source: David Beckworth, 2008. "Aggregate Supply-Driven Deflation and Its Implications for Macroeconomic Stability", Cato Journal.

Part of his concluding notes,

"Adopting such a benign deflation-friendly monetary policy rule is important moving forward as the continued opening of China and India and the ongoing rapid technological gains are likely to create
positive aggregate supply shocks for some time.16 Consequently, an overhaul of the conventional view of deflation is needed, one that would incorporate the insights of the nuanced view of deflation and open the door for a more thoughtful monetary policy."

Government central planners do not distinguish benign or malign deflation, the same way that they do not distinguish causes of poverty, whether self-inflicted (irresponsibility, laziness, inefficiency, etc.) or nature and external-created. Governments just push one policy after another and those policies tend to contradict each other over the long term.

Since this deflationary pressure is partly caused by high taxes that contribute to high prices of goods and services, governments should learn to step back, cut taxes, help  bring down prices and encourage people to spend more.

See also:
Inequality 21: Marx, Keynes and Pikkety are ideological soulmates, December  01, 2014 
Welfarism 30: Big Government and Corruption of People's Values, December06, 2014 
Top 10 News in 2014, Happy New Year 2015, December 31,2014

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