Happy Halloween! If these three don't scare the hell out of you, then nothing will.

Inflation or Deflation...which is it?

From Greg Mankiw's Blog:

What's wrong with deflation? Let me count the ways.

Someone recently emailed and asked "Why couldn't deflation be a good thing? Lower prices for consumers, greater investment, economic stimulation....."

Well, not quite. Here's my answer....


Dear (fill in name here): That's not how I think of these things. In my mind....

1. Deflation means much higher real interest rates that will kill investment when it is dead already. Remember the Fisher equation: real interest = nominal interest minus inflation. If we have deflation, then that minus sign becomes a plus sign. With nominal rates already at zero, the real rate becomes unbounded on the up side. See Great Depression 1929-33.
2. We had deflation in the housing industry and the financial industry, just two sectors of the economy. How's that working out for us?
3. Deflation puts consumption in a downward spin cycle of households playing chicken to see how low prices will go and thus never spending as deflation begets further expected deflation. See Japan 1989-2005.
4. Deflation would trash housing prices further and would convert toxic assets that are still on financial institutions' balance sheets into radioactive garbage.
5. Deflation would drop wages and incomes and raise unemployment. Quite the opposite of what you envision.
6. Deflation would trash firm cash flows, wreck already weak balance sheets of both households and firms as assets plummeted in value and would give us another round of financial institutions needing to re-capitalize since their capital would be vaporized with deflation. Credit to any but the most ultra safe investments would be unobtainable at any price. The European P.I.I.G.S. would go over the edge.
7. Deflation could potentially increase the real burden of debt so that people with falling incomes and falling wages could face higher real, price-adjusted debt servicing. That is called "debt deflation".
8. Once this started, public expectations would become even more depressed than they already are and would begin looking to worse times in the future, not better. That would definitely kick start the party of further and deeper economic misery.

Of course none of this would be a concern if changes to prices and wages were instantaneous and perfectly flexible in the downward direction. That of course is nonsense.

Deflation only has to happen if the central bank wants it to happen. And you can believe that more than anything. If Chairman Bernanke were to let that happen I will quit my job as an economist and go back to my old position as a Chippendale dancer.
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Randy Parker Hall of Fame: Barry Eichengreen

This boys and girls is Barry Eichengreen. He is an economist at The University of California at Berkeley. He is also one of the greatest scholars on the Great Depression and is in my second book. Anytime he speaks about international economics we need to listen. Break up the Euro? Absolutely unthinkable.

http://www.voxeu.org/index.php?q=node/2815

You are 26 minutes and 26 seconds away from true economic intellectual power.

Jim Hamilton tells you what you need to know. Listen to this and you will know what to think. Click on the link below and then click on the podcast.

http://www.econbrowser.com/archives/2008/12/podcast_on_the.html

This is an absolute must read!

From Jim Hamilton...

The Japanese would not do this and paid a big price. We need to do it and now. Another month of deflation and it will certainly focus the mind.

http://www.econbrowser.com/archives/2008/11/time_for_a_chan.html

I really like this guy...but here he gets it wrong.

Robert Samuelson is now sounding the alarm regarding deflation. That is total and utter economic rot. Deflation is the easiest thing in the world to fix. Don't believe it? Then tell me the Fed could buy up all the assets in the world and not cause inflation and then you'd be right. Of course, it is utter nonsense. I have a lot of respect for the writings of Robert Samuelson. Here he is dead wrong. And so are people who speak of "the liquidity trap." It shows a confusion between nominal and real quantities. But they neither know it nor admit it.

And if you think Ben Bernanke is going to preside over deflation, you are http://www.youtube.com/watch?v=qFx7xNPP8bQ

http://www.realclearpolitics.com/articles/2008/11/the_specter_of_deflation.html

Total nonsense. This is the one thing we can fix and very quickly.

If there is one lesson from economic history we know for sure, it is how to fix deflation. So look at the link below, but don't believe it. Housing deflation...sure. But general deflation? Never as long as Ben Bernanke draws breath.



http://online.wsj.com/article/SB122428776277746551.html