Why Does the Government Fear Deflation?

by Gerard Emershaw

Federal Reserve Chair Janet Yellen has said that the United States economy is still in need of stimulus because unemployment and inflation are well short of the Federal Reserve’s goals. Yellen claims that the inflation rate is below the Federal Reserve’s target of 2%.

Inflation hurts the average American consumer. The prices of goods and services became more expensive. The Federal Reserve’s “printing” of money has destroyed the value of the dollar over the decades, eroding up to 95% of its purchasing power. Why is this a good thing? Even if it is a good thing, is it true that there is virtually no inflation? The Federal Reserve uses the Bureau of Labor Statistics’ Core CPI (Consumer Price Index) as its measurement of inflation. The Core CPI does not include prices of food and fuel. Without taking these important economic factors into account, how can anyone be sure what the inflation level is? If the rate of inflation were to be measured in the same way that it was calculated in 1990 before the federal government began hiding the true inflation rate, it would be 5% and not under 2%.

The Federal Reserve and the federal government in general are fans of inflation. Deflation is what they fear and dread. The worst thing that they can imagine is that the prices of goods and services should fall. Imagine the horror if all of a sudden the dollar could buy more. Imagine the evils that would arise if suddenly struggling American families could put more food on the table for the same amount of money. Nearly 15% of Americans are food insecure—including approximately 25% of black and Hispanic households. Imagine the apocalypse that would arise if the working poor could afford more food and worry less about their families being food insecure. The horror! The horror!

Deflation is bad. Or at least that’s what the Federal Reserve, the federal government, and economists like Paul Krugman tell us. Paul Krugman is a genius. At least that is what he and the left-wing media constantly tell us. Paul Krugman is such an enlightened Keynesian that he believes the magic bullet to save the economy is an alien invasion: “If we discovered that space aliens were planning to attack, and we needed a massive build-up to counter the space alien threat, and inflation and budget deficits took secondary place to that, this slump would be over in 18 months.” Given that Mr. Krugman has apparently read the graphic novel Watchmen or perhaps has watched a few too many “Twilight Zone” episodes, of course he knows what he is talking about.

Mr. Krugman believes that deflation is bad:

So first of all: when people expect falling prices, they become less willing to spend, and in particular less willing to borrow. After all, when prices are falling, just sitting on cash becomes an investment with a positive real yield– Japanese bank deposits are a really good deal compared with those in America—and anyone considering borrowing, even for a productive investment, has to take account of the fact that the loan will have to repaid in dollars that are worth more than the dollars you borrowed. If the economy is doing well, all this can be offset by just keeping interest rates low; but if the economy isn’t doing well, even a zero rate may not be low enough to achieve full employment.

And when that happens, the economy may stay depressed because people expect deflation, and deflation may continue because the economy remains depressed. That’s the deflationary trap we keep worrying about.

He must be right. After all, The New York Times believes that Paul Krugman is a genius, so he must be. Plus, he came up with that brilliant idea to spend money to build up arms to defend against imaginary little green men. That idea is even more brilliant than Keynes’ idea to save the economy by paying workers to dig holes and then fill them in again. Given that Krugman is correct, it is true that American consumers have not bought laptops and tablets, flat screen TVs, or smartphones. These high-tech items have been getting both better and less expensive. Therefore, it is the case that most Americans are still using their Commodore 64s, still watching their black and white console televisions with rabbit ears, and still communicating with soup cans connected by strings. Since they know such high-tech goods will drop in price, they will defer such purchases. Perhaps indefinitely. Wait. These items are popular? Actually, they are becoming rather ubiquitous. Given that Krugman is such a genius and must be correct, it would be folly for a retail chain like Walmart to advertise a policy of falling prices. If widgets are advertised by Walmart as having “falling prices,” then consumers will put off buying widgets. After all, they’ll be cheaper tomorrow. So, of course, Walmart must be nearing bankruptcy since consumers will not spend money if they even suspect prices may be lower tomorrow. Somehow, Walmart earned $17 billion in profits in 2013.

It appears that Americans will spend money even if prices are falling. In general, the American consumer will nearly always spend money—whether he or she has it or not. If anything, lower prices will likely cause them to spend even more money than they normally do. After all, many Americans have the bad habit of buying things not because they need them, but simply because they are on sale. If anything, deflation would increase demand and increase spending.

Krugman also believes that deflation is bad because it increases the burden of debtors:

A second effect: even aside from expectations of future deflation, falling prices worsen the position of debtors, by increasing the real burden of their debts. Now, you might think this is a zero-sum affair, since creditors experience a corresponding gain. But as Irving Fisher pointed out long ago, debtors are likely to be forced to cut their spending when their debt burden rises, while creditors aren’t likely to increase their spending by the same amount. So deflation exerts a depressing effect on spending by raising debt burdens – which, as Fisher also points out, can lead to another kind of vicious circle, in which depressed spending because of rising real debt leads to further deflation.

Out of control spiraling deflation would certainly not be a good thing. That would cause debtors to be unable to service their debts, and this would lead to massive bankruptcies. However, nobody is talking about that. If one assumes that all deflation is dangerous deflation of this kind, then in fairness, one must also assume that all inflation is Weimer Republic wheelbarrow hyperinflation. With mild deflation, the increase in real debt of debtors will be offset in good part by the fact that the debtors will be able to purchase more with their money. This will allow them to have more money to apply to their debts since they need to spend less on goods and services. Mild deflation will also encourage investments of all sorts. Those who do defer spending are likely to invest their money—even if that investment is as simple as placing money in an interest bearing bank account. Some will win and some will lose in the end. But that is always the case. Some debtors will be burdened. However, creditors will earn more money and will have more money to spend and invest. Some of those lucky creditors may even be Kurgan’s alien friends.

Finally, Krugman worries about falling wages. This was a constant worry during the Great Depression. And in fact, it was President Herbert Hoover and President Franklin D. Roosevelt’s unwillingness to allow wages to drop along with prices that exacerbated the Great Depression. According to Krugman:

Finally, in a deflationary economy, wages as well as prices often have to fall—and it’s a fact of life that it’s very hard to cut nominal wages—there’s downward nominal wage rigidity. What this means is that in general economies don’t manage to have falling wages unless they also have mass unemployment, so that workers are desperate enough to accept those wage declines.

This assumes that the economy will be more or less stagnant. However, regular mild deflation will likely spur the economy as consumers have more money to spend and invest. Wage levels are always in great part affected by unemployment levels. When the economy has high levels of unemployment, wages will drop as there are more workers willing to do the job for less. However, at times of near “full employment,” wages inevitably rise because workers who can fill job openings become more scarce. Therefore, deflation is unlikely to harm workers. Any drop in wages will be offset by a drop in prices. As employers’ dollars have more buying power, it is also likely than many of them will hire additional workers. This falling wage fear is a delusional relic of the Progressive Era.

Why do the Federal Reserve, the federal government, and statist economists like Paul Krugman actually favor inflation? The answer is simple. Inflation allows the government to play its economic shell games. It allows the federal government to “tax” the people through the mechanism of the Federal Reserve. It allows the federal government to spend money on its welfare/warfare empire without actually having to openly raise taxes. Inflation makes banksters like those behind the Federal Reserve even wealthier by redistributing money from American citizens to the banks and their cronies. In the long run, as Keynes said, we are all dead. But in the slightly shorter run, inflation makes more citizens dependent on the state by draining the value of their dollars. This means that more Americans will rely on government largesse, and as a result, more Americans will be loyal. As this happens, fewer will protest against unconstitutional wars of aggression, mass illegal domestic surveillance, or any other type of tyranny. Inflation enslaves the people. All statists ultimately love that idea.