“Deflation” is a word that we will be hearing a lot over the next year or two. This is because most of the major economies such as the US, Europe and Japan, are currently experiencing very low or negative changes in their price levels. Nearly every central banker and finance minister spits the word “deflation” out as if they have just sucked the venom out of a snakebite. This is curious, however, since deflation is the opposite of inflation, and inflation itself has been an enemy of the state for decades! Mario Draghi, the president of the ECB, has vowed to do everything possible to stave off the threat of deflation. What is everyone scared of?
If inflation is a tax, then deflation is a subsidy. People who are owners of nominal claims such as cash, bank deposits and bonds benefit from lower prices since they can buy more stuff with the same amount of money. The average man in the street is such a person. Fighting deflation, as the ECB has vowed to do, is akin to denying the average man in the street a higher standard of living.
This is the fact, but central bankers and finance ministers read a lot of fiction, specifically Keynesian economic fiction, which associates falling prices with lower GDP. This is the public justification for denying the average man a higher standard of living.
I can think of two reasons why the “fight deflation” warcry has become popular:
1. Taxation. Deflation is a subsidy that the government would rather not pay.
2. Survival. I have argued many times that monetary policy does not work. By this I mean that the monetary authorities cannot systematically influence either output or prices. Admitting this would be publicly embarrassing and also professional suicide, so taking the challenge to defeat deflation is a last ditch effort to prove their policy power. Put simply, its a desperate act of survival for the current species of Central Bankers.