Politics & Policy

Not to Deflate You . . .

Are we there yet?

‘Deflation is everywhere right now. Housing prices, gas prices . . . ” says California businessman Rob Arkley. But, he quickly adds, “Fear not. These are not necessarily certain signs of permanent deflation. In fact, I don’t think that deflation is much of a long-term problem. Politicians will not let it continue for long.”

Are we in a Christmas season of deflation? If not, is it coming? Is there anything we can do to stop it? Perhaps it is not inevitable, but could happen if we don’t play our cards right? What is your thinking and what are your cautions?


I think deflation is our economy’s fundamental problem. Unlike in the early 1930s, however, it is not caused by a shrinkage of the money supply, but by a sharp decline in velocity — the speed at which people and businesses spend money. Since velocity is the ratio of the money supply to GDP, it means that the same quantity of money will support a smaller nominal GDP. This will require either a decline in prices or a fall in output. Right now we are seeing both.

The Fed, to its credit, is attempting to expand the money supply to compensate for the fall in velocity. But it is hampered by the extremely low level of interest rates on Treasury securities. On Friday the yield on three-month T-bills was 0.01 percent. This indicates the existence of a liquidity trap. It means that the Fed cannot expand the money supply by buying Treasury bills since there is at this point essentially no difference between a Treasury bill and a dollar bill.

The Fed must become more creative and buy longer-term securities and others that have higher yields. Fed Chairman Ben Bernanke has indicated a willingness to do so, but it will still take time for new money to circulate and stimulate consumer spending, business investment, and bank lending.

Bruce Bartlett was a White House economist in the Reagan administration and a Treasury Department economist in the George H. W. Bush administration.


A central point of Milton Friedman’s work was that the Fed caused the Depression by allowing the money supply to collapse, causing sharp deflation. The Fed should maintain a stable effective supply of money, including raising the supply to offset any declining velocity. But the real solution is a stiff dose of Reaganomics, which would get the real sectors of the economy booming again, in turn unfreezing the credit markets as lenders are induced to participate in the boom, aided by a new worldwide influx of investment capital. The resulting boom is also the only good way to stop the decline in housing prices, and, of course, would short-circuit deflation. 

– Peter Ferrara is director of entitlement and budget policy for the Institute for Policy Innovation.


Historically, deflation has sometimes helped economic development in the U.S. After the Civil War, we had several decades of deflation while the U.S. greatly expanded industrial production. The increasing supply of goods and services (and competition among suppliers) led to both slow deflation and strong economic growth. Kerosene, for example, went from 58 to 8 cents a gallon and John D. Rockefeller’s Standard Oil Company not only made America energy independent, it also supplied over half the oil used by all nations on Earth. The U. S. became a world power. Many Americans today are enjoying the falling prices of oil, copper, and other commodities.

Deflation can be a problem if it results from low purchasing power (liquidity) or a decline in money supply, which in the 1930s helped cause the Great Depression. Fed policy led to this problem then, which suggests the possibility that federal tinkering is the cause — not the solution — for both inflation and deflation. In the 1930s, for example, Roosevelt artificially raised the price of gold and silver to attack deflation, and then, under the AAA, paid farmers not to produce. In doing so, he traded deflation for a prolonged Great Depression. Ouch!

– Burton Folsom Jr. is professor of history at Hillsdale College and author of New Deal or Raw Deal? (Simon & Schuster, 2008).


The credit markets are like a stopped-up pipe. There’s something not very pretty stuck down there, preventing much new credit from getting to borrowers. The pipe poses two grave dangers, one if it stays clogged, and the other if it doesn’t.

Without credit, there is little buying. When credit dried up for overvalued housing two years ago, house prices started to plummet. Now, the credit crisis is affecting the price of goods and services.

As demand for everything from steel to luxury purses has plummeted by double digits, the consumer price index declined by 1 percent in October compared to the previous year, the sharpest drop on record.

This deflation, if sustained, has chilling implications. Foreclosures and other debt defaults will rise as old debt becomes more expensive relative to new, lower prices.

That’s why the Fed is furiously pumping money and its own credit into the stuck pipe, trying to get some of it past the clog to borrowers. It’s not working, yet.

What’s the best-case scenario? That over time, what the Fed is doing will work — but not too well. By creating credit modestly for consumers and businesses, the government can make what’s already going to be a painful but necessary adjustment — a mass switchover from consumer borrowing to saving, and a continued decline in house and other asset prices — a little less painful. If this happens, and if the Fed sees that it’s happening, it can mop up some of the extra money and credit it has tried to push into the economy before . . . well, before it turns into a worst-case scenario.

What’s the worst-case scenario? That suddenly, and mysteriously, the pipe may unclog, sending all of the money and credit the Fed has created into the economy, vastly amplifying it, too. Suddenly, the economy would have more money and credit that it knows what to do with. At the same time, the stuff to buy with that money and credit would have become more scarce, because of all of the missed farm-growing seasons, factory closures, and layoffs we’re hearing about today.

Deflation and hyperinflation are opposites, but it’s a very thin line.

Nicole Gelinas is a chartered financial analyst and a contributing editor of City Journal.


“Is deflation coming?” It’s already here!

The price to buy a share of the income stream of almost every public company that trades in the U.S. is already much less than it was a year ago. The same is true for real estate — it costs much less today than a year ago. We have had price deflation for computing power, and almost every other source of technology — including, significantly, communications technology — for the last 30 years. We have had price deflation for food for the last century — 100 years ago the average household spent more than 50 percent of its income on food.

Price deflation can be a sign of rising productivity, and is not per se bad. What is scary right now is the deflation of demand. This deflation is a reaction to a hyperinflation of demand in the Western world, fueled by debt from the non-Western world, over the last ten years. We reached a tipping point where the holders and borrowers of that debt became alarmed that such debt would be unsustainable, and, just like the guy whose doctor tells him if he doesn’t lose 100 pounds, he is going to die of a heart attack, decides he needs to diet. He can go on a crash diet that is very painful and difficult (severe economic slowdown/depression); he can gradually diet, but that means being miserable for several years, and probably falling off the diet; or he can crash diet, get tired of that, and reset his scales (temporary deflation, followed by inflation). We are going to do the latter, because we already feel like we are starving.

– Frank Hanna is author of What Your Money Means (and How to Use It Well).


Fourth-quarter GDP is now looking like it will post a decline of more than four percentage points. There is a good chance it will be much worse than that, and show the biggest drop in GDP in decades. With demand that weak, prices will drop. Deflation in the near term is a done deal. A spike in inflation is only a big deal for long-run growth if it is followed by an upward adjustment to long-run inflationary expectations. That can lead to a wage-price spiral, and cause drastic Fed action. A similar force is present for deflation. The key is that consumers and firms not begin to expect ongoing deflation, in which case, there can be a devastating downward spiral, as consumers hold off buying things in anticipation of lower prices in the future. The Fed should be able to print enough money to keep this from happening, but the risks are uncomfortably high. 

Kevin A. Hassett is director of economic-policy studies at the American Enterprise Institute.


There is no prospect for a general deflation of consumer prices for more than a few months. Bank reserves have increased by several hundred billion dollars since August, and current actions by the Fed will probably lead to a rapid continued increase in bank reserves for some additional months. There is more reason to expect a large increase in inflation within two years unless the Fed is willing to increase interest rates sharply once the recovery is underway.     

– William Niskanen is chairman emeritus of the Cato Institute.


The important goal in addressing monetary policy or the bailout spendfest is “how do we avoid getting into this mess again.” Even if one could bail fast enough, it won’t do any good if we leave the hole in the bottom of the boat. Or leave the person in the lower decks who keeps poking those holes in the ship’s bottom.

The goal of monetary policy should be to keep the value of the dollar steady so it is a solid, dependable, and non-politicized store of value that the real economy can count on. In the past, folks have used a gold standard. Others suggest a basket of goods including but not limited to gold. Milton Friedman calls for a stable price rule. Any of the above has the advantage that it does not require us to believe that any one bureaucrat or bureaucracy can make foxlike decisions over many years without screwing up. All of official Washington fell in love with the idea that Daddy Greenspan was in charge and we didn’t have to limit his authority and all would be well.

Let us move away from the rule of man and back to a fixed-price rule that is transparent, stable, and nonpoliticized.

It is not necessary to toss Mr. Greenspan from the Tarpeian rock. Just don’t let him or any would-be pretender near such power again. Oh, and in that fun movie, My Big, Fat Greek Wedding, the father cures everything with Windex. I sorta feel the same way about cutting or abolishing the capital-gains tax. It might cure the deflation. Let’s try it.

– Grover G. Norquist is president of Americans for Tax Reform and author of Leave Us Alone — Getting the Government’s Hands Off Our Money, Our Guns, Our Lives.


Although it may be counterintuitive to say, deflation may be nature’s way of attempting to rectify the problems attendant to economic recession. Falling prices mean that the economically disadvantaged can afford food, a car to replace the one falling apart, clothing, and gasoline to get to work or to visit families. Falling house prices mean that, perhaps for the first time, the poor can actually afford a nice home. Every penny not spent on these items means more for saving and for buying medical insurance and perhaps paying for a child’s college education.

How striking, then, that there is such widespread panic about falling prices in a country that purports to care for the less well-off. Whatever the cause (and this is mostly due to economic slowdown coupled with an understandable reticence to borrow), there can be no doubt who benefits from falling prices. In some ways, deflation is sustenance for the poor, who suffer more than anyone during recessionary times.

This was also true in the Great Depression. Those were terrible times, with high unemployment and hopelessness all around. But the saving grace for the poor was the lower prices. If we want to add more suffering to bad times, the surest way is to attempt to reverse this. It doesn’t work any more than catching things as they fall reverses gravity. Beware those who call for price controls to ease deflation; it can only do harm to the least among us.

Rev. Robert A. Sirico is president and co-founder of the Acton Institute.


The United States economy has entered uncharted waters. We have moved from an overleveraged position of reckless financial risk-taking to a situation that may be even worse: no financial risk-taking. With the bursting of the financial bubble, we are witnessing the downward reappraisal of the value of virtually every asset in the world.

Not many months ago, central banks were fixated on rising inflationary expectations. Not anymore. Though the U.S. economy may skirt a scenario of outright deflation, a significant round of disinflationary pressure is underway. Notice that this situation has produced the conditions for the “incredible shrinking central bank.” Since the outbreak of the financial crisis, the Federal Reserve has slashed short-term interest rates from 5.25 percent to 1 percent, and will likely reduce rates further. Disinflationary pressures nonetheless continue. The Fed has flooded the economy with liquidity, yet plummeting domestic demand and the slowdown in the velocity of money has rendered monetary policy ineffective.

In the process, the Fed has taken on unprecedented amounts of debt onto its balance sheet, having participated in various bailout exercises. Meanwhile, Congress and the Obama administration look to increase the federal budget deficit dramatically. At some point several years from now, the U.S. economy will likely be in full recovery. Long-term rates will by then have moved sharply higher (creating a steeply sloped yield curve). That is because bond traders will assume the Fed will monetize its mountain of debt, creating higher inflation as the only “way out.” The U.S. economy could find itself in a slingshot scenario moving from a disinflationary scenario to an inflationary scenario in a surprisingly short fashion.

None of this is to deny that the current situation reflects the worst financial crisis since the 1930s and the weakest economy since 1982. The Federal Reserve in particular should be credited with coming up with its “kitchen sink” approach in responding to the crisis. But make no mistake, there are always unintended consequences to policy actions. Our central bankers in coming years will need to be extraordinarily vigilant.

– David M. Smick is chairman and CEO of the global financial-advisory firm Johnson Smick International, Inc., and founder and editor of The International Economy magazine. He is the author of the best seller The World Is Curved: Hidden Dangers to the Global Economy (2008, Penguin/Portfolio).

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