The Price Is Right

IT’S official: We should all start worrying about deflation. That, at least, is the message most listeners took from Alan Greenspan’s January 3 speech before the American Economic Association. The Consumer Price Index rose only 1.7 per cent last year, and, if critics of its current method of calculation are correct, consumer price inflation was probably close to zero. Producers’ prices actually fell last year. By this reckoning, deflation really is staring us in the face. Steve Forbes, Robert Reich, the editors of the Wall Street Journal, and the chief economist at Merrill Lynch have all explained that, inflation having been vanquished, “deflationary pressures” are the new threat.

The Federal Reserve can prevent deflation. It need only expand its purchases of government securities, which it pays for with newly created Federal Reserve dollars that are subsequently deposited in commercial banks. In recent years, this expansionary monetary policy has more than compensated for the deflationary effects of productivity gains, replacing what might have been mild deflation with mild inflation. But the fact that the Fed can prevent deflation doesn’t mean it should. Right now, we should be welcoming a long-awaited opportunity to watch the cost of living decline—something it has not done since 1955. The idea that deflation must be avoided at all costs traces back to myths that arose in the 1930s, when the Fed did allow it to proceed too far.

About the Author

George Selgin

George Selgin is a senior fellow at the Cato Institute and the author of False Dawn: The New Deal and the Promise of Recovery, 1933–1947.

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IT’S official: We should all start worrying about deflation. That, at least, is the message most listeners took from Alan Greenspan’s January 3 speech before the American Economic Association. The Consumer Price Index rose only 1.7 per cent last year, and, if critics of its current method of calculation are correct, consumer price inflation was probably close to zero. Producers’ prices actually fell last year. By this reckoning, deflation really is staring us in the face. Steve Forbes, Robert Reich, the editors of the Wall Street Journal, and the chief economist at Merrill Lynch have all explained that, inflation having been vanquished, “deflationary pressures” are the new threat.

The Federal Reserve can prevent deflation. It need only expand its purchases of government securities, which it pays for with newly created Federal Reserve dollars that are subsequently deposited in commercial banks. In recent years, this expansionary monetary policy has more than compensated for the deflationary effects of productivity gains, replacing what might have been mild deflation with mild inflation. But the fact that the Fed can prevent deflation doesn’t mean it should. Right now, we should be welcoming a long-awaited opportunity to watch the cost of living decline—something it has not done since 1955. The idea that deflation must be avoided at all costs traces back to myths that arose in the 1930s, when the Fed did allow it to proceed too far.