Today is my final for macroeconomics and hopefully my students will demonstrate some level of economic understanding. However, I fear that perhaps the culture of economic ignorance which pervades our public understanding might make all my efforts for naught. Unfortunately as they leave my class they will be surrounded for the rest of their lives (at least I fear) media that continually puts out economic foolishness.
Perhaps the greatest bogeyman of all modern economics is that deflation is bad; an evil that if even a minor virus is caught can turn into a life-threatening disease. This goes hand in hand with the Keynesian idea that a little inflation is always a good thing to “grease the skids” of the economy. Let me say it here very clearly: gentle deflations that are generally consistent with productivity growth are always a GOOD thing. However, large price deflations associated with a collapse in money supply are always a BAD thing. So we have good and bad deflation. Yet the mainstream media continually trumpets deflation as always a bad thing, such as today’s concern over low oil prices. For most of us, lower oil prices are a very GOOD thing. They are in large part due to increased supply (certainly here in the U.S.), a productivity led contributor to a lower price level. They are also a reflection that the speculation that the middle east was going to be a tinderbox have not materialized to the degree feared. They are also a reflection (but not the cause) of a drop in aggregate demand because the monetary stimulus exported by the Fed to China is having diminishing returns, putting pressure on worldwide commodity prices.
Make no mistake, fears over deflation are unfounded, and deflation is a good thing generally. The ultimate risk is the incessant devaluation of our currency, which has lost 96% of its value since we created a Federal Reserve to stabilize its value. And paradoxically, the inflationary process usually ends in a bust, which can lead to the very deflation that is so feared.
I don’t know what the end result of the sharp drop in oil prices will be, and it may not be all positive. But inflation and deflation are monetary phenomenon, not driven by goods. We don’t need to fear that a sharp drop in oil will lead to deflation. It can’t. It can only lead to a one-shot drop in the price level, unless our Fed blows it again as they did during the Great Depression. I for one cheer a lower price level. So go out for a Sunday drive and smile. Enjoy your Christmas. Don’t let the nattering nabobs of negativism spoil your cheer. And don’t fear the deflation bogeyman!