AAgh! Economic idiocy abounds! I’m getting despondent..

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!

8 thoughts on “AAgh! Economic idiocy abounds! I’m getting despondent..”

  1. I am continually amazed at how people will confuse that inflation is generally good and deflation is generally bad. Many people will continue to say that inflation is good, but many often do not have a reason. Being able to talk and discuss openly about these topics is crucial to finding the truth.

    1. Thing is about “Inflation”, is that if IT TOO is gradual and subdued, it can be a sign things are going well.
      Prices and profits and loan rates going up, because so many people are buying things. Mortgages. Things like that. So, to control use and keep the thing from going crazy, (During Carters years) the markets raise pricing in small increments. A sure sign of a budding economy. So, imo; not all “Inflation” is bad. Just as not all “DEflation”.
      Good blog post tho. I agree a lot. 😉

  2. Lower gas/oil prices coupled with a decrease in demand may cause massive layoffs in the gas/oil industry causing a ripple effect to suppliers, transporters etc. especially if rather than taking a Sunday drive we spend the savings on a Big Mack or worse yet an imported TV. Is that a possible outcome? The dollars spent else ware may not cause much job creation because everyone is just demanding more productivity or it could just create minimum wage part time jobs as that seems to be the trend.

    Your comments?

  3. Is that possible? Most anything is conceptually possible. The question is “is it likely?”. As I suggested in the post, I’m not particularly pleased to see the gigantic swing in price of a fundamental commodity, and there certainly could be some pain in the industry, and also some change in a positive sense to wherever the consumer dollars will ultimately flow. But the same $$ are still there. In your example, either there would be larger profits (which would result in shareholders or the firms having some extra money to be spent somewhere in the economy) or more part-time jobs, which will still result in add’l spending. So the total spending in the economy is likely to be rearranged, not destroyed. If the Fed simply ensures the money stock does not fall, there will be no harmful deflation. But that doesn’t mean there won’t be necessary readjustments to a maladjusted economy, and it could be painful for the affected industry. So there are really two different issues, which are often conflated. Deflation, as I outline in the post, is a separate issue, and is a root a monetary problem if the harmful deflation occurs. Lower general level of prices are not indicative necessarily of something bad–if the driver is productivity growth.

    However, we have relative price changes all the time in the economy, and this is distinct from deflation. In this case, the relative price of oil (compared to other goods) is falling. This can have temporary adjustment problems, but is not the same as deflation. So go enjoy your drive.

    For those investing in energy, the market is giving you a clear signal that the future profitability of your investment is lower; you should, at the margin, consider other ways to satisfy consumer needs.

    The post did not address or discuss the geopolitical implications of a lower oil price, and they are potentially huge, and certainly not all positive. But many are–such as defanging Mr. Putin a bit, as forcing the socialists in Venezuela to come to terms with reality more quickly.

    The broader commodity collapse is indicative of perhaps the end of coordinated flood of central bank liquidity, and I’m not at all sanguine about where this is going to go. That is a separate but related issue.

    But all the more reason to go out and enjoy a Sunday drive! If the weather was warmer, it would be an occasion for the convertible top to come down!

    1. Thanks I continue to learn from and enjoy your thoughts.
      I was wondering if you have the time to explain how lowering or raising the relative value of the dollar affects inflation or deflation and if said unemployed oil/gas workers mean there is less money in the economy.

      Thanks again.

      1. The value of the dollar is determined, just like any other commodity, by supply and demand. So if the Fed is raising or lowering the value of our currency, at any snapshot in time, they are decreasing or increasing (respectively) the supply of money. Of course in a growing economy, the Fed may be allowing the currency to expand at a rate greater than or less than the general rate of growth in the economy, and that will result in the value of the currency decreasing or increasing (respectively). As an example, Japan has been decreasing the value of its currency relative to the U.S. dollar in an effort to stimulate its economy, and to do this they have engaged in large increase in the stock of money.

        As for oil’s problems leading to less money in the economy, the answer is no–certainly not in a longer period of time. Remember that any reduction of $$ spent on oil frees those same $$ to be spent elsewhere. Those other businesses will expand production to meet the increased demand, and ultimately will hire additional workers to meet that demand.

        There are, of course, always transition issues to get us from the short run to the long run, and they may not be inconsequential (certainly not to the worker who might lose his or her job). Nevertheless, these relative price adjustments are a necessary part of a market economy, and they happen all the time. In the case of oil, however, people are a little more concerned because of the large drop in the price of oil. I think there is room for concern, but not directly due to the drop in the price of oil, but rather that the drop of a major commodity like oil may be reflective of a broader problem in the economy. The global economy may be starting to run out of central bank liquidity; sometimes coming of the central bank money “fix” can be painful, and the price of oil may simply be a signal of that.

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