Noam Scheiber takes Greenspan to school:
And yet, just because the prices of many goods are falling--and may continue to do so for the foreseeable future--doesn't mean the country is anywhere close to the kind of economic catastrophe that keeps central bankers up at night. Such fears confuse the cause and effect of a deflationary crisis. As James Grant, editor of Grant's Interest Rate Observer, points out, economics giants such as Ludwig von Mises and John Maynard Keynes understood deflation as a condition brought about by a scarcity of money and credit in the financial system. If, for example, there was too little money relative to the amount people needed to transact their day-to-day business, then people might start rationing and even hoarding it, which would cripple economic activity. True, prices would fall under these circumstances, since fewer dollars makes each one worth more. But those falling prices would only be a symptom of the real problem, which was a collapse in the money supply.
As it happens, we can be pretty confident that today's downward pressure on prices isn't the result of too little money. For one thing, while average prices are indeed increasing at a slower and slower rate, individual prices are all over the map. Prices for many services, such as cable television and child care, are increasing by 5 percent per year. Meanwhile, prices for many manufactured goods, such as stereos and televisions, are falling by 5 to 10 percent per year. On average, these price hikes and price declines are roughly canceling each other out, hence the drift toward zero inflation. Second, the Fed has been aggressively lowering interest rates for almost two and a half years now, which it does by expanding the money supply. According to one broad measure, the money supply has been increasing by about 7 percent annually throughout the last few years.
There are two key reasons the prices of certain goods are falling, neither of which has to do with the money supply. First, all the equipment and information technology that companies invested in during the last 20 years--particularly during the late '90s--has dramatically increased productivity, enabling companies to produce the same amount of goods more cheaply than ever before. Second, that investment has led to excess capacity, meaning companies are able to produce more goods than the market can absorb. According to The Wall Street Journal, for example, the global-production capacity for automobiles stands at about 80 million per year, while global demand is about 60 million. Companies that overproduce tend to cut prices to move all their extra goods.
he Fed's confusion of cause (a contraction of money and credit) and effect (falling prices) arises from a misreading of the two historical episodes upon which today's conventional wisdom about deflation is based ...
Well, you'll have to read the rest here.
Posted by Greg Ransom
