June 04, 2003

Hal Varian explain it all for you -- deflation, that is. Varian, I'm guessing, has never read Hayek or Garrison or Selgin:

Today we have some of the excess supply pressures of the 1890's along with the weak demand pressures of the 1930's, albeit in a far milder form.The big difference today is that the Fed is pursuing active monetary growth and has made it clear that it will be aggressive in dealing with any further economic deterioration. The excess supply we see today comes from two related forces: the investment binge of the late 1990's and the strong productivity growth in recent years. Because of these two factors, businesses have had little inclination to make new investments, leading to slack demand and downward pressure on prices. The Fed has responded appropriately by loosening monetary policy to stimulate aggregate demand. Consumers have responded to low interest rates by refinancing their mortgages and continuing to buy, keeping aggregate demand stronger than it would have been under a tighter monetary policy. Prices aren't increasing, but they aren't falling, either. The worry is that the loose monetary policy won't be effective indefinitely. If economic activity stays slow, and unemployment rises, consumers will become more cautious, making them more reluctant to spend. As John Maynard Keynes put it, "You can't push on a string," meaning you can give people more dollars, but you can't make them spend them. To pursue the medical analogy introduced earlier: the symptom is deflation (or, at least, soft prices), the diagnosis is weak aggregate investment demand, and the recommended treatment is money supply growth. But the critical question is, as always, will the patient recover?
Posted by Greg Ransom