Deflation is not to be feared

One of the most bizarre concerns that economist have is of falling prices, commonly referred to as deflation. We hear horror stories about how deflation is associated with economic collapse and we need to avoid inflation at all costs. Nothing could be farther from the truth.

Inflation is actually historically more commonly associated with depression than deflation. (Andrew Atkeson and Patrick J. Kehoe, "Deflation and Depression: Is There an Empirical Link," American Economic Review Papers and Proceedings 94 (May 2004): 99–103.) This purported link is mainly due to the observation of falling prices during the Great Depression. However, in general this is not the case as Atkeson and Kehoe show. Even if such a correlation existed, it would not prove any particular causal relationship.

A different argument against deflation is that if prices fall, people will put off their purchases. Certainly in the short run people will be willing to wait for prices to fall before they make a purchase for certain items, but in general it is an absurd argument. Simply look at the video game industry. Gamers willingly buy titles on the launch date, even pre-order titles, that in a year will be discounted 20-50%. Prices of computers have been falling and yet people continue to buy despite the fact they could pay less if they waited a year.

So the economic arguments against deflation are bogus. More importantly though is the moral argument against inflation, meaning the increase of the money supply that leads to higher prices. By increasing the supply of money, the value of money decreases and prices rise. This devaluation of the currency directly hurts the poor and savers. For this reason alone, regardless of other reasons, we should oppose any policy that is intended to increase inflation.