It's counterintuitive that falling prices can be bad. After all, nobody ever complained about stuff being cheaper. The problems, though, are twofold. First, if prices fall across the board, so too will wages -- but debts won't. Borrowers will have a harder time making their payments. More of them will default. And defaults will push down prices and wages even more. This so-called debt deflation is basically a doomsday machine for mass bankruptcy -- and it's exactly what happened in the 1930s. The other way of thinking about why deflation is so toxic is that it effectively increases interest rates just when we want to reduce them. What matters for borrowers is the real interest rate: that is, the interest rate minus inflation. But falling prices mean inflation is negative, so real interest rates go up. Again, bad for borrowers.
Quick article about the GOP's misunderstanding with respect to Friedman's economic policies. Perhaps he would have supported Bernanke's decision to buy up long-term Treasury securities.
What do you guys make of this comparison between the Fed and the Bank of Japan in the 1990s? Are we still in a 'do the opposite of what Bernanke says' world?
It'd be interesting to hear the Austrians on this forum chime in here.
Should be interesting to hear what people think of the OP's post and the Atlantic article.
Did you see the Atlantic's profile on Ben Bernanke yesterday? Ben Bernanke is a Republican. The GOP is super inconsistent lately trying to be both populist and laissez-faire at the same time
Yeah... super long, but super interesting. The Free Exchange blog at the Economist had an interesting (and much shorter) response: http://www.economist.com/blogs/freeexchange/2012/03/monetary-policy-1
It seems like way too many Republican politicians forget Bush appointed Bernanke...Not an Obama guy but the crisis predates January 2009
Don't have time to read the article at the moment, but couple points:
1) You can't build a real economy or have any period of sustainable growth with artificially low interest rates. Savings and investment are more important than consumption.
2) Anyone that thinks deflation is universally bad is severely ignorant. The good kind of deflation is derived from productivity increases that lead to cheaper products. Anyone who owns a $100 smartphone or a $2000 plasma tv is a beneficiary of deflation. There is this idea that we need inflation in order to scare people into buying stuff now as opposed to later which completely defies any reason. When a shop owner wants to boost sales does he suddenly announce he's marking everything up by 50%? It's common sense. Also, check out the industrial revolution.
3) Deflation in the form of what the OP mentioned would lead to an instantaneous wealth transfer from the banks to the public. Bad for banks, good for the public. We could do without zombie banks.
We all know his main recommendation coming out of his Great Depression analysis is that monetary policy was excessively tight. The Debt-Deflation theory makes sense, at least in an economy with very high levels of debt, which we had. Friedman would certainly have advocated a loose policy to combat the recession, and it's likely he would have advocated QE as well for our situation, judging by his comments on Japan's situation, as well as his critique of the 1930s Fed.
It's always puzzled me a bit why GOP and Republicans in general climb all over Bernanke for his actual monetary policy. If they want to argue that the Fed overstepped and monetized to buy massive amounts of worthless securities, and that now we have no exit strategy in the midst of a fragile recovery that could lead to inflation down the road, then fine. Reasonable people can argue that. But as far as interest rates and QE go, it is more or less in line with what Friedman would recommend. None of these GOP critics understand or have read the monetary theory of the Austrian school (fairly safe assumption), so what type of economic policy are they espousing exactly? Even Hayek showed support for nominal GDP targeting eventually. I also attended a debate recently with Steven Horwitz (St. Lawrence U), an Austrian. He said Bernanke's actions were in line with Friedman's recommendations and are, at least in part, a reason why things weren't worse.
Note: Banks would obviously lose in terms of default. However if debtors (consumers) could continue to make payments in a deflationary / falling wage environment, banks benefit.
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