Fed Friday: Krugman’s Ideas on Deflation & Why He’s Really not a KnuckleheadFebruary 25th, 2011
Preeminent neo-Keynesian scholar Paul Krugman has interesting thoughts in his new op-ed regarding whether or not rising commodity prices in Japan would end their disruptive deflation.
Why does deflation have a depressing effect on the economy? Two reasons. First, it reduces money incomes while debt stays the same, so it worsens balance sheet problems, reducing spending. Second, expectations of future deflation mean that any borrowing now will have to be repaid out of smaller wages (if the borrower is a household) or smaller profits (if the borrower is a firm.) So expected future deflation also reduces spending.
The Austrian approach most of us at Silver Underground are familiar with is that deflation is actually a good thing. It means people can buy more with less money and it rewards net savers for their prudence.
Krugman is ostensibly right that deflation in the manner he describes may have the effects mentioned. It is for this reason that the Chicago School of economic thought as led by Milton Friedman advocated steadily inflating the money supply about the same amount as the total growth of annual GDP. That way the policy doesn’t reward borrowers and punish savers or vice versa but instead is merely a reliable tool to make economic calculations with.
Far be it for me to argue economics with Paul Krugman. The man is extremely well-credentialed and has been published widely. Even if I don’t see eye to eye with him I don’t think he’s a knucklehead like many libertarians assert. Moreover, once we’re working inside of monopoly capitalism like we are now he very well may be right about how to manage its wackiness and the imperative of doing so. After all, the Keynesian foundational position is one which acknowledges the inherent instability of state capitalism as it needs the state’s anti-market power to substantially interfere in order to keep the system afloat.
The Austrian or libertarian position we hold though isn’t purely about the follies of central planning or maintaining state capitalism but also the injustice of doing so. We aren’t as concerned with how to keep state capitalism/corporatism afloat because its existence is an insult to a free people. We should be able to legally choose our own tender without threat of punishment for which currency we peacefully use. This true federation and competition between monies would go very far in protecting us from the volatility of the currency market, meddlesome bureaucrats and political whim.
I’ll leave it to an Austrian economist if they want to battle over the economics of deflation with Dr. Krugman. I wouldn’t take the challenge of arguing second order macroeconomics with a Nobel Prize Winner at this point in my life.
Right now, I’d rather strike the root!