Worth Reading

Gavyn Davies attempts a rather hard task: explaining conventional economics to Guardian readers. And explains it very well actually.

Deflation is defined as a pervasive decline in the general price level, not just a decline in the relative prices of a few goods (which is an inevitable feature of a healthy competitive economy). When such a decline starts, three very dangerous things can happen. First, real (inflation-adjusted) interest rates rise, and the central bank becomes powerless to prevent this, because it cannot reduce the level of nominal interest rates below zero. As the rate of deflation gets larger, the real rate of interest actually increases, and this perversely tightens the stance of monetary policy.

It\’s all rather pearls before swine given the Guardian\’s readership but why not raise the average IQ of the piece\’s readership by giving it a go?

8 comments on “Worth Reading

  1. It’s largely hogwash, actually. A lot of stuff (food and electronics, for example) has been getting steadily cheaper for years, and people still buy it. If you know that food and beer are going to be a few per cent cheaper in a year’s time, do you then go without for a year? I doubt it.

    Clearly, falling house prices DO encourage people to defer buying, and rightly so – all the governments and their propagandists are trying to do is reflate the housing/credit bubble, heck knows why. And anybody who cites Bernanke as authority is a twat.

    And even if manufactured and grown stuff gets cheaper, as long as productivity rises by an equal and opposite amount, nobody need be worse off.

  2. Do you endorse the thrust of his argument (i.e. that the Bank of England ought to ‘print money’?)

    Tim adds: I endorse what he actually says….which is that we don’t need to print money yet but as and if we do then that’s what we should do.

  3. And even if manufactured and grown stuff gets cheaper, as long as productivity rises by an equal and opposite amount, nobody need be worse off.

    But why would productivity rise?

  4. Patrick Vessey of LPUK is much stronger in this area than I am. Here’s his view (which I am inclined to accord with):

    “In fact, any competent economist should be welcoming deflation with open arms, as should any financially responsible householder.”

    If he’s wrong, why?

    Tim adds: He’s wrong because of “stickiness”. One of the foibles of human beings is that we hate to see our incomes go down in nominal terms. But we’re (less so) not worried about them going down in actual terms so much. So take two situations. Inflation of 4% and incomes rise at 2% a year. Deflation of 2% and wages fall by 4%. Both have the same effect on actual real incomes. But the former we’d grumble about, the latter would have us rioting in the streets. Because we just hate seeing our incomes fall in nominal terms.

    In fact, we could have deflation of 4% and falling wages of 2% (ie, rising real incomes) and we’d still get rioting. Simply because humans are funny folk. Inflation acts (a low rate of inflation that is, 2 % or so) as a sort of grease, an oil, that means that relative wages can indeed change as the econopmy does, but without anyone actually seeing nominal wages fall.

  5. Tim, the stickiness argument is much more complex. Keynes made out the situation to be asymmetric as you describe. He may have being right. But he looked at only one part of the economy. As Hayek and Von Mises pointed out there are effects on other parts too.

    It is not possible to artificially manipulate prices in two markets – those for wages and consumer goods – without doing so in every other market too.

    Read a book on Austrian Economics.

    On Econlog the view of those like Gavyn Davis has being demolished today:
    http://econlog.econlib.org/archives/2008/11/hamilton_scoffs.html

  6. I’ve decided to rename one of our cats “Goldman Socks”. He too seizes every opportunity to advance his own interests.

  7. To improve a bit on what Current has tried to get across, the gist of the “takeaway” from Mises:
    “nobody aquiesces in an index number if he does not expect a personal advantage from its acknowledgment by public opinion.” And, since there cannot exist an interest “in favor” of any
    policy whatever without a more or less equal interest in the opposite direction (whether politically well-represented or not), Mises’ words immediately following the above quote are even more important: “The establishment of index numbers does not settle disputes; it merely shifts them into a field in which the clash of antagonistic opinions and interests is irreconcilable.”

    The complex of strategies and tactics by means of which the political alliance of some attempt to victimize their political opponents by means of economic and tax policies (within that nation) cannot be enforced beyond national borders; the uneconomic measures pursued at home are manifested in changes in the naturally-produced trade relations between nations, which changes will occur in fashion tending to the detriment of those primarily employing “economic policy” domestically, requiring “trade negotiations” between nations for their maintenance and, ultimately armed conflict.

    If the just-past American election and the present financial crises have any message, it is that the wars, destruction, and deaths of the 20th century have had no educational impact whatever. It isn’t “history” that repeats itself
    but inappropriate action of those who refuse
    to learn that “crime doesn’t pay.”

    “Bailouts” will be “paid for,” it should be recognized, with blood as well as money.

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