There is a current incessant flow of articles warning us of the certain economic calamity if deflation is allowed to show its nose for even the briefest period of time. This ogre of deflation, we are told, must be defeated with the printing presses at all costs. Of course, the real objective of this fear mongering is to enable continued government theft through debasement. Every dollar printed is a government tax on cash balances.
There are two main sources of deflation. The first comes from a general increase in the amount of goods and services available. In this type of deflation, a reduction in costs, in a competitive environment, leads to lower prices. The high technology sector has thrived in this type of deflation for decades as technical progress (e.g., the effect of Moore’s Law) has powered innovations and computing power at ever-decreasing costs. The same was true for most industries during much of the nineteenth century, as the living standard increased considerably. Every man benefited from the increase in real wages resulting from lower prices.
The second source of deflation is from a reduction in the money supply that comes from an increase in the desire of the public or banking sectors to hold cash (i.e., hoarding).[1]Â An uncomplicated example will make this point clearer. Suppose we have 10 pencils and $10. Only at an equilibrium price of $1 will there be no excess output or excess money.
Suppose the production cost of a pencil is 80 cents. The rate of return is 25 percent. Now suppose people hoard $5 and stuff money in their mattress instead of saving it. The price of a pencil will be cut in half, falling from $1 to 50 cents, since we now have a money supply of $5 chasing 10 pencils. If input prices also fall to 40 cents per pencil then there is no problem since the rate of return is still 25 percent. In this example, a drop in output prices forced an adjustment in input prices.
The Keynesian fear is that input prices will not adjust fast enough to a drop in output prices so that the economy will fall into a deflation-depression spiral. The Keynesian-monetarist solution is to have the government print $5 to avoid this deflation.
