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Deflation and Economic Recovery

Posted by: Michael Mandel on December 16

I just did a story arguing that deflation might help economic recovery. Here’s a piece:

Is price deflation a sign of an accelerating economic downturn? History is not encouraging. Periods with falling prices—consider Japan in the 1990s and the Great Depression—have been unhappy times, economically.

But there’s another possibility: The fall in some consumer prices could be part of the “normal” adjustment to unprecedented economic circumstances. These price declines, combined with the coming “wall of money”—the enormous monetary and fiscal stimulus on the way in 2009—could actually accelerate an economic rebound

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Reader Comments


December 16, 2008 04:28 PM


During periods of deflation, when spending shrinks and savings (in anticipation of lower consumer prices) rise, households hoard cash and cash-equivalents such as short-term U.S. Treasury debt, bank deposits, and money-market instruments. Gold and silver are also a cash equivalents and some will choose to hold more of their savings in these metals, particularly during times of stress and economic uncertainty when gold just feels safer.

Moreover, deflations are also characterized by very low interest rates, both in nominal and real (inflation-adjusted) terms. Why? Because the demand for credit is very low (no one wants to borrow and, if they do want to borrow, the banks are loathe to lend), savings are high, and — importantly — the Fed and other central banks will push rates down to encourage economic recovery. So the opportunity cost of holding gold and silver (the interest forgone by holding these metals rather than an interest-bearing asset) is extremely low, further encouraging some investors to favor the metals (because of gold and silver’s other attractions and attributes) over alternatives.

I’ll have more to say about the prospects for deflation versus inflation — and the implications for gold and silver — on my blog

Joe Cushing

December 17, 2008 12:39 AM

You can't compare the deflation of today to the deflation of the depression because the depression era deflation contained fiscal deflation where our deflation only contains cyclical deflation. One could argue that cyclical deflation is healthy because it helps put assets to work for profit or for home use. Fiscal deflation is different because the business cycle can't reverse it.

John Konop

December 18, 2008 07:10 PM

Time to Bailout Main Street

To the surprise of very few who have been paying attention, the Wall Street bailout has had little positive effect on making credit available to businesses or individuals. The $350 trillion in TARP funds already made available, plus the almost $1 trillion in loans directly from the Federal Reserve, have only been used to replace capital already recognized as lost, or to buttress balance sheets in anticipation of the write-offs to come as the economy slides deeper into recession.

Also to the surprise of no one, every industry, trade group, union, state government, and municipality lobbyist has formed a long line in order to get “their share” of the bailout. The federal government will continue to write checks to every interest group possible before they do what they presumably already know needs to be done: make credit available directly to the American people and small businesses via temporary government backing of basic credit facilities.

We need to drive the economy via consumer behavior. The following plan lubricates the wheels of the economy by making available sensible, properly leveraged credit.

An old axiom of government is that for every action, there is an equal and opposite over-reaction. This is the current situation in our credit market. Failure to regulate leverage has lead to a current environment where lenders expect to be over-regulated. Only customers with spotless credit are able to make purchases. Yet, due to the economic downturn, many people with good jobs, down payments, and the ability going forward to repay loans will have blemished credit.

There are many who share blame that got us into this mess. But the solution is to reward good future behavior. The blame game can continue until the end of time, but we must lay a foundation to get us back to a market-based, productive economy once again.

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Michael Mandel, BW's award-winning chief economist, provides his unique perspective on the hot economic issues of the day. From globalization to the future of work to the ups and downs of the financial markets, Mandel-named 2006 economic journalist of the year by the World Leadership Forum-offers cutting edge analysis and commentary.

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