Thursday, November 20, 2008

Deflation?

The bad news is that the headaches and fatigue you’ve been experiencing aren’t just stress. According to our tests, you have a serious illness, and if it’s not treated soon, you could be dead within a year or two.

The good news is that the treatment is 100% covered by your health insurance, and with a good, aggressive treatment plan, you should be virtually symptom-free within a few months.

Some patients do experience side effects, but those are generally quite mild except at extremely high doses. In rare cases, where patients had doses far above the therapeutic range, some of the side effects have persisted after the treatment was finished, but those side effects can also be treated, so that’s not something you should be worrying about.

I have to warn you, doctors have had a tendency to be too conservative in treating this illness, and some patients have remained very sick for years – not because they couldn’t be cured but because doctors were uncertain about the right dosage. Given the balance of risks, it’s always better to prescribe too much than too little, and the therapeutic range is actually fairly wide, so with appropriate treatment, you should never have to experience the more painful symptoms that people in advanced stages of the disease go through.

There isn’t really much good news or bad news right now with respect to the possibility of deflation. Yes, there was a record drop in consumer prices in October, but that was mostly due to rapidly falling energy prices, which are unlikely to fall much further (although they have continued to fall in November, so we should expect one more large drop in the CPI next month). The core CPI also fell, but by only one tenth of a percentage point, which should not be alarming. (The last time the core CPI fell was in 1982, but such drops were not uncommon during the early 1960s – a time of some economic weakness but hardly a depression.) So the tests are inconclusive at worst, but it would be reasonable to begin some prophylactic treatment.

If there does turn out to be deflation, will that necessarily be a bad thing? It will be quite bad if it’s allowed to persist for years, but if it’s handled appropriately, it has a good side too. Basically deflation means that the Fed can create huge amounts of money without having much of any ill effect. (What would you be worried about? Inflation?) Those huge amounts of money can be used to finance huge federal deficits for a while without having to borrow additional funds from the public. So even a shockingly large fiscal stimulus could be more or less free – paid for by seignorage in an economy where people are only too eager to accept intrinsically worthless fiat money as payment for real goods and services. (That’s essentially the definition of deflation. Money has no intrinsic value, but in a deflation, producers offer greater and greater quantities of goods and services in exchange for a given amount of money.)

So if the headaches and fatigue that the US economy is beginning to experience turn out to be symptoms of the serious illness known as deflation, the treatment will be 100% covered. And with a good, aggressive treatment plan, we should be virtually symptom free within a few months. Not that that’s likely to happen, but I’m more afraid of the timid doctors in the US Congress than I am of deflation per se.

12 Comments:

Anonymous Anonymous said...

Why couldn't Japan get out of it? You make it sound like getting out of deflation is pretty straightforward, but I thought one of the reasons it's so feared is because it's hard to recover from.

Fri Nov 21, 02:44:00 AM EST  
Blogger knzn said...

Japan was a patient that "remained very sick for years...because doctors were uncertain about the right dosage" (and perhaps because of an overly cautious temperament). The Japanese should have been much more aggressive about fiscal policy, even though the deficits they did have were huge by traditional standards. People don't seem to get it that seignorage is free: the even larger deficits don't cost anything.

Fri Nov 21, 09:47:00 AM EST  
Anonymous Anonymous said...

knzn, perhaps splitting hairs about "deflation versus disinflation" would be useful here. The YOY change in US prices (measured by CPI and PPI) is still fairly positive.

Sun Nov 23, 04:12:00 AM EST  
Anonymous Anonymous said...

Timid doctors, maybe. It does look like Obama is promoting an aggressive stimulus package though...

Sun Nov 23, 06:49:00 PM EST  
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