Wednesday, July 24, 2013

Response to Andy K on Deflation

I am currently in a debate/discussion on inflation vs deflation.  My initial post is here be sure to read the comments, and the link to his response to my comments can be found in the comment section.  Here is my response to his blog post:

I'd like to point out that Woods and Herbener directly claim that when economists are talking about deflation they are talking about price decreases.  Not cuts in the money supply.  Hence, I addressed this argument.  I'd like to further point out that Andy is doing the same thing.  He is pointing out the benefits of price decline due to increased productivity.  Of course this is good for the economy.  Milton Friedman's theory allows for this.  If we increase a targeted money supply each year by say 3%, and if we have a year of high growth, this will cause mild price declines due to increased productivity.  This is why I claim that Milton Friedman and other economists are not afraid of mild deflation or price declines.

Like I said before and explained in my previous post they disfavor cuts in the money supply.  One argument the Austrians utilize is to ALWAYS refer to the price decline due to added production in the late 19th century.  That is not what I am talking about when I am talking about investment.  I am talking about 2% decrease in the money supply each year.  Maybe I did not make that clear.

To claim that fiat money and stable dollars is an oxymoron is truly confusing.  I commend you for not being a believer in gold standards, but rather a fan of competing currencies.  I as well believe we should allow competing currencies.  And just to point out Milton Friedman was not in the favor of the federal reserve.  All of his theorizing is given that it exists.

But if we had these competing currencies, would people not swarm to the company that is providing stable money, as Hayek points out in his paper "A Free Market Monetary System"?  He even says the most desired dollar could possibly be fiat as long as it is stable.  If it is not stable people will leave the dollar.  Even Herbener points this out in the video.  If deflation is all you make it out to be why would people be dumping this deflated dollar?  It is because you did not address the consequences of cutting the money supply, but rather you address the benefits of falling prices due to increased productivity.

Friedman wrote the book on monetary history of the United States, so if you want to see how he speaks about the 20's through the depression I suggest that you read his work.  But in summation, what he says is that the crash of 1929 is a normal bust caused by the federal reserve.  You would agree with that.  What he goes on to say is that the severity of it is caused by a 33% decrease in the money supply over the next 3-4 years.  Is a third of the banks closing good for the economy? No.  So what Friedman argues is that we should have had less of a boom in the 20's by proper monetary policy which would have not caused as large as a bust in the 30's.

You wrote very eloquently on the benefits of price decline caused by increased productivity and are obviously very knowledgeable on the subject.  But the reason why mainstream economists don't adopt Austrian theory is because it is incomplete.  There HAS to be consequences to cuts in the money supply.  If deflationary policies were as much of the bees knees as Austrians point out, 1, people would adopt the Austrian Theory, and 2, we would constantly be using deflationary policies and the economy would be perfect all the time.


I'd like to add a few things here:

1) My example about the 100 million dollar investment seems to have validity due to the fact that Herbener's solution to this problem that deflation creates is to abandon the currency that is deflating.  We obviously cannot do that in America.  Hence, deflation will cause real problems.

2) During the twenties Andy pointed out the dollar was still stable.  This is not entirely true.  The main thing to take home is that the fed was newly enacted and for the most part clueless.  They thought they could just use quantitative easing and make everyone millionaires.  This is why the crash happened.  Milton Friedman was against quantitative easing.

3) Andy points out that economists are regularly arguing that any slow down in the money supply will be disastrous.  These are Keynesians who do believe that is true during an economic crisis that we have right now.  However, I still hold to my claim that even Keynesians are not afraid of mild deflation during normal economic times.  Deflation is built into their model in order to steer other economic factors.  Obviously I disagree with that, but I do not believe they think it will be a catastrophe if they advocate it at certian times.

4) Milton Friedman, points out in an interview that during the economic crisis of the 70s two of the things we needed to do is cut spending and start slowing down the money supply (along with other things)


  1. Thank you for the reply Jacob to my post. I'll respond in kind to this post and link back here. This is an important topic that deserves a great amount of attention.

    In short though, I'd recommend those interested in reading (at a minimum) Chapter 4 of America's Great Depression by Rothbard which can be accessed here for free -

    1. Here is my final reply on this thread.

      Obviously, this is an important topic that deserves a lot of attention. If anything, I think the Austrian have it right on money where other schools (including Chicagoan) get it wrong. I feel it is monumentally important to understand the economics of money, banking, inflation, and deflation especially given our current financial crisis and the implications of fiat-money, inflation, and the business cycle. Obviously, we disagree but I enjoy the discussion.


      Andy Katherman

  2. Also, my initial reply to his post can be accessed here to have the full context of our disagreement.