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The New
York Times along with most of the other financial media reports that
Japan has finally achieved what many Federsal Reserve economists (see for
example 1,
2,
3)
, including Bernanke and (non-Fed economist) Paul Krugman have identified as
the key goal for Japanese economic health: positive inflation. Krugman, as
economist Benjamin Powell notes, has advised that Japan pass a law requiring
the central bank to inflate at a minimum rate of 4% for the next 15 years.
Similarly, the monetaris school have advised a policy of inflation.
The Fed economists have the
story wrong from start to finish. As Benajmain Powell writes in Explaining
Japan's Recession,
Japan’s problem, however, is not inadequate
aggregate demand but a structure of production that does not meet
consumers’ particular demands. Producing things that nobody wants and
propping up malinvestments cannot possibly help any economy. This policy is
equivalent to the old Keynesian depression nostrum of paying people to dig
holes and fill them. Neither policy will revive the economy because neither
forces businesses to realign their structures of production to match consumer
demands.
The problem with the mainstream
explanation of Japan is that it focuses on the monetary aggregates and
ignores the real structure of production. There is nothing about falling
prices that makes production more difficult or impossible. Entrepreneurs
attempt to identify opportunities for expliating differences between input
prices and output prices. The general price level is not particularly
important.
The rapid deflations resulting
from credit contraction are the effect, not the cause. The stage for these
contractions is set by a prior credit expansion, which resulted in a
misallocation in the pattern of investment within the economy. As Powell
notes, "The recession or depression that follows an artificial boom is
not something to avoid but is essential to the alignment of consumer time
preferences and the structure of production. According to Austrian theory,
the late 1980s boom was artificial, caused by the Bank of Japan’s
expansionary monetary policy."
The misplaced focus on the
deflation ignores the real cause of the problem, in the previous round of
inflation, and the unsustainable pattern of investment that resulted.
Advising a further policy of inflation only layers more mal-investments on
top of the existing ones and makes it more difficult for investors to
allocate capital in a manner consistent with consumer preferences.
Inflation is the problem,
deflation is the cure. The mainstream has demonized deflation as a
rationalization for the preferred inflationary policies, and to justify
activist central banking. Here, Hülsmann
refutes othe deflation myths. Many Austrians would agree with Hayek when
he wrote (cited by Salerno):
It is, however, rather doubtful whether, from a
long-term point of view, deflation is really more harmful than inflation.
Indeed, there is a sense in which inflation is infinitely more dangerous and
needs to be more carefully guarded against. Of the two errors, it is the one
much more likely to be committed. The reason for this is that moderate
inflation is generally pleasant while it proceeds, whereas deflation is
immediately and acutely painful. . . . The difference between inflation and
deflation is that, with the former, the pleasant surprise comes first and the
reaction later, while, with the latter, the first effect on business is
depressing. There is little need to take precautions against any practice the
bad effects of which will be immediately and strongly felt; but there is need
for precautions wherever action which is immediately pleasant or relieves
temporary difficulties involves much greater harm that will be felt only
later. . . . It is particularly dangerous because the harmful aftereffects of
even small doses of inflation can be staved off only by larger doses of
inflation. Once it has continued for some time, even the prevention of
further acceleration will create a situation in which it will be very
difficult to avoid a spontaneous deflation. . . . Because inflation is
psychologically and politically so much more difficult to prevent than
deflation and because it is, at the same time, technically so much more
easily prevented, the economist should always stress the dangers of
inflation.
Robert Blumen
Robert Blumen is an independent
software developer based in San Francisco, California
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