This archived content originally appeared at Freebanking.org, the predecessor site to Alt-M.org, and does not carry the sponsorship of the Cato Institute.

Is Deflation Salvation?

That's the title that the Adam Smith Institute assigned to the talk I gave there a couple weeks ago. Not having realized that the talk was being taped, I was pleasantly surprised to discover it on YouTube today. It offers, I think, a pretty accessible half-hour overview (not counting question and answer) of my arguments concerning "good" deflation. I noted one gaffe, where I say that Keynes's theory assumes that prices are generally "below" equilibrium. Of course I ought to have said "above," or (alternatively) that equilibrium prices are generally below actual ones.

Do please pass the video on to anyone you know who believes that central banks should never allow prices generally to fall. Of course, we can't expect central bankers themselves to change their stripes. But we can and should try to encourage the public to question their arguments to the effect that having the general level of prices double every generation or so is a sine qua none of responsible monetary policy.

Addendum. O.K., I admit to having replied flippantly to the question concerning whether productivity-driven deflation would not cause a problem by encouraging everyone to put off buying things because they are likely to cost less in the future. But can you really blame me? I mean, consider: when the expected productivity growth rate goes up, so, ceteris paribus, must real interest rates and, hence, the return on saving. It follows that, in fact, people will be more inclined to put off consumption until later, that is, that they will be inclined to save more, but only to a limited extent. But what's wrong with that? Answer: nothing. Moreover, the extra saving will be inspired whether prices are allowed to decline or not, because it is a reaction, not to deflation per se, but to the increased return on capital, which is bound to manifest itself in higher equilibrium real interest rates no matter what the general price level does. If the price level is kept stable, both real and nominal rates will increase in response to improved productivity. If it is allowed to fall in accord with a productivity norm, nominal rates stay unchanged, but the deflation itself raises realized real returns. The only difference made by the productivity norm is that under it money balances also earn a return, making the overall inducement to save somewhat greater than it would be otherwise. And there's nothing wrong with that, either.