Is deflation bad? The answer is – it is good.

Paul Krugman, a Nobel-winning economist, should know that deflation can be a positive sign.

In a very terse blog post, Krugman wrote that it “Smells like deflation.”

Had he bothered to check it out, he would have known that it is deflation. Prices were lower than the year-earlier month by 0.28% in March, 0.74% in April and by 1.28% in May.

Big deal.

They are only numbers.

Yes, we had deflation in the Great Depression.

Yes, the Japanese had deflation in the 1990s.

But we also enjoyed deflation in the post-war era with prices falling from May 1949 to June 1950 and again from August 1954 to August 1955.

In the first case, price and wage controls were put in place to ward off post-war inflation that topped the double-digits.

The real issue is what is being deflated and why.

Falling prices reflect demand. If supply costs remain below the price, no problem.

Computer users learned this in the last 20 years. New computers (which were slower and had less memory) cost $2,000 in the 1990s. The one I just bought cost $300. Computer companies are fine with it because as the prices have dropped, productivity for computers and their component parts has increased and costs have gone down. As long as cost is below price, no problem.

Deflation today is caused by two things: The burst of the housing bubble and the precipitous drop in the price of oil.

The housing price drop slowed production of new homes because productivity is not improving fast enough to keep pace. The upside is construction is less expensive and this helps public works projects.

The downside is that property values are dropping and with them the property tax revenues, which largely go to support schools.

Housing prices likely will drop further as the supply of mortgages has fallen due to a variety of factors, mainly interventionist government. Stopping foreclosures is breaking the Rule of Law, which hurts any economy by introducing instability. This scares off investors.

The drop in the price of oil — and with it energy — helps all other producers by cutting their costs. They may or may not pass those savings on to consumers.

If I can figure this out, a Nobel-winning economist should.

Don Surber. Daily Mail. July 02, 2009.


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