Deflation: no big deal
But why, one wonders, has [Ted Allrich, who has hysterically warned of the baleful effects of deflation] not taken to heart what I wrote thirty-seven years ago in my first book, The Transformation of the American Economy, 1865–1914 (New York: Wiley, 1971), on p. 21: “Notably, rapid economic growth occurred both before and after 1897; neither a falling nor a rising general price level was uniquely associated with economic growth.” To elaborate just a bit, the rate of economic growth from 1866 to 1897, a period of secular deflation, was perhaps the greatest ever experienced by the US economy during a period of comparable length. Real GDP grew by more than 4 percent per year, on average, notwithstanding the persistent deflation.
So, even if you’ve not mastered the works of Ludwig von Mises and Murray Rothbard, even if you are a confirmed positivist in your methodological bent (as I was in 1971), you can see clearly that the rate of economic growth and the rate of price-level change have been independent, at least within the ranges of these variables in US economic history. (Hyperinflation or hyperdeflation would be another matter: either would be devastating by making economic calculation and long-term contracting virtually impossible.)
Any decent economics teacher makes sure that before the students have gone more than a week or two, they have mastered the difference between absolute (nominal) and relative (real) prices. All of economic analysis hinges on this understanding. Yet practicing politicians, investment gurus, news media hyperventilators, and others who play important roles in influencing public opinion are completely lacking in this basic understanding. The upshot is a destructive bias in favor of secular inflation, with the risk of periodic bouts of rapid inflation.
Which brings us to the second question: for better or worse, does deflation actually loom at present? If it does, its occurrence will surprise me greatly, because the Fed has been creating base money as if there were no tomorrow, and if the bailouts continue, as seems likely, more of the same is virtually certain.
