Today’s significant, yet trivial action by the BOJ has the media proclaiming an official truce in Japan’s war against deflation. However, waging a war against falling consumer prices is the policy equivalent of committing monetary hara-kiri. Far from being the menace they are portrayed to be, falling consumer prices, often incorrectly referred to as deflation, are in reality the natural and beneficial results of rising productivity inherent in a free market economy. They result in real increases in the value of wages and savings, and therefore lead to rising standards of living.
There is no doubt that Japan has suffered its share of economic problems, but falling consumer prices, in reality one of the lone bright spots in an otherwise cloudy picture, are certainly not among them. Japan’s economic problems result mainly from monetary and fiscal policies designed to slow the liquidation of the mal investments accumulated during the bubble years. The sooner these misguided polices are abandoned, the sooner Japan’s economy can properly rebalance.
If Japan’s economy faltered during an environment of falling consumer prices, imagine how much weaker its economy would have been had consumer prices risen instead. What about Japan’s unemployed? Would their lots have really improved if they were confronted with a rising cost of living as well? If Japanese consumers were reluctant to buy products even as falling prices made them more affordable, imagine what the effect would have been had rising prices instead made them more expensive. If Japanese companies found it hard to generate adequate profits with their costs declining, imagine how much more difficult the task would have been had their costs been rising instead.
Take a step back and think about the whole subject of falling consumer prices rationally. Suppose health care were to become more affordable, if the cost of educating our children became less expensive, if necessities such as food, energy, clothing, and shelter consumed a smaller fraction of our family budgets, if it became cheaper to travel, buy a car, appliances, or toys for our children: wouldn’t these be good things? Do central banks really need to save us from this peril?
As far as I can tell, there are basically four flawed arguments advanced for why falling consumer prices are bad:
1. Consumers will defer spending in anticipation of lower prices. This argument is ridiculous on its face. First of all, most purchases such as food or energy cannot be put off. After all, consumers cannot refrain from eating while waiting for lower food prices. Other purchases, such as those for televisions, VCR’s, DVD players, digital watches, personal computers, or cell phones can be postponed. However, since prices for all of these items have been falling for years on increasing sales, our real-world example of the way consumers respond to falling prices disproves this argument.
2. Businesses will have their profits squeezed because of falling prices for their goods. This argument ignores the basic fact that costs are themselves prices. If a business’ costs are falling in line with its prices, its profit margins are not affected. In fact, as falling prices lead to increased sales, the net effect on profitability in such circumstances it to enhance and not diminish it.
3. The United States had falling prices during the Great Depression, and Japan had falling prices during its recent contraction therefore falling prices must be bad. This is basically false logic, because a causal relationship is assumed between two unrelated elements. The argument goes as follows. The economy in Japan is bad. Japan has falling prices. Therefore falling prices must be bad for the economy. This is a false conclusion. During the Industrial revolution, which saw the most rapid economic expansion in American history, consumer prices fell consistently. In fact, for the 120-year period which spanned from 1790 to 1913, U.S. consumer prices fell. The brief exception was during the Civil War, when for the first time the United States government issued paper money (Greenbacks) to finance the war. This expansion of the money supply (inflation) resulted in rising consumer prices. When the war ended, the government discontinued the issuance of Greenbacks, and over the years they were gradually withdrawn from circulation. Prices resumed their downward trend, which remained intact until 1913, with the introduction of the Federal Reserve. It was the continuous expansionary monetary policy (inflation) of the Federal Reserve that reversed the downward trend in consumer prices which had prevailed since the birth of the republic.
4. Falling prices hurt debtors by increasing the real burden of their debts. This is the one argument that has some merit. Falling prices benefit creditors while rising prices benefit debtors. Since most governments are debtors, as is certainly the case in Japan, it is no wonder that inflation is the path down which central banks chose to travel. However, since savings make possible the capital formation vital for true economic growth, a monetary policy designed to discourage savings cannot possibly by considered beneficial for an economy.
In summation, falling consumer prices are the economic equivalent of manna from heaven. By continually debasing their currencies, central bankers routinely rob their citizens of this bounty. The fact that they do so under the pretense of sparing them from suffering the ravages of a falling cost of living does not alter this reality.