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I've got a few problems with Mayer's response. The gist of my problem is that he speaks in general terms without taking into account the choices made by investors and the public at large:

Assuming the supply and demand for dollars is unchanged, an increase in the quantity of goods produced will result in falling prices.... Growth deflation, then, is by no means harmful.

It's not harmful to consumers. But isn't it harmful to investors in companies that provide such goods? Maybe yes, maybe no - depends on whether the increased quantity of goods can overcome potentially lower margins.

The other thing is that as consumers adapt their expectations, they gradually come to expect a level of deflation and build it into their behavior. I know many people who delay computer purchases as long as possible because they know that if they wait an extra month, they will either get a better model at the same price or the same model at a lower price.

If one remembers that the ultimate basis for economic action is to satisfy human wants and needs, it is hard to imagine why cash-building deflation (called “hoarding” by its critics) is thought to be malign. From the perspective of the consumer doing the cash-holding, it is obviously not a bad thing.

From the perspective of the borrower who is betting against the cash-holder, cash-building deflation is a terrible thing. And given that we do not have a nation of savers but rather a nation of borrowers (and indeed, the nation as a sovereign is a huge borrower), it's a bit too comfortable to say that deflation won't hurt the vast majority of people.

Despite the beneficial effect of bank runs and credit deflation in helping to check credit inflation, it is hard to imagine any widespread bank failures given the hyper-interventionist government we live with today and the ease with which money can be created.

Given that we have been in a long era of credit inflation - even the S&L problems ended up being paid off rather than endured in this way - it's hard to predict what a massive credit deflation would do. My guess is that the elimination of the money multiplier would effectively remove large numbers of marginal borrowers from the capital pool, which would in turn cause the shutdown of marginal businesses and the repossession of assets on marginal personal loans. It's hard to argue that this would be benign in the usual sense - while it might be purgative, those of us who'd have to live in purgatory for a while probably wouldn't be pleased with it.

Salerno concludes that “an existing or imminent deflation in the U.S. is chimera conjured up by those unfamiliar with sound, Austrian monetary theory.”

Perhaps in a laissez faire society, we would conclude that deflation is a good way to purge the last of the excesses of the past. In the society we actually live in, however, people and their elected politicians will not act like sound Austrian monetary theorists. Mistakes will be made - at a time when we can least afford them. Therein lies the real danger.

dan
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