Deflation Isn’t Always Bad

As we noted yesterday, the Federal Reserve Board’s attempt to avoid deflation has resulted in lowering income for those in the bottom 25% of the income scale. But we likely would have been better off if the Fed didn’t try to bring inflation up to 2%.

Would paying more for your flat-screen TV help the economy?

Inflation and deflation are often a reflection of the economy. When the economy is growing and thriving, inflation typically increases. When it is weak or in a recession, deflation may take place. But sometimes deflation is “the byproduct of a healthy, growing economy,” according to The Heritage Foundation.

When a lack of demand results in lower prices, it’s usually because consumers can no longer afford certain products.

When technological development results in lower prices for computers, flat-screen TVs, smart phones and even oil, it’s as if consumers have been given a raise, because their buying power increases, even if their wages don’t.

According to The Heritage Foundation, one study of nearly 20 countries documents “many more periods of deflation with reasonable growth than with depression, and many more periods of depression with inflation than with deflation.”

The Fed played an important role in taming inflation during the post-Carter years, but in recent years it has sought to jumpstart inflation to avoid deflation.

According to “Historical Costs of Deflation” a study by the Bank for International Settlements, “Deflation may actually boost output. Lower prices increase real incomes and wealth. And they may also make export goods more competitive.”

Meanwhile, the Fed has grown its portfolio from under a trillion dollars to nearly $4.5 trillion. No one quite figured out why doing so didn’t cause hyperinflation. The only explanation has been that economic growth was so flat, it kept inflation in check.

Now that the economy is healthier and appears to be growing at a faster rate, what will happen to inflation? What will happen as the Fed draws down its $4.5 trillion portfolio.

We quoted Mike Shedlock from Zero Hedge yesterday and will add his conclusion here about his expected result of Fed policy.

“The Fed’s policies are extremely counterproductive,” he wrote. “To produce 2% inflation in a price-deflationary world, the Fed helped inflate asset prices to the extremes seen in 2007, 2000, and 1929.

“Another Fed-induced asset-price bust is baked in the economic cake.”

If you enjoyed this post, please consider leaving a comment or subscribing to the RSS feed to have future articles delivered to your feed reader.