Dehomogenizing deflation

From Selgin, Lastrapes, and White:

The postwar eradication of deflation would count among the Fed’s achievements were deflation always a bad thing. But is it? Many economists appear to assume so. But a contrasting view, supported by a number of recent studies, holds that deflation may be either harmful or benign depending on its underlying cause. Harmful deflation—the sort that goes hand-in-hand with depression—results from a contraction in overall spending or aggregate demand for goods in a world of sticky prices. As people try to rebuild their money balances they spend less of their income on goods. Slack demand gives rise to unsold inventories, discouraging production as it depresses equilibrium prices. Benign deflation, by contrast, is driven by improvements in aggregate supply—that is, by general reductions in unit production costs—which allow more goods to be produced from any given quantity of factors and which are therefore much more likely to be quickly and fully reflected in corresponding adjustments to actual (and not just equilibrium) prices.

Historically, benign deflation has been the far more common type.

In other words, not all falls in the price level are bad. When prices fall because of improvements in productive technologies, for example, that’s good. That’s the point of growth. That is growth.

The lowdown on negative interest rates

Here’s my humble attempt to explain the logic of “negative interest rates” over at Enhancing Capital. I’ve found some good stuff written on this topic already, but nothing that I thought was accessible to the average person. Hopefully this report helps to fill that gap.

One highlight I’d like to point out is that negative interest rates on reserves at the central bank aren’t necessarily a “game changer.” They do reverse the logic of interest on reserves (commercial banks pay interest to the central bank instead of the central bank paying interest to commercial banks), but they don’t mean that banks are all of a sudden going to try to get rid of all their reserves. This hasn’t been the experience of banks in the Eurozone, where negative rates already exist on some deposits at the ECB. It won’t be the experience of banks in the U.S. if the Federal Reserve takes similar measures. Finance is all about trade-offs—paying a small fee to hold reserves at the central bank could still be a more attractive option to commercial banks than making more loans to keep their negative interest-bearing reserve balances from growing. What matters is whether commercial banks can identify enough credit-worthy borrowers whose risk of default is low enough to promise a higher return than the negative interest rate charged by the central bank. If not, then banks might very well be content to pay interest to the central bank rather than make more loans.

Finally, I realize this report might seem mistimed. If anything, talk on the town regards when the Fed is going to tighten monetary policy, not loosen it. My explanation is three-fold:

  1. I’m not convinced tightening is as imminent as many analysts are making it out to be, for reasons I’ve explained before.
  2. It’s important for investors to understand the logic of negative interest rates before they happen, not after (no harm in being over-prepared!).
  3. The ECB has already imposed negative interest rates, and the Bank of Japan has toyed with the idea. The policies at these banks, of course, have ramifications worldwide, and investors everywhere ought to understand what negative interest rates are.

Read the full report at

QOTD: Lew Rockwell

Lew Rockwell writing in last Friday’s Mises Daily:

We do not need “monetary policy” any more than we need a paintbrush policy, a baseball bat policy, or an automobile policy. We do not need a monopoly institution to create money for us. Money, like any good, is better produced on the market within the nexus of economic calculation. Money creation by government or its privileged central bank yields us business cycles, monetary debasement, and an increase in the power of government.