I have an economics professor who basically worships at Ben Bernanke's feet. He seems to side with the deflationist in their thinking that the Fed needs to inject more paper into the economy. In fact he even states the Fed should have done more of it as if a couple trillion of new money wasn't enough. His reasoning is that in 2008-early 2009 money velocity and the money multiplier crashed so the Feds had to make up for this or the sky was goig to come crashing down.
Now he had previously said that the US government and its citizens have overspent and borrowed far too much than was sustainable. So I attempted to use this against him by saying that the decrease in velocity and the money multiplier was the beginning of people and businesses attempting to deleverage. I knew I was setting myself up, but I just had to say it. He told me that if money demand increases too much and spending falls then prices would fall leading to deflation obviously. This in turn makes outstanding debts that much more of a burden to pay off.
So how would you have responded to this?
Modus Tollens: Deflation, when driven by an excess demand for money, increases the real burden of debt. It is not a solution to anything. In my opinion, your professor is quite correct.
Deflation, when driven by an excess demand for money, increases the real burden of debt. It is not a solution to anything. In my opinion, your professor is quite correct.
Yeah, it's a real burden to make the necessary corrections for the errors of the previous inflation. Let's just continue to inflate.
Of course, since an excess demand for money is the evil of all evils according to you, then you must also provide the necessary liquidity to banks in order to avoid the dreadful monetary deflation that a fractional reserve banking crisis would result in, since that in turn would lead to further excess demand for money by individuals.
Edit: In other words, socialism should bailout the system during a crisis.
I would say yes. Modern economists fears of deflation are based on how FRB works. In the current crisis allowing the default of all these loans would immediately shrink the money supply dramaticly. Then you would have dramatic falls in prices and earnings. Making the burden of that debt which did not default harder to carry. Those who previously would have no problem carrying their debt would now find themselves unable to. This would lead to more defaults and a further restriction of the money supply. Their fears are justified. This sort of sequence would be devestating.
However, the defaults have to occur, but our policy makers have chosen to have it done over the next decade or so, as opposed to the next few years.
Southern:Their fears are justified.
They fear liquidation over inflation because they don't understand ABCT. So "justified" is a bit inaccurate given the alternative.
Sure, if I just know half the story and engage in false choice fallacies and other false dilemmas, I too oppose any attempt for the economy to correct itself.
Southern:Their fears are justified. They fear liquidation over inflation because they don't understand ABCT. So "justified" is a bit inaccurate given the alternative. Sure, if I just know half the story and engage in false choice fallacies and other false dilemmas, I too oppose any attempt for the economy to correct itself.
I think they are more fearful of deflation than inflation because of how each relates to debt and then how that debt relates to money supply. They see deflation as self reinforcing.
Default on debt contracts the money supply.... when the money supply contracts and prices and wages fall debt becomes more burdensome... leading to more defaults... which lead to futher contraction of the money supply.... which leads to more deflation etc. etc.
In the process of this accelerating deflation many other people and companies will be taken down, not because they have malinvested but because of a devestating monetary shock to the economy. That is why I say their fears are justified.
i dont think Austrians and mainstream economists disagree on this. This is simply the mechanics of what happens given our current monetary system. What is disagreed apon is what initiates the cycle. Thats where the ABCT comes in. The understanding of why these things happen.
On a side note I think that inflation may have the same reinforcing mechanism, but I havent heard it discussed much.
Modus Tollens:Deflation, when driven by an excess demand for money, increases the real burden of debt. It is not a solution to anything. In my opinion, your professor is quite correct.
See also DD5's and Southern's replies, above.
This is a near century old debate between the ideas of interventionists and the economists*. The interventionist* justifies the initial monetary expansion by the central bank (2001 - 2004), then justifies the even greater expansion needed to counter the inevitable bust (2007 to ????).** The debate will not be settled here.
*I use the term "interventionist" to describe the orthodox schools of economic thought, like the professor described in the OP.
**The tightening of 2004-2006 exposed the malinvestment.
"The market is a process." - Ludwig von Mises, as related by Israel Kirzner. "Capital formation is a beautiful thing" - Chloe732.
Excessive demand is excessive.
scineram:Excessive demand is excessive.
A classic reply from scineram.